1
Exhibit 99.1
The Kroger Co.
Consolidated Statement of Operations
Three years ended January 2, 1999
(In millions, except per share amounts)
1998 1997 1996
-------- -------- --------
Sales ........................................................... $ 43,082 $ 33,927 $ 29,701
Merchandise costs, including warehousing and transportation ..... 32,058 25,468 22,486
-------- -------- --------
Gross profit .................................................. 11,024 8,459 7,215
Operating, general and administrative ........................... 7,783 6,060 5,292
Rent ............................................................ 619 465 393
Depreciation and amortization ................................... 837 592 480
Merger related costs ............................................ 269 -- --
-------- -------- --------
Operating profit .............................................. 1,516 1,342 1,050
Interest expense ................................................ 645 388 349
-------- -------- --------
Earnings before income tax expense and extraordinary loss ..... 871 954 701
Tax expense ..................................................... 377 365 265
-------- -------- --------
Earnings before extraordinary loss ............................ 494 589 436
Extraordinary loss, net of income tax benefit ................... (257) (124) (3)
-------- -------- --------
Net earnings .................................................. $ 237 $ 465 $ 433
======== ======== ========
Basic earnings per common share:
Earnings before extraordinary loss ............................ $ 1.21 $ 1.64 $ 1.32
Extraordinary loss ............................................ (0.63) (0.34) (0.01)
-------- -------- --------
Net earnings ............................................... $ 0.58 $ 1.30 $ 1.31
======== ======== ========
Average number of common shares used in basic calculation ....... 408 359 331
Diluted earnings per common share:
Earnings before extraordinary loss ............................ $ 1.16 $ 1.58 $ 1.27
Extraordinary loss ............................................ (0.60) (0.33) (0.01)
-------- -------- --------
Net earnings ............................................... $ 0.56 $ 1.25 $ 1.26
======== ======== ========
Average number of common shares used in diluted calculation ..... 426 372 343
- --------------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
2
The Kroger Co.
Consolidated Balance Sheet
January 2, 1999 and December 27, 1997
(In millions, except per share amounts)
1998 1997
-------- --------
ASSETS
Current assets
Cash .................................................. $ 299 $ 183
Receivables ........................................... 587 509
Inventories ........................................... 3,493 3,040
Prepaid and other current assets ...................... 692 530
-------- --------
Total current assets .............................. 5,071 4,262
Property, plant and equipment, net ...................... 7,220 5,724
Goodwill, net ........................................... 3,847 1,323
Other assets ............................................ 503 409
-------- --------
Total Assets ...................................... $ 16,641 $ 11,718
======== ========
LIABILITIES
Current liabilities
Current portion of long-term debt ..................... $ 311 $ 30
Accounts payable ...................................... 2,926 2,548
Salaries and wages .................................... 639 489
Other current liabilities ............................. 1,574 1,069
-------- --------
Total current liabilities ......................... 5,450 4,136
Long-term debt .......................................... 7,848 5,491
Other long-term liabilities ............................. 1,426 1,174
-------- --------
Total Liabilities ................................. 14,724 10,801
-------- --------
SHAREOWNERS' EQUITY
Preferred stock, $100 par, 5 million shares
authorized and unissued ............................... -- --
Common stock, $1 par, 1 billion shares
authorized: 438 million shares issued in 1998 and
406 million shares issued in 1997 ..................... 438 406
Additional paid-in capital .............................. 2,351 1,498
Accumulated deficit ..................................... (421) (658)
Common stock in treasury, at cost; 25 million shares in
1998 and 22 million shares in 1997 ................. (451) (329)
-------- --------
Total Shareowners' Equity ........................... 1,917 917
-------- --------
Total Liabilities and Shareowners' Equity ........... $ 16,641 $ 11,718
======== ========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
3
The Kroger Co.
Consolidated Statement of Cash Flows
Three years ended January 2, 1999
(In millions)
1998 1997 1996
------- ------- -------
Cash Flows From Operating Activities:
Net earnings .................................................. $ 237 $ 465 $ 433
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Extraordinary loss ......................................... 257 124 3
Depreciation ............................................... 745 576 479
Goodwill amortization ...................................... 92 16 1
Deferred income taxes ...................................... (49) 81 54
Other ...................................................... 101 (16) 10
Changes in operating assets and liabilities net of effects
from acquisitions of businesses:
Inventories ............................................ 86 (198) (224)
Receivables ............................................ (56) (76) (36)
Accounts payable ....................................... 93 65 24
Other current liabilities .............................. 255 76 93
Other .................................................. 77 -- (106)
------- ------- -------
Net cash provided by operating activities ............ 1,838 1,113 731
------- ------- -------
Cash Flows From Investing Activities:
Capital expenditures .......................................... (1,646) (942) (914)
Proceeds from sale of assets .................................. 96 104 135
Decrease (increase) in other investments ...................... 114 12 (133)
Payments for acquisitions, net of cash acquired ............... (86) (354) --
Other ......................................................... 57 2 13
------- ------- -------
Net cash used by investing activities ................ (1,465) (1,178) (899)
------- ------- -------
Cash Flows From Financing Activities:
Proceeds from issuance of long-term debt ...................... 5,307 2,520 382
Reductions in long-term debt .................................. (5,089) (2,411) (390)
Debt prepayment costs ......................................... (308) (127) (4)
Financing charges incurred .................................... (118) (33) (18)
Increase (decrease) in book overdrafts ........................ (44) (7) 217
Proceeds from issuance of capital stock ....................... 122 269 57
Treasury stock purchases ...................................... (122) (85) (70)
Other ......................................................... (5) (8) (9)
------- ------- -------
Net cash provided (used) by financing activities ..... (257) 118 165
------- ------- -------
Net increase (decrease) in cash and temporary cash investments .. 116 53 (3)
Cash and temporary cash investments:
Beginning of year ........................................... 183 130 133
------- ------- -------
End of year ................................................. $ 299 $ 183 $ 130
======= ======= =======
disclosure of cash flow information:
Cash paid during the year for interest ...................... $ 635 $ 402 $ 354
Cash paid during the year for income taxes .................. 172 199 204
Non-cash changes related to purchase acquisitions:
Fair value of assets acquired ............................. 2,209 1,986 --
Goodwill recorded ......................................... 2,389 1,252 --
Value of stock issued ..................................... (652) (765) --
Liabilities assumed ....................................... (3,791) (2,047) --
- --------------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
4
The Kroger Co.
