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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 20, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------------------- ------------------
Commission file number 1-303
THE KROGER CO.
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(Exact name of registrant as specified in its charter)
Ohio 31-0345740
- ------------------------------------ ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1014 Vine Street, Cincinnati, OH 45202
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(Address of principal executive offices)
(Zip Code)
(513) 762-4000
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(Registrant's telephone number, including area code)
Unchanged
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(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No.
----- -----
There were 825,880,361 shares of Common Stock ($1 par value) outstanding as of
June 28, 2000.
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
THE KROGER CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS
(in millions, except per share amounts)
(unaudited)
1st Quarter Ended
--------------------------
May 20, May 22,
2000 1999
------------ -----------
Sales................................................................ $14,329 $13,493
------- ------
Merchandise costs, including advertising, warehousing, and
transportation....................................................... 10,502 9,962
Operating, general and administrative................................ 2,718 2,470
Rent................................................................. 220 199
Depreciation and amortization........................................ 307 281
Asset impairment charges............................................. 191 --
Merger related costs................................................. 9 35
------- -------
Operating profit................................................... 382 546
Interest expense..................................................... 206 199
------- -------
Earnings before income tax expense................................. 176 347
Income tax expense................................................... 70 140
------- -------
Net Earnings....................................................... $ 106 $ 207
======= =======
Earnings per basic common share:
Net earnings ................................................... $ 0.13 $ 0.25
======= =======
Average number of common shares used in basic calculation............ 831 827
Earnings per diluted common share:
Net earnings.................................................... 0.12 $ 0.24
======= =======
Average number of common shares used in diluted calculation.......... 850 863
- -------------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
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THE KROGER CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in millions, except per share amounts)
(unaudited)
May 20, January 29,
2000 2000
-------------------- --------------------
ASSETS
Current assets
Cash.................................................................. $ 163 $ 281
Receivables........................................................... 608 622
Inventories........................................................... 3,903 3,938
Prepaid and other current assets...................................... 435 690
---------- ---------
Total current assets.............................................. 5,109 5,531
Property, plant and equipment, net....................................... 8,360 8,275
Goodwill, net............................................................ 3,725 3,761
Other assets............................................................. 426 399
---------- ---------
Total Assets...................................................... $ 17,620 $ 17,966
========== =========
LIABILITIES
Current liabilities
Current portion of long-term debt..................................... $ 570 $ 536
Accounts payable...................................................... 3,047 2,867
Salaries and wages.................................................... 657 695
Other current liabilities............................................. 1,548 1,630
---------- ---------
Total current liabilities......................................... 5,822 5,728
Long-term debt........................................................... 7,619 8,045
Other long-term liabilities.............................................. 1,575 1,510
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Total Liabilities................................................. 15,016 15,283
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Commitments and contingent liabilities -- --
SHAREOWNERS' EQUITY
Preferred stock, $100 par, 5 shares authorized
and unissued.......................................................... -- --
Common stock, $1 par, 1,000 shares authorized: 888 shares issued
in 2000 and 885 shares issued in 1999................................. 888 885
Additional paid-in capital............................................... 2,044 2,023
Retained earnings........................................................ 338 232
Common stock in treasury, at cost, 61 shares in 2000 and
50 shares in 1999..................................................... (666) (457)
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Total Shareowners' Equity......................................... 2,604 2,683
---------- ---------
Total Liabilities and Shareowners' Equity......................... $ 17,620 $ 17,966
========== =========
- -------------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
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THE KROGER CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in millions)
(unaudited)
First Quarter Ended
-----------------------------------------
May 20, May 22,
2000 1999
------------------- -------------------
Cash Flows From Operating Activities:
Net earnings.................................................................. $ 106 $ 207
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Depreciation............................................................... 276 252
Goodwill amortization...................................................... 31 29
Non-cash items............................................................. 258 2
Deferred income taxes...................................................... 181 42
Other...................................................................... 18 8
Changes in operating assets and liabilities net of
effects from acquisitions of businesses:
Inventories............................................................ 29 (31)
Receivables............................................................ 16 51
Accounts payable....................................................... 161 25
Other.................................................................. (33) 9
---------- ---------
Net cash provided by operating activities.......................... 1,043 594
---------- ---------
Cash Flows From Investing Activities:
Capital expenditures.......................................................... (455) (442)
Proceeds from sale of assets.................................................. 40 15
Payments for acquisitions, net of cash acquired............................... (36) --
Other......................................................................... (46) (22)
---------- ----------
Net cash used by investing activities.............................. (497) (449)
---------- ----------
Cash Flows From Financing Activities:
Proceeds from issuance of long-term debt...................................... 524 84
Reductions in long-term debt.................................................. (995) (246)
Financing charges incurred.................................................... (7) (1)
Increase in book overdrafts................................................... 3 51
Proceeds from issuance of capital stock....................................... 20 22
Treasury stock purchases...................................................... (209) --
Other......................................................................... -- (4)
---------- ----------
Net cash used by financing activities.............................. (664) (94)
---------- ----------
Net (decrease) increase in cash and temporary cash investments.................... (118) 51
Cash and temporary investments:
Beginning of year.......................................................... 281 263
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End of quarter............................................................. $ 163 $ 314
========== =========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest..................................... $ 175 $ 165
Cash paid during the year for income taxes................................. $ 66 $ 62
Non-cash changes related to purchase acquisitions:
Fair value of assets acquired.......................................... $ 60 $ --
Goodwill recorded...................................................... $ 33 $ --
Value of stock issued.................................................. $ -- $ --
Liabilities assumed.................................................... $ 57 $ --
- -------------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All amounts are in millions except per share amounts.
