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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 August 17, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________________ to ________________________
Commission file number 1-303
THE KROGER CO.
------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 31-0345740
- -------------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1014 Vine Street, Cincinnati, OH 45202
------------------------------------------------------------
(Address of principal executive offices)
(Zip Code)
(513) 762-4000
------------------------------------------------------------
(Registrant's telephone number, including area code)
Unchanged
------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No____.
-----
There were 773,232,383 shares of Common Stock ($1 par value) outstanding as of
September 25, 2002.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
THE KROGER CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
(in millions, except per share amounts)
(unaudited)
Second Quarter Ended Two Quarters Ended
-------------------------- ---------------------------
August 17, August 18, August 17, August 18,
2002 2001 2002 2001
------------- ------------ ------------- ------------
Sales ....................................................................... $11,927 $11,485 $27,594 $26,587
------- ------- ------- -------
Merchandise costs, including advertising, warehousing, and transportation ... 8,738 8,330 20,177 19,364
Operating, general and administrative ....................................... 2,216 2,184 5,104 5,025
Rent ........................................................................ 151 152 354 354
Depreciation and amortization ............................................... 247 246 570 566
Restructuring charges and related items ..................................... 2 -- 15 --
Merger-related costs ........................................................ (1) 2 1 4
------- ------- ------- -------
Operating profit ......................................................... 574 571 1,373 1,274
Interest expense ............................................................ 137 152 326 357
------- ------- ------- -------
Earnings before income tax expense, extraordinary loss and cumulative
effect of an accounting change ......................................... 437 419 1,047 917
Income tax expense .......................................................... 164 163 393 358
------- ------- ------- -------
Earnings before extraordinary loss and cumulative effect of an
accounting change ...................................................... 273 256 654 559
Extraordinary loss, net of income tax benefit ............................... (9) -- (12) --
------- ------- ------- -------
Earnings before cumulative effect of an accounting change ................ 264 256 642 559
Cumulative effect of an accounting change, net of income tax benefit ........ -- -- (16) --
------- ------- ------- -------
Net earnings ............................................................. $ 264 $ 256 $ 626 $ 559
======= ======= ======= =======
Earnings per basic common share:
Earnings before extraordinary loss and cumulative effect of an
accounting change ...................................................... $ 0.35 $ 0.32 $ 0.83 $ 0.69
Extraordinary loss, net of income tax benefit ............................ (0.01) 0.00 (0.02) 0.00
Cumulative effect of an accounting change, net of income tax benefit ..... 0.00 0.00 (0.02) 0.00
------- ------- ------- -------
Net earnings ........................................................... $ 0.34 $ 0.32 $ 0.79 $ 0.69
======= ======= ======= =======
Average number of common shares used in basic calculation ................... 786 805 790 809
Earnings per diluted common share:
Earnings before extraordinary loss and cumulative effect of an
accounting change ...................................................... $ 0.34 $ 0.31 $ 0.81 $ 0.67
Extraordinary loss, net of income tax benefit ............................ (0.01) 0.00 (0.01) 0.00
Cumulative effect of an accounting change, net of income tax benefit ..... 0.00 0.00 (0.02) 0.00
------- ------- ------- -------
Net earnings ........................................................... $ 0.33 $ 0.31 $ 0.78 $ 0.67
======= ======= ======= =======
Average number of common shares used in diluted calculation ................. 800 827 805 830
The accompanying notes are an integral part
of the consolidated financial statements.
1
THE KROGER CO. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in millions, except per share amounts)
(unaudited)
August 17, February 2,
2002 2002
------------------ ---------------
ASSETS
Current assets ............................................................
Cash ................................................................... $ 167 $ 161
Receivables ............................................................ 604 679
Inventories ............................................................ 4,076 4,178
Prepaid and other current assets........................................ 300 494
--------- ---------
Total current assets ............................................... 5,147 5,512
Property, plant and equipment, net ........................................ 10,226 9,657
Goodwill, net ............................................................. 3,566 3,594
Fair value interest rate hedges ........................................... 65 18
Other assets .............................................................. 294 306
--------- ---------
Total Assets ....................................................... $ 19,298 $ 19,087
========= =========
LIABILITIES
Current liabilities
Current portion of long-term debt including obligations under
capital leases .................................................... $ 437 $ 436
Accounts payable ....................................................... 3,293 3,005
Salaries and wages ..................................................... 524 584
Other current liabilities .............................................. 1,525 1,460
--------- ---------
Total current liabilities .......................................... 5,779 5,485
Long-term debt including obligations under capital leases..................