Consolidated Statement of Changes in Shareowners' Equity (Deficit)
Three years ended January 2, 1999
(In millions)
Common Stock Treasury Stock
------------------ ------------------
Additional
Paid-In Accumulated
Shares Amount Capital Shares Amount Deficit Total
------- ------- ------- ------- ------- ------- -------
Balances at December 31, 1995 349 $ 349 $ 462 19 $ (244) $(1,556) $ (989)
Issuance of common stock:
Stock options exercised 6 6 49 -- -- -- 55
Other 3 3 5 -- -- -- 8
Treasury stock purchases -- -- -- 5 (70) -- (70)
Tax benefits from exercise of stock options -- -- 23 -- -- -- 23
Net income -- -- -- -- -- 433 433
------- ------- ------- ------- ------- ------- -------
Balances at December 28, 1996 358 358 539 24 (314) (1,123) (540)
Issuance of common stock:
Stock options exercised 7 7 70 -- -- -- 77
KUI acquisition 2 2 34 -- -- -- 36
Hughes acquisition 10 10 182 -- -- -- 192
Smith's acquisition 33 33 687 -- -- -- 720
Other 1 1 12 -- -- -- 13
Treasury stock purchases -- -- -- 3 (85) -- (85)
Tax benefits from exercise of stock options -- -- 40 -- -- -- 40
Retirement of treasury stock (5) (5) (66) (5) 70 -- (1)
Net income -- -- -- -- -- 465 465
------- ------- ------- ------- ------- ------- -------
Balances at December 27, 1997 406 406 1,498 22 (329) (658) 917
Issuance of common stock:
Stock options exercised 10 10 111 -- -- -- 121
Ralphs acquisition 22 22 631 -- -- -- 653
Other -- -- 10 -- -- -- 10
Treasury stock purchases -- -- -- 3 (122) -- (122)
Tax benefits from exercise of stock options -- -- 101 -- -- -- 101
Net income -- -- -- -- -- 237 237
------- ------- ------- ------- ------- ------- -------
Balances at January 2, 1999 438 $ 438 $ 2,351 25 $ (451) $ (421) $ 1,917
======= ======= ======= ======= ======= ======= =======
- --------------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
-------------------------------------------------------
All dollar amounts are in millions except per share amounts.
1. ACCOUNTING POLICIES
The following is a summary of the significant accounting policies
followed in preparing these financial statements:
Basis of Presentation and Principles of Consolidation
-----------------------------------------------------
The accompanying financial statements include the consolidated accounts
of The Kroger Co. and its subsidiaries ("Kroger"), and Fred Meyer, Inc.
and its subsidiaries ("Fred Meyer") which were merged with Kroger on
May 27, 1999 (See note 2). Amounts included in the consolidated
financial statements for Fred Meyer as of January 2, 1999 and December
27, 1997 and for the years ended January 2, 1999, December 27, 1997 and
December 28, 1996 relate to Fred Meyer's fiscal years ended January 30,
1999, January 31, 1998 and February 1, 1997, respectively. Significant
intercompany transactions and balances have been eliminated. References
to the "Company" mean the consolidated company.
Pervasiveness of Estimates
--------------------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities. Disclosure of contingent assets and liabilities as of the
date of the consolidated financial statements and the reported amounts
of consolidated revenues and expenses during the reporting period also
is required. Actual results could differ from those estimates.
Inventories
-----------
Inventories are stated at the lower of cost (principally LIFO) or
market. Approximately 97% of inventories for 1998 and 94% of
inventories for 1997 were valued using the LIFO method. Cost for the
balance of the inventories is determined using the FIFO method.
Replacement cost is higher than the carrying amount by $530 at January
2, 1999 and $520 at December 27, 1997.
Property, Plant and Equipment
-----------------------------
Property, plant and equipment are stated at cost. Depreciation expense,
which includes the amortization of assets recorded under capital
leases, is computed principally using the straight-line method over the
estimated useful lives of individual assets, or remaining terms of
leases. Buildings and land improvements are depreciated based on lives
varying from ten to 40 years. Equipment depreciation is based on lives
varying from three to 15 years. Leasehold improvements are amortized
over their useful lives, which vary from four to 25 years. Depreciation
expense was $745 in 1998, $576 in 1997, and $479 in 1996.
Interest costs on significant projects constructed for the Company's
own use are capitalized as part of the costs of the newly constructed
facilities. Upon retirement or disposal of assets, the cost and related
accumulated depreciation are removed from the balance sheet and any
gain or loss is reflected in earnings.
6
Goodwill
--------
Goodwill is generally being amortized on a straight-line basis over 40
years. Accumulated amortization was approximately $115 at January 2,
1999 and $23 at December 27, 1997.
Impairment of Long-Lived Assets
-------------------------------
The Company reviews and evaluates long-lived assets for impairment when
events or circumstances indicate costs may not be recoverable. The net
book value of long-lived assets is compared to expected undiscounted
future cash flows. An impairment loss would be recorded for the excess
of net book value over the fair value of the asset impaired.
Interest Rate Protection Agreements
-----------------------------------
The Company uses interest rate swaps and caps to hedge a portion of its
borrowings against changes in interest rates. The interest differential
to be paid or received is accrued as interest expense. Gains and losses
from the disposition of hedge agreements are deferred and amortized
over the term of the related agreements.
Advertising Costs
-----------------
The Company's advertising costs are expensed as incurred and included
in merchandise costs in the Consolidated Statement of Operations.
Advertising expenses amounted to $489 in 1998, $375 in 1997 and $342 in
1996.
Deferred Income Taxes
---------------------
Deferred income taxes are recorded to reflect the tax consequences of
differences between the tax bases of assets and liabilities and their
financial reporting bases. See note 6 for the types of differences that
give rise to significant portions of deferred income tax assets and
liabilities. Deferred income taxes are classified as a net current or
noncurrent asset or liability based on the classification of the
related asset or liability for financial reporting purposes. A deferred
tax asset or liability that is not related to an asset or liability for
financial reporting is classified according to the expected reversal
date.
Comprehensive Income
--------------------
The Company has no items of other comprehensive income in any period
presented. Therefore, net earnings as presented in the Consolidated
Statement of Operations equals comprehensive income.
Consolidated Statement of Cash Flows
-------------------------------------------------
For purposes of the Consolidated Statement of Cash Flows, the Company
considers all highly liquid debt instruments purchased with an original
maturity of three months or less to be temporary cash investments. Book
overdrafts, which are included in accounts payable, represent
disbursements that are funded as the item is presented for payment.
Segments
--------
The Company operates retail food and drug stores, multi-department
stores and convenience stores in the Midwest, South and West. The
Company's retail operations, which represents approximately 98% of
consolidated sales, is its only reportable segment. All of the
Company's operations are domestic.
7
2. BUSINESS COMBINATIONS
On May 27, 1999, Kroger issued 156 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. On March 9, 1998, Fred Meyer
issued 41 million of shares of Fred Meyer common stock in connection
with a merger, for all of the outstanding stock of Quality Food
Centers, Inc. ("QFC"), a supermarket chain operating in the
Seattle/Puget Sound region of Washington state, and in Southern
California. The mergers were accounted for as poolings of interests,
and the accompanying financial statements have been restated to give
effect to the consolidated results of Kroger, Fred Meyer, and QFC for
all years presented.
The accompanying Consolidated Financial Statements reflect the
consolidated results as follows:
Kroger Fred Meyer Consolidated
Historical Company QFC Company
---------- ---------- ------ ------------
1998
Sales $28,203 $14,879 $ - $43,082
Extraordinary loss, net of
income tax benefit (39) (218) - (257)
Net earnings 411 (174) - 237
Diluted earnings per common share 1.55 (1.09) - 0.56
1997
Sales $26,567 $ 5,481 $1,879 $33,927
Extraordinary loss, net of
income tax benefit (32) (92) - (124)
Net earnings 412 13 40 465
Diluted earnings per common share 1.57 0.19 1.95 1.25
1996
Sales $25,171 $ 3,725 $ 805 $29,701
Extraordinary loss, net of
income tax benefit (3) - - (3)
Net earnings 350 59 24 433
Diluted earnings per common share 1.35 1.05 1.71 1.26
Prior period financial statements of Fred Meyer have been restated to
conform with accounting practices of Kroger with respect to certain
inventory related costs and the capitalization policy for property,
plant and equipment. As a result of the restatement Fred Meyer retained
earnings at December 31, 1995 was reduced by $3. In addition, the
restatement reduced Fred Meyer net earnings by $11 in 1998 and $1 in
1997. The effect of the conforming adjustments on 1996 net earnings was
not material.