1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the consolidated accounts
of The Kroger Co. and its subsidiaries ("Kroger"), including Fred
Meyer, Inc. and its subsidiaries ("Fred Meyer") which were merged with
Kroger on May 27, 1999 (see note 2). The year-end balance sheet
includes Kroger's January 29, 2000 balance sheet, which was derived
from audited financial statements, and, due to its summary nature, does
not include all disclosures required by generally accepted accounting
principles. 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 adjustments (consisting only of normal
recurring adjustments) which 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 generally accepted accounting principles have been
omitted pursuant to SEC regulations. Accordingly, the accompanying
consolidated financial statements should be read in conjunction with
the fiscal 1999 Form 10-K Annual Report of The Kroger Co. filed with
the SEC on April 27, 2000.
The unaudited information included in the consolidated financial
statements for the first quarters ended May 20, 2000 and May 22, 1999
includes the results of operations of the Company for the 16 week
periods then ended.
2. BUSINESS COMBINATIONS
On May 27, 1999, Kroger issued 312 million shares of Kroger common
stock in connection with a merger, for all of the outstanding common
stock of Fred Meyer, Inc., which operates stores primarily in the
Western region of the United States. The merger was accounted for as a
pooling of interests, and the accompanying financial statements
relating to periods in fiscal 1999 have been restated to give effect to
the consolidated results of Kroger and Fred Meyer.
3. MERGER RELATED COSTS
The Company is continuing the process of implementing its integration
plan relating to recent mergers. The integration plan, which involves
incurring transaction costs, includes distribution consolidation,
systems integration, store conversions, store closures, and
administration integration. Total merger related costs incurred were $9
during the first quarter of 2000, and $35 during the first quarter of
1999.
The following table presents the components of the merger related
costs:
First Quarter Ended
--------------------------------
May 20, May 22,
2000 1999
---------------- ---------------
CHARGES RECORDED AS CASH EXPENDED
Distribution consolidation..................................... $ 1 $ 4
Systems integration............................................ -- 24
Store conversions.............................................. -- 3
Transaction costs.............................................. -- 1
Administration integration..................................... 4 1
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5 33
NON-CASH WRITEDOWN
System integration............................................. -- 2
------ -----
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OTHER CHARGES
Administration integration..................................... 4 --
------ -----
Total merger related costs........................................ $ 9 $ 35
====== =====
TOTAL CHARGES
Distribution consolidation..................................... $ 1 $ 4
Systems integration............................................ -- 26
Store conversions.............................................. -- 3
Transaction costs.............................................. -- 1
Administration integration..................................... 8 1
------ -----
Total merger related costs........................................ $ 9 $ 35
====== =====
Distribution Consolidation
Represents costs to consolidate distribution operations and eliminate duplicate
facilities. The costs in the first quarter of 2000 represent severance costs
incurred and paid. The $4 in the first quarter of 1999 was for incremental labor
during the closing of the Hughes distribution center and other incremental costs
incurred as a part of the realignment of the Company's distribution system.
Systems Integration
Represents the costs of integrating systems and the related conversion of
corporate office and store systems. In the first quarter of 1999, costs totaling
$24 were expensed as incurred including $17 of incremental operating costs,
principally labor, during the conversion process, $5 paid to third parties, and
$2 of training costs. Additionally, the Company incurred $2 of asset writedowns
for computer equipment during the first quarter of 1999.
Store Conversions
Includes the cost to convert store banners. All costs represented incremental
cash expenditures for advertising and promotions to establish the banner,
changing store signage, labor required to remerchandise the store inventory and
other services that were expensed as incurred.
Transaction Costs
Represents fees paid to outside parties, employee bonuses that were contingent
upon the completion of the mergers, and an employee stay bonus program. The
Company incurred costs totaling $1 in the first quarter of 1999, related to fees
and employee bonuses recorded as the cash was expended.
Administration Integration
Includes labor and severance costs related to employees identified for
termination in the integration and charges to conform accounting policies.
During the first quarter of 2000, the Company incurred costs totaling $8
including approximately $4 resulting from restricted stock related to merger
synergies, and charges of $4 for severance payments recorded as cash was
expended. The restrictions on the stock grants will lapse as synergy goals are
achieved.