Face value long-term debt including obligations under capital leases ... 7,848 8,412
Adjustment to reflect fair value interest rate hedges .................. 65 18
--------- ---------
Long-term debt including obligations under capital leases .............. 7,913 8,430
Other long-term liabilities ............................................... 1,878 1,670
--------- ---------
Total Liabilities .................................................. 15,570 15,585
--------- ---------
Commitments and Contingencies (Note 11)
SHAREOWNERS' EQUITY
Preferred stock, $100 par, 5 shares authorized
and unissued ........................................................... -- --
Common stock, $1 par, 1,000 shares authorized: 905 shares issued
in 2002 and 901 shares issued in 2001 .................................. 905 901
Additional paid-in capital ................................................ 2,271 2,217
Accumulated other comprehensive loss ...................................... (33) (33)
Accumulated earnings ...................................................... 2,773 2,147
Common stock in treasury, at cost, 129 shares in 2002 and
106 shares in 2001 ..................................................... (2,188) (1,730)
--------- ----------
Total Shareowners' Equity .......................................... 3,728 3,502
--------- ---------
Total Liabilities and Shareowners' Equity .......................... $ 19,298 $ 19,087
========= =========
- -----------------------------------------------------------------------------
The accompanying notes are an integral part
of the consolidated financial statements.
2
THE KROGER CO. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in millions)
(unaudited)
Two Quarters Ended
-------------------------------
August 17, August 18,
2002 2001
-------------- --------------
Cash Flows From Operating Activities:
Net earnings .......................................................... $ 626 $ 559
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Cumulative effect of an accounting change ......................... 16 --
Extraordinary loss ................................................ 12 --
Depreciation and other amortization ............................... 570 509
Goodwill amortization ............................................. -- 57
Non-cash items .................................................... 1 4
LIFO charge ....................................................... 12 20
Deferred income taxes ............................................. 100 65
Other ............................................................. 16 10
Changes in operating assets and liabilities net of
effects from acquisitions of businesses:
Inventories .................................................... 90 22
Receivables .................................................... 75 52
Accounts payable ............................................... 343 292
Other .......................................................... 300 235
-------- --------
Net cash provided by operating activities .................. 2,161 1,825
-------- --------
Cash Flows From Investing Activities:
Capital expenditures .................................................. (1,029) (1,148)
Proceeds from sale of assets .......................................... 50 25
Payments for acquisitions, net of cash acquired ....................... (109) (85)
Other ................................................................. 6 12
-------- --------
Net cash used by investing activities ...................... (1,082) (1,196)
-------- --------
Cash Flows From Financing Activities:
Proceeds from issuance of long-term debt .............................. 853 1,290
Reductions in long-term debt .......................................... (1,422) (1,292)
Debt prepayment costs ................................................. (14) --
Financing charges incurred ............................................ (10) (14)
Decrease in book overdrafts ........................................... (55) (198)
Proceeds from issuance of capital stock ............................... 28 46
Treasury stock purchases .............................................. (453) (485)
-------- --------
Net cash provided (used) by financing activities ........... (1,073) (653)
-------- --------
Net increase (decrease) in cash and temporary cash investments ............ 6 (24)
Cash and temporary investments:
Beginning of year ................................................. 161 161
-------- --------
End of quarter .................................................... $ 167 $ 137
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest ............................ $ 313 $ 358
Cash paid during the year for income taxes ........................ $ 191 $ 143
Non-cash changes related to purchase acquisitions:
Fair value of assets acquired .................................. $ 109 $ 53
Goodwill recorded .............................................. $ -- $ 45
Liabilities assumed ............................................ $ -- $ 14
The accompanying notes are an integral part
of the consolidated financial statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Certain prior-year amounts have been reclassified to conform to
current-year presentation and all amounts presented 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. The February 2, 2002 balance
sheet was derived from audited financial statements, and, due to its
summary nature, does not include all disclosures required by generally
accepted accounting principles. 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) that are necessary for a fair presentation of
results of operations for such periods but should not be considered as
indicative of results for a full year. The financial statements have
been prepared by the Company pursuant to the rules and regulations of
the Securities and Exchange Commission ("SEC"). Certain information and
footnote disclosures normally included in financial statements prepared
in accordance with 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 2001 Annual Report on Form 10-K of The Kroger Co. filed with
the SEC on May 1, 2002, as amended.