On March 10, 1998, Fred Meyer acquired Food 4 Less Holdings, Inc.
("Ralphs/Food 4 Less"), a supermarket chain operating primarily in
Southern California by issuing 22 million shares of common stock to the
Ralphs/Food 4 Less stockholders. The acquisition was accounted for
under the purchase method of accounting. The financial statements
include the operating results of Ralphs/Food 4 Less from the date of
acquisition.
On September 9, 1997, Fred Meyer acquired Smith's, a regional
supermarket and drug store chain operating in the Intermountain and
Southwestern regions of the United States, by issuing 33 million shares
of common stock to the Smith's stockholders. The acquisition was
accounted for under the purchase method of accounting. The financial
statements include the operating results of Smith's from the date of
acquisition.
On March 19, 1997, QFC acquired the principal operations of Hughes
Markets, Inc. ("Hughes"), a supermarket chain operating in Southern
California and a 50% interest in Santee Dairies, Inc., one of the
largest dairy plants in California. The merger was effected through the
acquisition of 100% of the outstanding voting securities of Hughes for
approximately $361 cash, 10 million shares of common stock, and the
assumption of
8
$33 of indebtedness of Hughes. The acquisition was accounted for under
the purchase method of accounting. The financial statements include the
operating results of Hughes from the date of acquisition.
On February 14, 1997, QFC acquired the principal operations of Keith
Uddenberg, Inc. ("KUI"), a supermarket chain operating in the western
and southern Puget Sound region of Washington. The merger was effected
through the acquisition of the outstanding voting securities of KUI for
$35 cash, 2 million shares of common stock and the assumption of
approximately $24 of indebtedness of KUI. The acquisition was accounted
for under the purchase method of accounting. The financial statements
include the operating results of KUI from the date of acquisition.
Fred Meyer also completed other acquisitions and divestitures during
1998. These acquisitions do not have a material effect on the
consolidated operating results and, therefore, are not included in the
pro forma data presented below.
The following unaudited pro forma information presents the results of
operations assuming the Ralphs/Food 4 Less, Smith's, Hughes, and KUI
acquisitions occurred at the beginning of each period presented. In
addition, the following unaudited pro forma information gives effect to
refinancing certain debt as if such refinancing occurred at the
beginning of each period presented:
1998 1997
------- -------
Sales $43,628 $41,517
Earnings before extraordinary loss 444 560
Net earnings 187 309
Diluted earnings per common share:
Earnings before extraordinary loss 1.06 1.35
Net earnings .45 .75
The pro forma financial information is not necessarily indicative of
the operating results that would have occurred had the acquisitions
been consummated as of the beginning of each period nor is it
necessarily indicative of future operating results.
In conjunction with purchase acquisitions, the Company accrued certain
costs associated with closing and divesting of certain acquired
facilities and severance payments to terminate employees of the
acquired companies. The following table presents the activity in the
Company's accrued purchase liabilities:
Facility
Closure Employee
Costs Severance Total
-------- --------- ------
Balance at December 28, 1996 $ - $ - $ -
Additions 23 9 32
Payments (4) (1) (5)
----- ----- ------
Balance at December 27, 1997 19 8 27
Additions 122 22 144
Payments (13) (2) (15)
Adjustment to severance accrual - (3) (3)
----- ----- ------
Balance at January 2, 1999 $ 128 $ 25 $ 153
===== ===== ======
Facility Closure Costs
----------------------
The Company acquired certain idle facilities in its purchase
acquisitions including 63 closed stores, four closed warehouses and one
vacant parcel all of which are leased. The Company also acquired 16
stores that the California Attorney General required be divested and
17 stores that were duplicate facilities. Divestitures of thirteen
stores have been completed and 7 of the duplicate facilities have been
closed. The remaining 10 duplicate stores are expected to close by the
end of 1999. Facility
9
closure costs accrued include obligations for future contractual lease
payments, net of sublease income, and closure costs.
Employee Severance
------------------
Employee severance relates to 24 employees that have been terminated
and 73 employees that will be terminated in the future. Under severance
agreements, the severance will be paid over a period not to exceed
three years following the date of termination.
3. MERGER RELATED COSTS
Fred Meyer is in the process of implementing its plan to integrate Fred
Meyer Stores, Ralphs/Food 4 Less, Smith's, QFC and Hughes, resulting in
merger related costs of $269 in 1998. The integration plan includes the
consolidation of distribution, information systems, and administrative
functions, conversion of 78 store banners, closure of seven stores, and
transaction costs incurred to complete the mergers. The costs were
reported in the periods in which cash was expended except for $26 that
was accrued for liabilities incurred to discontinue activities and
retain key employees and an $83 charge to write-down assets. The
following table presents components of the merger related costs:
1998
-----
CHARGES RECORDED AS CASH EXPENDED
Distribution consolidation $ 16
Systems integration 50
Store conversions 48
Transaction costs 34
Administration integration 12
-----
160
NONCASH ASSET WRITE-DOWN
Distribution consolidation 29
Systems integration 26
Store closures 25
Administration integration 3
-----
83
ACCRUED CHARGES
Systems integration 1
Transaction costs 6
Store closures 7
Administration integration 12
-----
26
-----
Total merger related costs $ 269
=====
TOTAL CHARGES
Distribution consolidation $ 45
Systems integration 77
Store conversions 48
Transaction costs 40
Store closures 32
Administration integration 27
-----
Total merger related costs $ 269
=====
Distribution Consolidation
--------------------------
Represents costs to consolidate manufacturing and distribution
operations and eliminate duplicate facilities. The costs include a $29
write-down to estimated net realizable value for the Hughes
distribution center in Southern California. Net realizable value was
determined by a market analysis. The facilities are held for sale and
depreciation expense for the closed Hughes distribution facility has
been suspended. Depreciation expense in the second and third quarters
would have totaled $2 if it
10
had not been suspended. Efforts to dispose of the facilities are
ongoing and a sale is expected in 1999. Also included is $13 incurred
for incremental labor during the closing of the 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 from QFC, Hughes and
Smith's computer platforms into Fred Meyer and Ralphs' platforms and
the related conversion of all corporate office and store systems. The
asset write-down of $26 includes $18 for computer equipment and related
software that have been abandoned and $8 associated with computer
equipment at QFC which is being written off over 18 months at which
time it will be abandoned. Costs totaling $50 were expensed as incurred
and include $27 of incremental operating costs, principally labor,
during the conversion process, $14 paid to third parties, and $9 of
training costs. Also included are severance costs for system employees
who will be terminated as the integration is completed.
Store Conversions
-----------------
Includes the cost to convert 55 Hughes stores to the Ralph's banner, 15
Smitty's stores to the Fred Meyer banner, five QFC stores to the Fred
Meyer banner, and three Fred Meyer stores to the Smith's banner. The
conversion of the Hughes and QFC stores are substantially complete.
Costs totaling $48 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 which were expensed as incurred.