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The following table is a summary of the changes in accruals related to various
business combinations:
Facility Employee Incentive Awards
Closure Costs Severance and Contributions
----------------- -------------- ------------------
Balance at January 2, 1999..................................... $ 133 $ 30 $ --
Additions.................................................. 8 24 29
Payments................................................... (11) (25) --
------ ------ ------
Balance at January 29, 2000.................................... 130 29 29
Payments................................................... (8) (6) --
------ ------ ------
Balance at May 20, 2000........................................ $ 122 $ 23 $ 29
====== ====== ======
4. ONE-TIME ITEMS
In addition to the Merger Related Costs described above, the Company
incurred one-time expenses related to recent mergers of $81 and $6
during the first quarters of 2000 and 1999, respectively. The one-time
items in the first quarter of 2000 included approximately $15 for
inventory writedowns included as merchandise costs. The remaining $66
in 2000 is included in operating, general and administrative costs and
relates to stores that have closed or will close and severance expenses
related to headcount reductions and other miscellaneous costs. Of the
$66, $11 represented cash expenditures and $55 represented charges that
were accrued during the quarter. No payments were made on these
accruals during the quarter. All of the 1999 one-time items were costs
related to mergers and are included in merchandise costs.
5. ASSET IMPAIRMENT CHARGES
As a result of recent investments in stores that did not perform as
expected, updated profitability forecasts for 2000 and beyond, and new
divisional leadership, the Company performed an impairment review of
its long-lived assets. During this review, the Company identified
impairment losses for both assets to be disposed of and assets to be
held and used.
Assets to be Disposed of
The impairment charge for assets to be disposed of related primarily to
the carrying value of land, buildings, and equipment for 25 stores that
were closed in the first quarter or that management has committed to
close by the end of the fiscal year. The impairment charge was
determined using the fair value less the cost to sell. Fair value less
the cost to sell used in the impairment calculation was based on
discounted cash flows and third party offers to purchase the assets, or
market value for comparable properties, if applicable. Accordingly, an
impairment charge of $81 related to assets to be disposed of was
recognized, reducing the carrying value of fixed assets and goodwill by
$41 and $40, respectively.
Assets to be Held and Used
The impairment charge for assets to be held and used related primarily
to the carrying value of land, buildings, and equipment for 13 stores
that will continue to be operated by the Company. Updated projections,
based on revised operating plans, were used, on a gross basis, to first
determine whether the assets were impaired, then, on a discounted cash
flow basis, to serve as the estimated fair value of the assets for
purposes of measuring the asset impairment charge. As a result, an
impairment charge of $87 related to assets to be held and used was
recognized, reducing the carrying value of fixed assets and goodwill by
$47 and $40, respectively.
Other writedowns
In addition to the approximately $168 of impairment charges noted
above, the Company recorded a writedown of $23 to reduce the carrying
value of certain investments in unconsolidated entities, accounted for
on the cost basis of accounting, to reflect reductions in value
determined to be other than temporary. The writedowns related primarily
to investments in certain former suppliers that have experienced
financial difficulty and with whom supply arrangements have ceased.
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6. INCOME TAXES
The effective income tax rate differs from the expected statutory rate
primarily due to the effect of certain state taxes and non-deductible
goodwill.
7. EARNINGS PER COMMON SHARE
Earnings per common share equals net earnings divided by the weighted
average number of common shares outstanding, after giving effect to
dilutive stock options.
The following table provides a reconciliation of earnings and shares
used in calculating basic earnings per share to those used in
calculating diluted earnings per share.
For the quarter ended For the quarter ended
May 20, 2000 May 22, 1999
----------------------------------------- ---------------------------------------
Earnings Shares Per Share Earnings Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
---------------------------------------------------------------------------------
Basic earnings per common share...... $ 106 831 $ 0.13 $ 207 827 $ 0.25
Dilutive effect of stock options and
Warrants.......................... -- 19 -- 36
--------- --------- --------- --------
Diluted earnings per common share.... $ 106 850 $ 0.12 $ 207 863 $ 0.24
========= ========= ========= =========
8. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued
Statements of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This standard, as
amended, is effective for fiscal years beginning after June 15, 2000.
Given current activities, the Company expects that the adoption of the
standard will not have a material impact on the financial statements.
In March 2000, the Financial Accounting Standards Board issued
Interpretation No. 44, "Accounting for Certain Transactions involving
Stock Compensation." This standard becomes effective July 1, 2000. The
Company expects that the adoption of the standard will not have a
material impact on the financial statements.
9. GUARANTOR SUBSIDIARIES
Certain of the Company's Senior Notes and Senior Subordinated Notes
(the "Guaranteed Notes") are jointly and severally, fully and
unconditionally guaranteed by certain Kroger subsidiaries (the
"Guarantor Subsidiaries"). At May 20, 2000 a total of approximately
$5.6 billion of Guaranteed Notes were outstanding. The Guarantor
Subsidiaries and non-guarantor subsidiaries are wholly-owned
subsidiaries of Kroger. Separate financial statements of Kroger 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 represent less than 3% on an
individual and aggregate basis of consolidated assets, pretax 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,
but the obligations of each guarantor under its guarantee are limited
to the maximum amount as will result in obligations
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of such guarantor under its guarantee not constituting a fraudulent
conveyance or fraudulent transfer for purposes of Bankruptcy Law, the
Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act,
or any similar Federal or state law (e.g. adequate capital to pay
dividends under corporate laws).
The following tables present summarized financial information as of May
20, 2000 and January 29, 2000 and for the quarters ended May 20, 2000
and May 22, 1999.
SUMMARIZED FINANCIAL INFORMATION AS OF MAY 20, 2000 AND FOR THE QUARTER THEN
ENDED:
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------------------ -------------------- ------------------- ------------------- ----------------
Current assets $ 661 $ 4,448 $ -- $ 5,109
Non-current assets $ 11,007 $ 11,255 $ (9,751) $ 12,511
Current liabilities $ 1,148 $ 4,674 $ -- $ 5,822
Non-current liabilities $ 7,907 $ 1,287 $ -- $ 9,194
Sales $ 1,986 $ 12,550 $ (207) $ 14,329
Gross profit $ 385 $ 3,458 $ (16) $ 3,827
Operating profit $ 52 $ 330 $ -- $ 382
Net earnings $ 106 $ 188 $ (188) $ 106
SUMMARIZED FINANCIAL INFORMATION AS OF JANUARY 29, 2000:
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------------------ -------------------- ------------------- ------------------- ----------------
Current assets $ 578 $ 4,953 $ -- $ 5,531
Non-current assets $ 11,652 $ 11,180 $ (10,397) $ 12,435
Current liabilities $ 1,109 $ 4,619 $ -- $ 5,728
Non-current liabilities $ 8,437 $ 1,118 $ -- $ 9,555
SUMMARIZED FINANCIAL INFORMATION FOR THE QUARTER ENDED MAY 22, 1999:
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------------------ -------------------- ------------------- ------------------- ---------------
Sales $ 1,912 $ 11,795 $ (214) $ 13,493
Gross profit $ 355 $ 3,190 $ (14) $ 3,531
Operating profit $ 33 $ 513 $ -- $ 546
Net earnings $ 207 $ 294 $ (294) $ 207
10. COMMITMENTS AND CONTINGENCIES
The Company is a 50% owner of Santee Dairies, L.L.C. ("Santee") and has
a 10-year product supply agreement with Santee that requires Kroger to
purchase 9 million gallons of fluid milk and other products annually.
The product supply agreement expires on July 29, 2007. Upon acquisition
of Ralphs/Food 4 Less, Santee became excess capacity and a duplicate
facility. The Company is currently engaged in efforts to dispose of its
interest in Santee that may result in a loss.
11. SUBSEQUENT EVENTS
On June 22, 2000, the Company announced that it had reached an
agreement with Winn-Dixie Stores, Inc. to terminate the previously
announced plans to purchase 74 Winn-Dixie stores in Texas and Oklahoma.
This announcement was a direct result of the Federal Trade Commission's
decision to withhold approval of the Company's purchase of these
stores.
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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.
BUSINESS COMBINATIONS
On May 27, 1999 Kroger issued 312 million shares of Kroger common stock
in connection with a merger, for all of the outstanding common stock of
Fred Meyer Inc., which operates stores primarily in the Western region
of the United States. This merger was accounted for as a pooling of
interests, and the accompanying financial statements have been restated
to give effect to the consolidated results of Kroger and Fred Meyer for
all years presented.
RESULTS OF OPERATIONS
Total sales for the first quarter of 2000 increased 6.2% to $14.3
billion. Excluding sales from divested stores, sales for the first
quarter increased 6.8% or $902 million over the same period in 1999.
The increase in sales is attributable to an increase in comparable and
identical store sales and an increase in the number of stores due to
acquisitions and expansions. Identical food store sales, which includes
stores that have been in operation and have not been expanded or
relocated for five quarters, grew 1.3% from the first quarter of 1999.
Comparable food stores sales, which includes relocations and
expansions, increased 1.8% over the prior year. Excluding our Fry's
division, which has converted 35 former Smith's stores to the Fry's
banner, identical food store sales grew 1.4% and comparable food store
sales rose 1.9%.
As previously stated, a portion of the increase in sales was also due
to an increase in the number of stores. During the first quarter of
2000, we opened, acquired, relocated, and remodeled or expanded 57 food
stores stores and closed 18 food stores. We operated 2,319 food stores
at May 20, 2000 compared to 2,206 food stores at May 22, 1999. As of
May 20, 2000, food store square footage totaled 121 million, excluding
divested stores. This represents an increase of 6.5% over May 22, 1999.
The gross profit rate, excluding one-time expenses and the effect of
LIFO, was 26.9% in 2000 and 26.3% in 1999. During the first quarter of
2000, we incurred $15 of one-time expenses included in merchandise
costs compared to only $6 during the same period of 1999. Including
these costs, the gross profit rates were 26.8% in 2000 and 26.3% in
1999. This increase is primarily the result of synergy savings,
reductions in product costs through our corporate-wide merchandising
programs, and increases in private label sales and profitability. The
economies of scale created by the merger are providing reduced costs by
enabling strategic initiatives in coordinated purchasing. Technology
and logistics efficiencies have also led to improvements in category
management and various other aspects of our operations, resulting in a
decreased cost of product. During the quarter, we introduced 256
private-label products that produce a higher gross profit than national
brands.