Transaction Costs
-----------------
Represents $34 for fees paid to outside parties and employee bonuses
that were contingent upon the completion of the mergers and $6 for an
employee stay bonus program. The stay bonus program was accrued ratably
over the stay period and paid in the fourth quarter of 1998.
Store Closures
--------------
Includes the costs to close four stores identified as duplicate
facilities and to sell three stores pursuant to a settlement agreement
with the State of California ("AG Stores"). Annual sales and operating
income for the four duplicate facilities and three AG Stores are
approximately $133 and $3, respectively. The asset write-down
represents $6 of book value in excess of sale proceeds, $19 for the
write-off of the goodwill associated with the AG Stores, and $7 of
lease termination costs. All stores have been closed or sold. The net
book value on the AG Stores representing building, fixtures and
equipment was written down to an estimated net realizable value of $6.
Depreciation expense continues to be recorded at the historical rate.
Administration Integration
--------------------------
Includes $15 for labor and severance costs. $9 has been expended and
the employees have been terminated. $9 of this amount is to conform
accounting policies of QFC and Hughes to Fred Meyer, including the
calculation of bad debt and costs for real estate transactions.
11
The following table presents the activity in the reserve accounts for
1998. The beginning balance was zero:
Cash Amount Accrued
Expense Payments Reclass At January 2, 1999
------- -------- ------- ------------------
SYSTEMS INTEGRATION
Severance $ 1 $ - $ - $ 1
TRANSACTION COSTS
Stay bonus program 6 6 - -
STORE CLOSURES
Lease obligation 7 2 - 5
ADMINISTRATION INTEGRATION
Severance 12 8 - 4
----- ----- ----- ------
Total amounts included in
current liabilities $ 26 $ 16 $ - $ 10
===== ===== ===== ======
Severance
---------
Severance relates to 183 Hughes administrative employees in Southern
California and 75 QFC administrative employees in Seattle. As of
year-end, all of the Hughes employees have been terminated. The QFC
employees have been notified of their terminations on various dates
ranging from February 15, 1999 to December 31, 1999. Under severance
agreements, the amount of severance will be paid over a period
following the date of termination.
Lease Obligation
----------------
Fred Meyer closed a QFC store in the first quarter of 1998 and agreed
to dispose of the AG Stores under a settlement agreement with the State
of California. The lease obligation represents future contractual lease
payments on these stores over the expected holding period, net of any
sublease income. The Company is actively marketing the stores to
potential buyers and sub-lease tenants.
Stay Bonus Program
------------------
Represents amounts that were paid under a stay bonus program in the
fourth quarter of 1998.
4. ONE-TIME EXPENSES
In the second quarter of 1998, the Company incurred a $41 one-time
expense associated with logistics projects. This expense included the
costs associated with ending a joint venture related to a warehouse
operation that formerly served the Company's Michigan stores and
several independent customers. The warehouse is now operated by a third
party that distributes the Company's inventory to its Michigan stores.
These expenses also included the transition costs related to one of the
Company's new warehouses, and one new warehouse facility operated by an
unaffiliated entity that provides services to the Company. These costs
included carrying costs of the facilities idled as a result of these
new warehouses and the associated employee severance costs. The
expenses described above included non-cash asset writedowns of $16 and
were included in merchandise costs, including warehouse and
transportation. The remaining $25 of expenses are summarized as
follows:
Cash Amount Accrued
Expense Payments At January 2, 1999
------- -------- ------------------
Employee severance . . . . . . . . . . . $11 $ 7 $ 4
Carrying costs of idled facilities . . . 9 3 6
Ending the Joint Venture . . . . . . . . 5 5 -
--- --- ---
$25 $15 $10
=== === ===
The employee severance costs will be paid through the second quarter of
1999 and we project the carrying costs of the idled warehouse
facilities will be paid through 2001.
12
Additionally, in the second quarter of 1998, the Company incurred
one-time expenses of $12 associated with accounting, data and
operations consolidations in Texas. These included the cost of closing
eight stores and relocating the remaining Dallas office employees to a
smaller facility. These expenses, which included non-cash asset
writedowns of $2, were included in operating, general and
administrative expenses. Cash expenses paid to date are $1 and the
remaining accrual of $9 at January 2, 1999 represents estimated rent or
lease termination costs that will be paid on closed stores through
2013.
5. ACCOUNTING CHANGE
In the second quarter of 1998, Kroger changed its application of the
Last-In, First-Out, or LIFO method of accounting for store inventories
from the retail method to the item cost method. The change was made to
more accurately reflect inventory value by eliminating the averaging
and estimation inherent in the retail method. The cumulative effect of
this change on periods prior to December 28, 1997 cannot be determined.
The effect of the change on the December 28, 1997 inventory valuation,
which includes other immaterial modifications in inventory valuation
methods, was included in restated results for the quarter ended March
21, 1998. This change increased merchandise costs by $90 and reduced
earnings before extraordinary loss and net earnings by $56, or $0.21
per diluted share. The Company has not calculated the pro forma effect
on prior periods because cost information for these periods is not
determinable. The item cost method did not have a material impact on
earnings subsequent to its initial adoption.
6. TAXES BASED ON INCOME
The provision for taxes based on income consists of:
1998 1997 1996
---------- ---------- -------
Federal
Current $ 406 $ 254 $ 186
Deferred (49) 81 54
----- ----- -----
357 335 240
State and local 20 30 25
----- ----- -----
377 365 265
Tax credit from extraordinary loss (162) (77) (2)
----- ----- -----
$ 215 $ 288 $ 263
===== ===== =====
A reconciliation of the statutory federal rate and the effective rate
follows:
1998 1997 1996
---------- ---------- -------
Statutory rate 35.0% 35.0% 35.0%
State income taxes, net of
federal tax benefit 3.8 2.8 2.7
Non-deductible goodwill 3.2 0.6 -
Other, net 1.3 (0.1) -
----- ----- -----
43.3% 38.3% 37.7%
===== ===== =====
The tax effects of significant temporary differences that comprise
deferred tax balances were as follows:
1998 1997
---------- ----------
Current deferred tax assets:
Compensation related costs $ 69 $ 43
Depreciation 35 55
Insurance related costs 72 63
Inventory related costs 54 16
Net operating loss carryforwards 138 4
Other 116 35
----- -----
Total current deferred tax assets 484 216
----- -----
13
Current deferred tax liabilities:
Compensation related costs (103) (85)
Inventory related costs (88) (86)
Other (9) (14)
----- -----
Total current deferred tax liabilities (200) (185)
----- -----
Current deferred taxes, net included
in prepaid and other current assets $ 284 $ 31
===== =====
Long-term deferred tax assets:
Compensation related costs $ 146 $ 138
Insurance related costs 92 45
Lease accounting 58 25
Net operating loss carryforwards 319 65
Other 78 50
----- -----
693 323
Valuation allowance (157) (12)
----- -----
Long-term deferred tax assets, net 536 311
----- -----
Long-term deferred tax liabilities:
Depreciation (407) (483)
Other (55) (72)
----- -----
Total long-term deferred tax liabilities (462) (555)
Long-term deferred taxes, net $ 74 $(244)
===== =====
Long-term deferred taxes, net are included in other assets at January
2, 1999 and other long-term liabilities at December 27, 1997.