We incurred $66 million of one-time operating, general and
administrative expenses in the first quarter of 2000 compared to none
during the first quarter of 1999. Excluding these one-time items,
operating, general and administrative expenses as a percent of sales
were 18.5% during the first quarter of 2000. Including these one-tim
items, operating, general and administrative expenses as a percent of
sales were 19.0% in the first quarter of 2000 compared to 18.3% in the
first quarter of 1999. Nearly half of this increase was due to the
reclassification of several Fred Meyer expenses to operating, general
and administrative in the current year. These expenses were reclassed
primarily from interest, depreciation and amortization expense. There
was no effect on net earnings due to these reclassifications. The
increase in operating, general and administrative expenses is also due
to higher bonus accruals and higher health care costs.
The effective tax rate differs from the expected statutory rate
primarily due to the effect of certain state taxes and non-deductible
goodwill. Goodwill amortization was $31 million in the first quarter of
2000 and $29 million in the first quarter of 1999.
Net earnings, excluding merger related costs and one-time items, were
$276 million or $0.33 per diluted share in the first quarter of 2000.
These results represent an increase of approximately 22% over net
earnings of $0.27 per diluted share excluding merger related costs and
one-time items for the first quarter of 1999.
MERGER RELATED COSTS
We are continuing the process of implementing our integration plan
relating to recent mergers. The integration plan, which involves
incurring transation costs, includes distribution consolidation,
systems integration, store conversions, store closures,
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and administration integration. Total merger related costs incurred
were $9 million during the first quarter of 2000, and $35 million
during the first quarter of 1999.
The following table presents the components of the merger related
costs:
Quarter Ended
--------------------------------
May 20, May 22,
2000 1999
---------------- ---------------
(in millions)
CHARGES RECORDED AS CASH EXPENDED
Distribution consolidation..................................... $ 1 $ 4
Systems integration............................................ -- 24
Store conversions.............................................. -- 3
Transaction costs.............................................. -- 1
Administration integration..................................... 4 1
------ -----
5 33
NON-CASH WRITEDOWN
System integration............................................. -- 2
------ -----
OTHER CHARGES
Administration integration........................................ 4 --
------ -----
Total merger related costs........................................ $ 9 $ 35
====== =====
TOTAL CHARGES
Distribution consolidation..................................... $ 1 $ 4
Systems integration............................................ -- 26
Store conversions -- 3
Transaction costs.............................................. -- 1
Administration integration..................................... 8 1
------ -----
Total merger related costs........................................ $ 9 $ 35
====== =====
Distribution Consolidation
Charges related to "Distribution Consolidation" represent costs to
consolidate distribution operations and eliminate duplicate facilities.
The costs in the first quarter of 2000 represent severance costs
incurred and paid. The $4 million in the first quarter of 1999 was for
incremental labor during the closing of the Hughes distribution center
and other incremental costs incurred as a part of the realignment of
the Company's distribution system.
Systems Integration
Charges related to "Systems Integration" represent the costs of
integrating systems and the related conversion of corporate office and
store systems. In the first quarter of 1999, costs totaling $24 million
were expensed as incurred including $17 million of incremental
operating costs, principally labor, during the conversion process, $5
million paid to third parties, and $2 million of training costs.
Additionally, the Company incurred $2 million of asset writedowns for
computer equipment during the first quarter of 1999.
Store Conversions
Charges related to "Store Conversions" include the cost to convert
store banners. All costs represented incremental cash expenditures for
advertising and promotions to establish the banner, changing store
signage, labor required to remerchandise the store inventory and other
services that were expensed as incurred.
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Transaction Costs
Charges related to "Transaction Costs" represent fees paid to outside
parties, employee bonuses that were contingent upon the completion of
the mergers, and an employee stay bonus program. We incurred costs
totaling $1 million in the first quarter of 1999, related to fees and
employee bonuses recorded as the cash was expended.
Administration Integration
Charges related to "Administration Integration" include labor and
severance costs related to employees identified for termination in the
integration and charges to conform accounting policies. During the
first quarter of 2000, we incurred costs totaling $8 including
approximately $4 million resulting from the issuance of restricted
stock related to merger synergies, and charges of approximately $4
million for severance payments recorded as cash was expended. The
restriction on the stock grants will lapse as synergy goals are
achieved.
The following table is a summary of the changes in accruals related to
various business combinations:
Facility Employee Incentive Awards
Closure Costs Severance and Contributions
----------------- -------------- -------------------
(in millions)
Balance at January 2, 1999........................................ $ 133 $ 30 $ --
Additions...................................................... 8 24 29
Payments....................................................... (11) (25) --
-------- ------- ------
Balance at January 29, 2000....................................... 130 29 29
Payments....................................................... (8) (6) --
-------- ------- ------
Balance at May 20, 2000........................................... $ 122 $ 23 $ 29
======== ======= ======
ONE-TIME ITEMS
In addition to the Merger Related Costs described above, we incurred
one-time expenses related to recent mergers of $81 million and $6
million during the first quarters of 2000 and 1999, respectively. The
one-time items in the first quarter of 2000 included approximately $15
million for inventory writedowns included as merchandise costs. The
remaining $66 million in 2000 is included in operating, general and
administrative costs and relates to stores that have closed or will
close and severance expenses related to headcount reductions. Of the
$66 million, $11 million represented cash expenditures and $55 million
represented charges that were accrued during the quarter. No payments
were made on these accruals during the quarter. All of the 1999
one-time items are included in merchandise costs.
ASSET IMPAIRMENT CHARGES
As a result of recent investments in stores that did not perform as
expected, updated profitability forecasts for 2000 and beyond, and new
divisional leadership, we performed an impairment review of our
long-lived assets. During this review, we identified impairment losses
for both assets to be disposed of and assets to be held and used.
Assets to be Disposed of
The impairment charge for assets to be disposed of related primarily to
the carrying value of land, buildings, and equipment for 25 stores that
were closed in the first quarter or that management has committed to
close by the end of the fiscal year. The impairment charge was
determined using the fair value less the cost to sell. Fair value less
the cost to sell used in the impairment calculation was based on
discounted cash flows and third party offers to purchase the assets, or
market value for comparable properties, if applicable. Accordingly, an
impairment charge of $81 million related to assets to be disposed of
was recognized, reducing the carrying value of fixed assets and
goodwill by $41 million and $40 million, respectively.
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Assets to be Held and Used
The impairment charge for assets to be held and used related primarily
to the carrying value of land, buildings, and equipment for 13 stores
that we will continue to operate. Updated projections, based on revised
operating plans, were used, on a gross basis, to first determine
whether the assets were impaired, then, on a discounted cash flow basis
to serve as the estimated fair value of the assets for purposes of
measuring the asset impairment charge. As a result, an impairment
charge of $87 related to assets to be held and used was recognized,
reducing the carrying value of fixed assets and goodwill by $47 million
and $40 million, respectively.
Other writedowns
In addition to the approximately $168 million of impairment charges
noted above, we recorded a writedown of $23 million to reduce the
carrying value of certain investments in unconsolidated entities,
accounted for on the cost basis of accounting, to reflect reductions in
value determined to be other than temporary. The writedowns related
primarily to investments in certain former suppliers that have
experienced financial difficulty and with whom supply arrangements have
ceased.
LIQUIDITY AND CAPITAL RESOURCES
Debt Management
---------------
During the quarter, we invested $209 million to repurchase 11.3 million
shares of Kroger stock at an average price of $18.52 per share. We
purchased 10.7 million shares under our $750 million stock repurchase
plan and we purchased an additional 0.6 million shares under our
program to repurchase common stock funded by the proceeds and tax
benefits from stock option exercises.
We had several lines of credit totaling $4.0 billion, with $2.0 billion
in unused balances at May 20, 2000. In addition, we had a $470 million
synthetic lease credit facility with no unused balance and a $95
million money market line with an unused balance of $83 million at May
20, 2000.
Net debt increased $77 million to $8.6 billion at the end of the first
quarter of 2000 compared to the first quarter of the prior year. Net
debt is defined as long-term debt, including capital leases and current
portion thereof, less investments in debt securities and prefunded
employee benefits. Net debt decreased $355 million from year-end 1999,
despite the $209 million repurchase of Kroger stock and acquisitions
completed during the first quarter. The decrease since year-end
resulted from strong free cash flow from operations, including an
improvement in net working capital.
Our bank credit facilities and the indentures underlying our publicly
issued debt, contain various restrictive covenants. Some of these
covenants are based on EBITDA, which we define as earnings before
interest, taxes, depreciation, amortization, LIFO, extraordinary
losses, and one-time items. The ability to generate EBITDA at levels
sufficient to satisfy the requirements of these agreements is a key
measure of our financial strength. We do not intend to present EBITDA
as an alternative to any generally accepted accounting principle
measure of performance. Rather, we believe the presentation of EBITDA
is important for understanding our performance compared to our debt
covenants. The calculation of EBITDA is based on the definition
contained in our bank credit facilities. This may be a different
definition than other companies use. We were in compliance with all
EBITDA-based bank credit facilities and indenture covenants on May 20,
2000.
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The following is a summary of the calculation of EBITDA for the first
quarter of 2000 and 1999.
1st Quarter Ended
----------------------------------
May 20, May 22,
2000 1999
---------------- ----------------
(in millions)
Earnings before tax expense............................. $ 176 $ 347
Interest................................................ 206 199
Depreciation............................................ 276 252
Goodwill amortization................................... 31 29
LIFO.................................................... 12 12
One-time items included in merchandise costs............ 15 6
One-time items included in operating, general and
Administrative expenses.............................. 66 --
Merger related costs.................................... 9 35
Impairment charges 191 --
Other................................................... -- (1)
---------- ----------
EBITDA.................................................. $ 982 $ 879
========== =========
Cash Flow
---------
We generated $1.043 billion of cash from operating activities during
the first quarter of 2000 compared to $594 million in the first quarter
of 1999. Cash flow from operating activities increased in the first
quarter of 2000 largely due to a reduction in working capital and an
increase in net earnings excluding non-cash charges.