The change in the valuation allowance during 1998 relates to the
allocation of the purchase price to Ralphs/Food 4 Less. At January 2,
1999, the Company had net operating loss carryforwards for federal
income tax purposes of $1,257 which expire from 2004 through 2017. In
addition, the Company has net operating loss carryforwards for state
income tax purposes of $641 which expire from 1999 through 2017. The
utilization of certain of the Company's net operating loss
carryforwards may be limited in a given year.
7. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, net consists of:
1998 1997
----------- -----------
Land $ 979 $ 767
Buildings and improvements 2,479 2,094
Equipment 5,288 4,570
Leasehold improvements 1,692 1,368
Construction-in-progress 492 319
Leased property under capital leases 468 340
------- -------
11,398 9,458
Accumulated depreciation (4,178) (3,734)
------- -------
$ 7,220 $ 5,724
======= =======
Accumulated depreciation for leased property under capital leases was
$161 at January 2, 1999 and $133 at December 27, 1997.
Approximately $271 and $369, original cost, of property, plant and
equipment collateralizes certain mortgage obligations at January 2,
1999 and December 27, 1997, respectively.
14
8. DEBT OBLIGATIONS
Long-term debt consists of:
1998 1997
------- -------
Senior Credit Facility $ 3,010 $ 1,746
Credit Agreement 844 1,262
6% to 11% Senior Notes and Debentures due through 2018 3,475 1,267
7.875% to 10.25% mortgages due in varying amounts through 2017 465 692
Other 365 554
------- -------
Total debt 8,159 5,521
Less current portion 311 30
------- -------
Total long-term debt $ 7,848 $ 5,491
======= =======
In conjunction with the acquisitions of QFC and Ralphs/Food 4 Less in
March 1998, the Company entered into new financing arrangements that
refinanced a substantial portion of the Company's debt. The Senior
Credit Facility provides for a $1,875 five-year revolving credit
agreement and a $1,625 five-year term note. All indebtedness under the
Senior Credit Facility is guaranteed by certain of the Company's
subsidiaries and collateralized by the stock of those subsidiaries. The
revolving portion of the Senior Credit Facility is available for
general corporate purposes, including the support of the commercial
paper program of the Company. Commitment fees are charged at .30% on
the unused portion of the five-year revolving credit facility. Interest
on the Senior Credit Facility is at adjusted LIBOR plus a margin of
1.0%. At January 2, 1999, the weighted average interest rate on both
the five year term note and the amounts outstanding under the revolving
credit facility was 5.9%. The Senior Credit Facility requires the
Company to comply with certain ratios related to indebtedness to
earnings before interest, taxes, depreciation and amortization
("EBITDA") and fixed charge coverage. In addition, the Senior Credit
Facility limits dividends on and redemption of capital stock. The
Company may prepay the Senior Credit Facility, in whole or in part, at
any time, without a prepayment penalty.
The Company also has a $1,500 Five Year Credit Agreement and a $500
364-Day Credit Agreement (collectively the "Credit Agreement"). The
Five Year facility terminates on May 28, 2002 unless extended or
earlier terminated by the Company. The 364-Day Credit Agreement would
have terminated in May 1999, but was extended as a $430 facility. The
364-Day facility terminates on May 24, 2000 unless extended, converted
into a two year term loan, or earlier terminated by the Company. The
364-Day Credit Agreement would have terminated in May 1999, but was
extended as a $430 facility. Borrowings under the Credit Agreement bear
interest at the option of the Company at a rate equal to either (i) the
highest, from time to time, of (A) the base rate of Citibank, N.A., (B)
1/2% over a moving average of secondary market morning offering rates
for three month certificates of deposit adjusted for reserve
requirements, and (C) 1/2% over the federal funds rate or (ii) an
adjusted Eurodollar rate based upon the London Interbank Offered Rate
("Eurodollar Rate") plus an Applicable Margin. In addition, the Company
pays a Facility Fee in connection with the Credit Facility. Both the
Applicable Margin and the Facility Fee vary based on the Company's
achievement of a financial ratio. At January 2, 1999, the Applicable
Margin for the 364-Day facility was .140% and for the Five-Year
facility was .120%. The Facility Fee for the 364-Day facility was .060%
and for the Five-Year facility was .080%. The Credit Agreement contains
covenants which among other things, restrict dividends and require the
maintenance of certain financial ratios, including fixed charge
coverage ratios and leverage ratios. The Company may prepay the Credit
Agreement, in whole or in part, at any time, without a prepayment
penalty.
In December 1998, the Senior Credit Facility and the Credit Agreement
were amended to permit the merger of Kroger and Fred Meyer (See note
2). The amendments, which became effective when the merger was
completed, increased interest rates on the Credit Agreement to market
rates.
Unrated commercial paper borrowings of $830 and borrowings under money
market lines of $105 at January 2, 1999 have been classified as
long-term because the Company expects that during 1999 these borrowings
will be refinanced using the same type of securities. Additionally, the
Company has the ability to refinance these borrowings on a long-term
basis and has presented the amounts as outstanding under the Credit
Agreement or the Senior Credit Facility. The money market lines, which
generally have terms of approximately one year, allow the Company to
borrow from the banks at mutually agreed upon rates, usually below the
rates offered under the Senior Credit Facility.
15
All of the Senior Notes and Debentures are subject to early redemption
at varying times and premiums beginning in 1999. In addition, subject
to certain conditions (including repayment in full of all obligations
under the Credit Agreement or obtaining the requisite consents under
the Credit Agreement), the Company's publicly issued debt will be
subject to redemption, in whole or in part, at the option of the holder
upon the occurrence of a redemption event, upon not less than five
days' notice prior to the date of redemption, at a redemption price
equal to the default amount, plus a specified premium. "Redemption
Event" is defined in the indentures as the occurrence of (i) any person
or group, together with any affiliate thereof, beneficially owning 50%
or more of the voting power of the Company or (ii) any one person or
group, or affiliate thereof, succeeding in having a majority of its
nominees elected to the Company's Board of Directors, in each case,
without the consent of a majority of the continuing directors of the
Company.
The aggregate annual maturities and scheduled payments of long-term
debt for the five years subsequent to 1998 are:
1999 $ 311
2000 $ 462
2001 $ 385
2002 $ 1,480
2003 $ 2,178
The extraordinary loss in 1998, 1997 and 1996 relates to premiums paid
to retire certain indebtedness early and the write-off of related
deferred financing costs.
9. INTEREST RATE PROTECTION PROGRAM
The Company uses derivatives to limit its exposure to rising interest
rates. The guidelines the Company follows are: (i) use average daily
bank balance to determine annual debt amounts subject to interest rate
exposure, (ii) limit the annual amount of debt subject to interest rate
reset and the amount of floating rate debt to a combined total of
$2,300 or less, (iii) include no leveraged products, and (iv) hedge
without regard to profit motive or sensitivity to current
mark-to-market status.
The table below indicates the types of derivatives used, their
duration, and their respective interest rates. The variable component
of each interest rate derivative is based on the 6 month LIBOR using
the forward yield curve.
1998 1997
---------- -------
Receive fixed swaps
Notional amount . . . . . . . . . . . . . . . . . . . . . $ 785 $1,085
Duration in years . . . . . . . . . . . . . . . . . . . . 2.0 3.0
Average receive rate. . . . . . . . . . . . . . . . . . . 6.50% 6.33%
Average pay rate. . . . . . . . . . . . . . . . . . . . . 5.30% 5.79%
Receive variable swaps
Notional amount . . . . . . . . . . . . . . . . . . . . . $ 925 $1,345
Duration in years . . . . . . . . . . . . . . . . . . . . 2.4 2.7
Average receive rate. . . . . . . . . . . . . . . . . . . 5.57% 5.85%
Average pay rate. . . . . . . . . . . . . . . . . . . . . 7.09% 6.91%
Interest rate caps
Notional amount . . . . . . . . . . . . . . . . . . . . . $ - $ 200
Duration in years . . . . . . . . . . . . . . . . . . . . - .9
Average receive rate. . . . . . . . . . . . . . . . . . . - 5.81%
At January 2, 1999, the Company had entered into a two year $75 receive
variable swap that becomes effective July 1, 1999. In addition, the
Company has an interest rate collar which limits the interest rate on a
notional amount of $300 to a variable rate between 4.10% and 6.50%
until 2003.
16
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair
value of each class of financial instruments for which it is
practicable to estimate that value:
Long-term Investments
---------------------
The fair values of these investments are estimated based on quoted
market prices for those or similar investments.
Long-term Debt
--------------
The fair value of the Company's long-term debt, including the current
portion, thereof, is estimated based on the quoted market price for the
same or similar issues. The fair value of commercial paper and
long-term debt outstanding under the Company's credit agreements
approximates carrying value.
Interest Rate Protection Agreements
-----------------------------------
The fair value of these agreements is based on the net present value of
the future cash flows using the forward interest rate yield curve in
effect at the respective year-ends.
The estimated fair values of the Company's financial instruments are as
follows:
1998 1997
-------------------- ------------------
Estimated
Carrying Fair Carrying Fair
Value Value Value Value
------- --------- -------- ------
Long-term investments for which it is
Practicable ............................. $ 96 $ 97 $ 177 $ 178
Not Practicable ......................... $ 9 $ -- $ 34 $ --
Long-term debt for which it is
Practicable ............................. $ 7,687 $ 7,973 $ 5,005 $ 5,138
Not Practicable ......................... $ 472 $ -- $ 516 $ --
Interest Rate Protection Agreements
Receive fixed swaps ..................... $ -- $ 22 $ -- $ 11
Receive variable swaps .................. -- (43) -- (43)
Interest rate caps and collars .......... -- (6) 1 --
------- ------- ------- -------
$ -- $ (27) $ 1 $ (32)
======= ======= ======= =======
The use of different assumptions and/or estimation methodologies may
have a material effect on the estimated fair value amounts.
Accordingly, the estimates presented herein are not necessarily
indicative of the amounts that the Company could actually realize. In
addition, the Company is not subjected to a concentration of credit
risk related to these instruments.
The investments for which it was not practicable to estimate fair value
relate to equity investments accounted for under the equity method and
investments in real estate development partnerships for which there is
no market. The long-term debt for which it was not practicable to
estimate fair value relates to Industrial Revenue Bonds, certain
mortgages and other notes for which there is no market.
11. LEASES
The Company operates primarily in leased facilities. Lease terms
generally range from 10 to 25 years with options to renew at varying
terms. Terms of certain leases include escalation clauses, percentage
rents based on sales, or payment of executory costs such as property
taxes, utilities, or insurance and maintenance. Portions of certain
properties are subleased to others for periods of from one to 20 years.
Rent expense under operating leases consists of:
1998 1997 1996
---------- ---------- -------
Minimum rentals $ 683 $ 515 $ 437
Contingent payments 18 14 13
Sublease income (82) (64) (57)
----- ----- -----
Net rent expense $ 619 $ 465 $ 393
===== ===== =====
17
Minimum annual rentals for the five years subsequent to 1998 and in the
aggregate are:
Capital Operating
Leases Leases
------- ---------
1999 $ 87 $ 657
2000 77 629
2001 65 598
2002 59 553
2003 54 532
Thereafter 500 4,998
---- ------
Total 842 $7,967
======
Less estimated executory costs included
in capital leases 16
----
Net minimum lease payments under capital leases 826
Less amount representing interest 412
----
Present value of net minimum lease payments
under capital leases $414
====
Total future minimum rentals under noncancellable subleases at January
2, 1999 were $417.
On March 11, 1998, the Company entered into a $500 five-year synthetic
lease credit facility that refinanced $303 in existing lease financing
facilities. Lease payments are based on LIBOR applied to the utilized
portion of the facility. As of January 2, 1999, the Company had
utilized $364 of the facility.
12. 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. 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. Actual claim settlements and expenses incident thereto may
differ from the provisions for loss. Property risks have been
underwritten by a subsidiary and are reinsured with unrelated insurance
companies. Operating divisions and subsidiaries have paid premiums, and
the insurance subsidiary has provided loss allowances, based upon
actuarially determined estimates.
Litigation
----------
The Company is involved in various legal actions arising in the normal
course of business. Although occasional adverse decisions (or
settlements) may occur, the Company believes that the final disposition
of such matters will not have a material adverse effect on the
financial position or results of operations of the Company.
Purchase commitment
-------------------
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 the
Company 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
18
engaged in efforts to dispose of its interest in Santee, which may
result in a loss.
13. WARRANT DIVIDEND PLAN
On February 28, 1986, Kroger adopted a warrant dividend plan providing
for stock purchase rights to owners of the Company's common stock. The
Plan was amended and restated as of April 4, 1997. Each share of common
stock currently has attached one-half of a right. Each right, when
exercisable, entitles the holder to purchase from the Company one
ten-thousandth of a share of Series A Preferred Shares, par value $100
per share, at $87.50 per on ten-thousandth of a share. The rights will
become exercisable, and separately tradeable, ten business days
following a tender offer or exchange offer resulting in a person or
group having beneficial ownership of 10% or more of the Company's
common stock. In the event the rights become exercisable and thereafter
the Company is acquired in a merger or other business combination, each
right will entitle the holder to purchase common stock of the surviving
corporation, for the exercise price, having a market value of twice the
exercise price of the right. Under certain other circumstances,
including certain acquisitions of the Company in a merger or other
business combination transaction, or if 50% or more of the Company's
assets or earning power are sold under certain circumstances, each
right will entitle the holder to receive upon payment of the exercise
price, shares of common stock of the acquiring company with a market
value of two times the exercise price. At the Company's option, the
rights, prior to becoming exercisable, are redeemable in their entirety
at a price of $.01 per right. The rights are subject to adjustment and
expire March 19, 2006.
14. BENEFIT PLANS
The Company administers non-contributory defined benefit retirement
plans for certain non-union employees. Funding for the pension plans is
based on a review of the specific requirements and on evaluation of the
assets and liabilities of each plan.
In addition to providing pension benefits, the Company provides certain
health care and life insurance benefits for retired employees. The
majority of the Company's employees may become eligible for these
benefits if they reach normal retirement age while employed by the
Company. Funding of retiree health care and life insurance benefits
occurs as claims or premiums are paid.