Investing activities used $497 million of cash during the first quarter
of 2000 compared to $449 million in 1999. This increase was primarily
due to the payment for acquisitions and the funding of a new insurance
subsidiary.
Financing activities used $664 million of cash in the first quarter of
2000 compared to $94 million in the first quarter of 1999. This
increase is due to our repurchase of treasury shares and reduction in
debt.
CAPITAL EXPENDITURES
Capital expenditures excluding acquisitions totaled $455 million in the
first quarter of 2000 compared to $442 million in the first quarter of
1999. During the first quarter of 2000 we opened, acquired, expanded,
or relocated 57 food stores. We had 18 operational closings and
completed 30 within the wall remodels. Square footage increased 6.5%
excluding divested stores.
OTHER ISSUES
On March 31, 2000, the Board of Directors approved a $750 million
common stock repurchase program. This repurchase program replaced the
$100 million program authorized in January of 2000.
Due to the Federal Trade Commission's decision to withhold approval of
our purchase of 74 Winn-Dixie stores in Texas and Oklahoma, on June 22,
2000, we announced that we had reached an agreement with Winn-Dixie
Stores, Inc. to terminate the previously announced plans to purchase
the 74 stores.
We are a 50% owner of Santee Dairies, L.L.C. ("Santee") and have a
10-year product supply agreement with Santee that requires us to
purchase 9 million gallons of fluid milk and other products annually.
The product supply agreement expires on July 29, 2007. Upon the merger
of Ralphs/Food 4 Less, Santee became excess capacity and a duplicate
facility. We are currently engaged in efforts to dispose of our
interest in Santee that may result in a loss.
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OUTLOOK
Information provided by us, including written or oral statements made
by our representatives, may contain forward-looking information as
defined in the Private Securities Litigation Reform Act of 1995. All
statements, other than statements of historical facts, which address
activities, events or developments that we expect or anticipate will or
may occur in the future, including such things as integration of the
operations of acquired or merged companies, expansion and growth of our
business, future capital expenditures and our business strategy,
contain forward-looking information. Statements elsewhere in this
report and below regarding our expectations, hopes, beliefs,
intentions, or strategies are also forward looking statements. This
forward-looking information is based on various factors and was derived
utilizing numerous assumptions. While we believe that the statements
are accurate, uncertainties and other factors could cause actual
results to differ materially from those statements. In particular:
- We obtain sales growth from new square footage, as well as
from increased productivity from existing locations. We expect
2000 full year square footage to grow 4.5% to 5.0%. We expect
to continue to realize savings from economies of scale in
technology and logistics, some of which may be reinvested in
retail price reductions to increase sales volume and enhance
market share.
- We expect combination stores to increase our sales per
customer by including numerous specialty departments, such as
pharmacies, seafood shops, floral shops and bakeries. We
believe the combination store format will allow us to
withstand continued competition from other food retailers,
supercenters, mass merchandisers and restaurants.
- We believe we have adequate coverage of our debt covenants to
continue to respond effectively to competitive conditions.
- We expect to continue capital spending in technology focusing
on improved store operations, logistics, manufacturing
procurement, category management, merchandising and buying
practices, which should continue to reduce merchandising costs
as a percent of sales.
- We expect to reduce working capital as compared to the third
quarter of 1999 by a total of $500 million over the next 5
years. We define working capital as current operating assets
less current operating liabilities. As of the end of the first
quarter we have reduced working capital $197 million since the
third quarter of 1999. A calculation of working capital based
on our definition as of the end of the first quarter 2000 and
the third quarter of 1999 is provided below:
First Quarter Third Quarter
2000 1999
------------- -------------
Cash..................................... $ 163 $ 283
Receivables.............................. 608 620
FIFO inventory........................... 4,416 4,812
Operating prepaid and other assets....... 358 199
Accounts payable......................... (3,047) (3,292)
Operating accrued liabilities............ (2,223) (2,268)
Prepaid VEBA............................. (118) --
---------- ---------
Working capital ......................... $ 157 $ 354
========== =========
- Our earnings per share target is a 16%-18% average annual
increase over the next three years.
- We expect our capital expenditures for the year to total
$1.5-$1.6 billion, net of acquisitions. Capital expenditures
reflect our strategy of growth through expansion and
acquisition as well as our emphasis, whenever possible, on
self-development and ownership of store real estate, and on
logistics and technology improvements. We intend to use the
combination of cash flows from operations, including
reductions in working capital, and borrowings under credit
facilities to finance capital expenditure requirements. If
determined preferable, we may fund capital expenditure
requirements by mortgaging facilities, entering into
sale/leaseback transactions, or by issuing additional debt or
equity.
- We expect to meet or exceed $380 million in synergy savings
over the next three years as a result of our mergers. We
project the timing of the annual savings by fiscal year to be
as follows: $260 million in 2000, $345 million in 2001,
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and $380 million in 2002 and beyond. As of the end of the
first quarter of 2000 we have achieved an annual run rate of
$198 million.
- We continue to utilize interest rate swaps and other
derivatives to limit our exposure to rising interest rates.