Information with respect to change in benefit obligation, change in
plan assets, net amounts recognized at end of year, weighted average
assumptions and components of net periodic benefit cost follows:
Pension Benefits Other Benefits
------------------ ------------------
1998 1997 1998 1997
--------- -------- --------- --------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year .......... $ 990 $ 874 $ 255 $ 259
Addition to benefit obligation from acquisitions . 94 39 16 --
Service cost ..................................... 37 28 9 10
Interest cost .................................... 77 69 18 20
Plan participants' contributions ................. -- -- 4 4
Amendments ....................................... -- -- (11) (5)
Actuarial loss (gain) ........................... 51 27 15 (13)
Curtailment credit ............................... -- -- (17) --
Benefits paid .................................... (57) (47) (17) (20)
------- ------- ------- -------
Benefit obligation at end of year ................ $ 1,192 $ 990 $ 272 $ 255
======= ======= ======= =======
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year ... $ 1,153 $ 948 $ -- $ --
Addition to plan assets from acquisitions ........ 63 57 -- --
Actual return on plan assets ..................... 206 193 -- --
Employer contribution ............................ 11 2 13 16
Plan participants' contributions ................. -- -- 4 4
Benefits paid .................................... (57) (47) (17) (20)
------- ------- ------- -------
Fair value of plan assets at end of year ......... $ 1,376 $ 1,153 $ -- $ --
======= ======= ======= =======
19
Pension plan assets include $167 and $149 of common stock of The Kroger
Co. at January 2, 1999 and December 27, 1997, respectively.
Pension Benefits Other Benefits
---------------- --------------
1998 1997 1998 1997
---- ---- ---- ----
NET AMOUNT RECOGNIZED AT END OF YEAR:
Funded status at end of year ..................... $ 183 $ 163 $(272) $(255)
Unrecognized actuarial gain ...................... (204) (148) (35) (52)
Unrecognized prior service cost .................. 19 21 (31) (23)
Unrecognized net transition asset ................ (5) (6) $ 1 1
----- ----- ----- -----
Net amount recognized at end of year ............. $ (7) $ 30 $(337) $(329)
===== ===== ===== =====
Prepaid benefit cost ............................. $ 48 $ 54 $ -- $ --
Accrued benefit liability ........................ (55) (24) (337) (329)
----- ----- ----- -----
$ (7) $ 30 $(337) $(329)
===== ===== ===== =====
WEIGHTED AVERAGE ASSUMPTIONS:
Discount rate .................................... 6.75% 7.25% 6.75% 7.25%
Expected return on plan assets ................... 9.50% 9.50%
Rate of compensation increase .................... 3.25% 3.75% 3.25% 3.75%
For measurement purposes, a 5 percent annual rate of increase in the
per capita cost of other benefits was assumed for 1999 and thereafter.
Pension Benefits Other Benefits
------------------- --------------------
1998 1997 1996 1998 1997 1996
---- ---- ---- ---- ---- ----
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost ........................... $ 37 $ 28 $ 26 $ 9 $ 10 $ 10
Interest cost .......................... 77 69 61 18 20 19
Expected return on plan assets ......... (98) (82) (76) -- -- --
Amortization of:
Transition asset ................... -- (9) (8) -- -- --
Prior service cost ................. 2 2 2 (3) (1) (1)
Actuarial (gain) loss .............. 1 -- -- (1) (1) --
Curtailment credit ..................... -- -- -- (17) -- --
---- ---- ---- ---- ---- ----
Net periodic benefit cost .............. $ 19 $ 8 $ 5 $ 6 $ 28 $ 28
==== ==== ==== ==== ==== ====
The accumulated benefit obligation and fair value of plan assets for
pension plans with accumulated benefit obligations in excess of plan
assets were $123 and $69 at January 2, 1999 and $24 and $0 at December
27, 1997.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point
change in the assumed health care cost trend rates would have the
following effects:
1% POINT 1% POINT
INCREASE DECREASE
-------- --------
Effect on total of service and interest cost components ........ $ 3 $ (3)
Effect on postretirement benefit obligation .................... $ 28 $(24)
The Company also administers certain defined contribution plans for
eligible union and non-union employees. The cost of these plans for
1998, 1997, and 1996 was $40, $32, and $29, respectively.
The Company participates in various multi-employer plans for
substantially all union employees. Benefits are generally based on a
fixed amount for each year of service. Contributions and expense for
1998, 1997, and 1996 were $133, $119, and $103, respectively.
20
15. STOCK OPTION PLANS
The Company grants options for common stock to employees under various
plans, as well as to its non-employee directors owning a minimum of
1,000 shares of common stock of the Company, at an option price equal
to the fair market value of the stock at the date of grant. In addition
to cash payments, the plans provide for the exercise of options by
exchanging issued shares of stock of the Company. At January 2, 1999,
7.8 million shares of common stock were available for future options.
Options generally will expire 10 years from the date of grant.
Currently granted options vest in one year to five years or, for
certain options, upon the Company's stock reaching certain
pre-determined market prices within ten years from the date of the
grant. Outstanding options generally become immediately exercisable
upon certain changes of control of the Company.
Changes in options outstanding under the stock option plans, excluding
restricted stock grants were:
Shares subject Weighted average
to option exercise price
-------------- ----------------
(In millions)
Outstanding, year-end 1995 33.0 $ 10.32
Granted 10.5 $ 17.92
Exercised (5.7) $ 8.96
Canceled or expired (2.0) $ 16.60
----
Outstanding, year-end 1996 35.8 $ 12.41
Granted 8.3 $ 25.68
Options of an acquired company 1.5 $ 7.33
Exercised (7.3) $ 10.34
Canceled or expired (.5) $ 12.92
----
Outstanding, year-end 1997 37.8 $ 15.50
Granted 5.0 $ 41.09
Exercised (9.5) $ 12.60
Canceled or expired (.5) $ 27.25
----
Outstanding, year-end 1998 32.8 $ 20.39
====
A summary of options outstanding and exercisable at January 2, 1999
follows:
Weighted-Average
Range of Number Remaining Weighted-Average Options Weighted-Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
--------------- ----------- ---------------- -------------- ----------- --------------
(In millions) (In years) (In millions)
$ 3.33 - $10.29 5.5 3.0 $ 8.08 5.5 $ 8.08
10.57 - 12.97 9.3 5.1 12.07 9.1 11.84
13.02 - 20.75 7.5 7.4 18.89 5.7 19.05
21.19 - 41.63 6.8 8.6 30.18 1.8 27.92
42.13 - 54.47 3.7 9.3 44.64 - -
----- -----
$ 3.33 - $54.47 32.8 6.5 $ 20.39 22.1 $ 14.16
===== =====
The Company applies Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees", and related interpretations
in accounting for its plans. Had compensation cost for the Company's
stock option plans been determined based upon the fair value at the
grant date for awards under these plans consistent with the methodology
prescribed under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation", the Company's net earnings
and diluted earnings per common share would have been reduced to the
pro forma amounts below:
21
1998 1997 1996
------------------- ------------------- ------------------
Actual Pro Forma Actual Pro Forma Actual Pro Forma
Net earnings $ 237 $ 195 $ 465 $ 425 $ 433 $ 416
Diluted earnings per common share $ 0.56 $ 0.46 $ 1.25 $ 1.14 $1.26 $ 1.21
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model, based on historical
assumptions from each respective Company. These amounts reflected in
this proforma disclosure are not indicative of future amounts. The
following table reflects the assumptions used for grants awarded in
each year to option holders of the respective companies:
1998 1997 1996
--------- --------- ---------
Kroger
------
Weighted average expected volatility (based on historical volatility) 26.60% 24.00% 22.70%
Weighted average risk-free interest rate 4.60% 5.70% 6.30%
Expected term 7.8 years 5.4 years 3.3 years
Fred Meyer
----------
Weighted average expected volatility (based on historical volatility) 39.37% 33.67% 34.97%
Weighted average risk-free interest rate 5.32% 6.10% 5.77%
Expected term 5.0 years 5.0 years 5.0 years
QFC
---
Weighted average expected volatility (based on historical volatility) n/a 43.50% 44.70%
Weighted average risk-free interest rate n/a 5.50% 5.12%
Expected term n/a 5.0 years 5.0 years
The weighted average fair value of options granted during 1998, 1997,
and 1996 was $19.73, $11.72, and $5.94, respectively.
16. EARNINGS PER COMMON SHARE
Basic earnings per common share equals net earnings divided by the
weighted average number of common shares outstanding. Diluted
earnings per common share equals net earnings divided by the
weighted average number of common shares outstanding after giving
effect to dilutive stock options and warrants.
The following table provides a reconciliation of earnings before
extraordinary loss and shares used in calculating basic earnings
per share to those used in calculating diluted earnings per share.
1998 1997 1996
------------------------- ------------------------- -------------------------
(In millions, except per share amounts)
-----------------------------------------------------------------------------
Income Shares Per Income Shares Per Income Shares Per
(Numer- (Denomi- Share (Numer- (Denomi- Share (Numer- (Denomi- Share
ator) nator) Amount ator) nator) Amount ator) nator) Amount
--------- ------- ------ -------- -------- ------ -------- ------- ------
Basic earnings per
common share.............. $ 494 408 $ 1.21 $ 589 359 $ 1.64 $ 436 331 $ 1.32
Dilutive effect of stock
options and warrants...... - 18 - 13 - 12
-------- -------- -------- -------- -------- --------
Diluted earnings per
common share.............. $ 494 426 $ 1.16 $ 589 372 $ 1.58 $ 436 343 $ 1.27
======== ======== ======== ======== ======== ========
22
17. RELATED-PARTY TRANSACTIONS
The Company had a management agreement for management and financial
services with The Yucaipa Companies ("Yucaipa"), whose managing general
partner became Chairman of the Executive Committee of the Board
effective May 27, 1999. The arrangement provides for annual management
fees of $.5 plus reimbursement of Yucaipa's reasonable out-of-pocket
costs and expenses. In 1998, the Company paid to Yucaipa approximately
$20 for services rendered in conjunction with the Ralphs/Food 4 Less
and QFC mergers and termination fees of Ralphs/Food 4 Less management
agreement. This agreement was terminated by Yucaipa upon consummation
of the Kroger and Fred Meyer merger (see note 2).
Yucaipa holds a warrant for the purchase of up to 3.9 million shares of
Common Stock at an exercise price of $23.81 per share. Half of the
warrant expires in 2005 and half expires in 2006. Additionally, at the
option of Yucaipa, the warrant is exercisable without the payment of
cash consideration. Under this condition, the Company will withhold
upon exercise the number of shares having a market value equal to the
aggregate exercise price from the shares issuable.
18. RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities", which will require a change in the
way that the Company accounts for its interest rate protection
agreements. In May 1999, the Financial Accounting Standards Board
issued an exposure draft requiring adoption of the standard for all
fiscal years beginning after June 15, 2000. Because of the uncertainty
of the Company's interest rate protection agreements and potential
changes in the debt portfolio as a result of the Fred Meyer merger, the
Company has not yet determined the expected impact, if any, that the
adoption of the standard will have on the financial statements.
The Accounting Standards Executive Committee of the American Institute
of Certified Public Accountants issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use", which is effective for fiscal years beginning after
December 15, 1998. The Company's accounting policy is consistent with
this statement. The Accounting Standards Executive Committee of the
American Institute of Certified Public Accountants also issued
Statement of Position 98-5, "Reporting on the Costs of Start-Up
Activities", which is effective for fiscal years beginning after
December 15, 1998. This statement is expected to have no effect on the
financial statements.
19. SUBSEQUENT EVENT
On January 6, 1999, the Company changed its fiscal year-end to the
Saturday nearest January 31 of each year. The first new fiscal year
ends January 29, 2000 and includes a 16-week first quarter ending May
22, 1999, and 12-week second, third and fourth quarters ending August
14, 1999, November 6, 1999, and January 29, 2000, respectively.
On May 20, 1999, the Company announced a distribution in the nature of
a two-for-one split, to shareholders of record of common stock on June
7, 1999. The financial statements do not reflect this distribution.
20. GUARANTOR SUBSIDIARIES
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 August 14, 1999 a total of approximately
$4.0 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,
except, however, the obligations of each guarantor under its guarantee
are limited to the maximum amount as will result in obligations 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
January 2, 1999 and December 27, 1998, and for the three years ended
January 2, 1999.
Summarized financial information as of January 2, 1999 and the year
then ended:
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------ ------ ------------ ------------ ------------
Current assets $ 734 $ 4,337 $ - $ 5,071
Non-current assets 5,622 10,398 (4,450) 11,570
Current liabilities 1,199 4,251 - 5,450
Non-current liabilities 3,240 6,034 - 9,274
Sales 8,849 34,845 (612) 43,082
Gross profit 1,566 9,543 (85) 11,024
Operating profit (94) 1,610 - 1,516
Net earnings 237 453 (453) 237
Summarized financial information as of December 27, 1997 and for the
year then ended:
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------ ------ ------------ ------------ ------------
Current assets $ 712 $ 3,550 $ - $ 4,262
Non-current assets 4,570 6,379 (3,493) 7,456
Current liabilities 1,058 3,078 - 4,136
Non-current liabilities 3,307 3,358 - 6,665
Sales 8,220 26,299 (592) 33,927
Gross profit 1,604 6,957 (102) 8,459
Operating profit 114 1,228 - 1,342
Net earnings 465 566 (566) 465
Summarized financial information for the year ended December 28,
1996:
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------ ------ ------------ ------------ ------------
Sales $ 7,994 $22,341 $(634) $29,701
Gross profit 1,686 5,631 (102) 7,215
Operating profit 291 759 - 1,050
Net earnings 433 403 (403) 433
23
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders of The Kroger Co.
In our opinion, based upon our audits and the report of other auditors, the
accompanying consolidated balance sheet, and the related consolidated
statements of operations, changes in shareowners' equity (deficit) and cash
flows present fairly, in all material respects, the financial position of The
Kroger Co. and its subsidiaries at January 2, 1999 and December 27, 1997, and
the results of their operations and their cash flows for the years ended January
2, 1999, December 27, 1997, and December 28, 1996, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
financial statements of Fred Meyer, Inc., a wholly-owned subsidiary, which
statements reflect total assets of $10.2 billion and $5.4 billion at January 2,
1999 and December 27, 1997, respectively, and sales of $14.9 billion, $7.4
billion and $4.5 billion for the fiscal years ended January 2, 1999, December
27, 1997 and December 28, 1996, respectively. Those statements were audited by
other auditors whose report thereon has been furnished to us, and our opinion
expressed herein, insofar as it relates to the amounts included for Fred Meyer,
Inc., is based solely on the report of the other auditors. We conducted our
audits of these consolidated statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits and the reports of other auditors provide a reasonable basis for the
opinion expressed above.
As described in Note 5 to the consolidated financial statements, the Company
changed its application of the LIFO method of accounting for store inventories
as of December 28, 1997.
(PricewaterhouseCoopers LLP)
Cincinnati, Ohio
May 28, 1999