The derivatives are used primarily to fix the rates on
variable debt and limit the floating rate debt to a total of
$2.3 billion or less. Currently, a 100 basis point increase
from the current range of interest rates would have less than
$0.01 a share impact on this year's earnings. For the balance
of the year, we expect less than 10% of our outstanding debt
will be exposed to upward movements in interest rates and
expect this floating rate debt to average $800 - $850 million
for the rest of the year.
Our ability to achieve our expectations may be impacted by several
factors that could cause actual results to differ materially from our
expectations. We operate in an increasingly competitive environment
that could adversely affect our expected increases in sales and
earnings. Competitors' pricing strategies, store openings, and remodels
may effect our sales and earnings growth. A downturn in the general
business or economic conditions in our operating regions may also
adversely affect our sales and earnings. Such an economic downturn may
include fluctuations in the rate of inflation, decreases in population,
or employment and job growth. Although we believe we have adequate
coverage of our debt covenants, our significant indebtedness could
adversely affect us by reducing our flexibility to respond to changing
business and economic conditions and increasing our borrowing costs.
Increases in labor costs and relations with union bargaining units
representing our employees or delays in opening new stores could also
cause us to fall short of our sales and earnings targets. Sales growth
may also be negatively affected if the impact of new square footage on
existing stores is greater than anticipated. While we expect to reduce
working capital, our ability to do so may be impaired by changes in
vendor payment terms or systems problems that result in increases in
inventory levels. Our capital expenditures could fall outside of the
expected range if we are unsuccessful in acquiring suitable sites for
new stores, if development costs exceed those budgeted, or if our
logistics and technology projects are not completed in the time frame
expected or on budget. While we expect to achieve benefits through
logistics and technology, due to our recent mergers and acquisitions,
there are inherent uncertainties that may hinder the development of new
systems and integration of systems. Unforeseen difficulties in
integrating Fred Meyer or any other acquired entity with Kroger could
cause us to fail to achieve the anticipated synergy savings, and could
otherwise adversely affect our ability to meet our other expectations.
Changes in laws and regulations, including changes in accounting
standards and taxation requirements may adversely affect our
operations. Accordingly, actual events and results may vary
significantly from those included in or contemplated or implied by
forward looking statements made by us.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to risk from the changes in interest rates as a result
of borrowing activities. We continue to utilize interest rate swaps and
other derivatives to limit our exposure to rising interest rates. The
derivatives are used primarily to fix the rates on variable debt and
limit the floating rate debt to a total of $2.3 billion or less.
There have been no 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 10K filed with the SEC on
April 27, 2000.
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PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBIT 3.1 - Amended Articles of Incorporation of the
Company are hereby incorporated by reference to Exhibit 3.1
of the Company's Quarterly Report on Form 10-Q for the
quarter ended October 3, 1998. The Company's Regulations
are incorporated by reference to Exhibit 4.2 of the
Company's Registration Statement on Form S-3 as filed with
the Securities and Exchange Commission on January 28, 1993,
and bearing Registration No. 33-57552.
EXHIBIT 4.1 - Instruments defining the rights of holders of
long-term debt of the Company and its subsidiaries are not
filed as Exhibits because the amount of debt under each
instrument is less than 10% of the consolidated assets of
the Company. The Company undertakes to file these
instruments with the Commission upon request.
EXHIBIT 27.1 - Financial Data Schedule.
EXHIBIT 99.1 - Additional Exhibits - Statement of
Computation of Ratio of Earnings to Fixed Charges.
(b) The Company disclosed and filed an underwriting agreement,
pricing agreement, and the Seventh Supplemental Indenture
related to the issuance of $500,000,000, 8.05% Senior
Notes, in its Current Report on Form 8-K dated February 11,
2000; and its earnings release for the fourth quarter and
fiscal year of 1999 in its Current Report on Form 8-K dated
March 9, 2000, as amended May 24, 2000.
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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 30, 2000 By: /s/ Joseph A. Pichler
------------------------------------
Joseph A. Pichler
Chairman of the Board and
Chief Executive Officer
Dated: June 30, 2000 By: /s/ M. Elizabeth Van Oflen
------------------------------------
M. Elizabeth Van Oflen
Vice President and
Corporate Controller
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Exhibit Index
-------------
Exhibit 3.1 - Amended Articles of Incorporation of the Company are
hereby incorporated by reference to Exhibit 3.1 of
the Company's Quarterly Report on Form 10-Q for the
quarter ended October 3, 1998. The Company's
Regulations are incorporated by reference to Exhibit
4.2 of the Company's Registration Statement on Form
S-3 as filed with the Securities and Exchange
Commission on January 28, 1993, and bearing
Registration No. 33-57552.
Exhibit 4.1 - Instruments defining the rights of holders of
long-term debt of the Company and its subsidiaries
are not filed as Exhibits because the amount of debt
under each instrument is less than 10% of the
consolidated assets of the Company. The Company
undertakes to file these instruments with the
Commission upon request.
Exhibit 27.1 - Financial Data Schedule.
Exhibit 99.1 - Additional Exhibits - Statement of Computation of
Ratio of Earnings to Fixed Charges.
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