The unaudited information included in the consolidated financial
statements for the second quarter and two quarters ended August 17,
2002 and August 18, 2001 includes the results of operations of the
Company for the 12-week and 28-week periods then ended.
2. MERGER-RELATED COSTS
The Company is continuing the process of implementing its integration
plan relating to recent mergers. During the first and second quarters
of 2001, and the first quarter of 2002, the Company recorded pre-tax,
non-cash merger-related costs of $2 resulting from the issuance of
restricted stock. The market value adjustment of the restricted stock
resulted in a pre-tax, non-cash credit of $1 in the second quarter of
2002. Restrictions on the stock awards lapsed based on the achievement
of synergy goals. All synergy-based awards were earned provided that
recipients were still employed by the Company on the stated restriction
lapsing date.
The following table is a summary of the changes in accruals related to
various business combinations:
Facility Employee Incentive Awards and
Closure Costs Severance Contributions
--------------- ----------- ----------------------
Balance at February 3, 2001 ..... $ 113 $ 18 $ 35
Additions ................... -- -- 4
Payments .................... (19) (3) (9)
------- ------- -------
Balance at February 2, 2002 ..... 94 15 30
Additions ................... -- -- 1
Payments .................... (5) (7) (11)
------- ------- -------
Balance at August 17, 2002 ...... $ 89 $ 8 $ 20
======= ======= =======
4
3. ONE-TIME ITEMS
In addition to the merger-related costs described in Note 2, the
Company incurred pre-tax one-time expenses of $4 and $9 during the
second quarters of 2002 and 2001, respectively. Second quarter 2002
amounts included $1 of expense resulting from the market value
adjustment of excess energy purchase contracts. In the first quarter
2002, the Company recorded pre-tax one-time income of $7 from the
market value adjustment of these contracts. For the first two quarters
of 2002, pre-tax one-time items netted to zero. Pre-tax one-time
expense totaled $24 for the first two quarters of 2001.
The one-time items were included in merchandise costs and operating,
general and administrative expense in 2001 and in operating, general
and administrative expense in 2002. Pre-tax expenses of $4 and $7 were
included in operating, general and administrative expense in the second
quarters of 2002 and 2001, respectively. Pre-tax expenses of $2 were
included in merchandise costs in the second quarter, 2001. For the
first two quarters of 2002, the pre-tax one-time items included in
operating, general and administrative expense netted to zero. For the
first two quarters of 2001, the one-time items included in operating,
general and administrative expense totaled $19 of pre-tax expense. The
remaining $5 of pre-tax expense recorded in the first two quarters of
2001 was included in merchandise costs. Details of these charges are:
Second Quarter Ended Two Quarters Ended
---------------------------------- -------------------------------
August 17, August 18, August 17, August 18,
2002 2001 2002 2001
--------------- -------------- ------------- --------------
One-time items in merchandise costs
Costs related to mergers ............................ $ -- $ 2 $ -- $ 5
------ ------ ------- ------
-- 2 -- 5
One-time items in operating, general and administrative
expense
Costs related to mergers ............................ 3 7 6 19
Market value adjustments of energy contracts ........ 1 -- (6) --
------ ------ ------- ------
4 7 -- 19
Total one-time items ......................................... $ 4 $ 9 $ -- $ 24
====== ====== ======= ======
Costs related to mergers
In 2001, product costs for excess capacity totaling $5 were included as
merchandise costs. The remaining $19 of expense in 2001 primarily
related to employee severance and system conversion costs and was
included as operating, general and administrative expenses. In 2002,
approximately $6 of expense related to system conversion costs and was
included as operating, general and administrative expense. All of the
costs in 2001 and $5 of the costs in 2002 represented cash
expenditures.
Energy contracts
During March through May 2001, the Company entered into four separate
commitments to purchase electricity from one of its utility suppliers
in southern California. At the inception of the contracts, forecasted
electricity usage indicated that it was probable that all of the
electricity would be utilized in the operations of the Company. The
Company, therefore, accounted for the contracts in accordance with the
normal purchases and normal sales exception under Statement of
Financial Accounting Standards ("SFAS") No. 133, as amended, and no
amounts were initially recorded in the financial statements related to
these purchase commitments.
During the third quarter 2001, the Company determined that one of the
contracts, and a portion of a second contract, provided for supplies in
excess of the Company's expected demand for electricity. This precluded
use of the normal purchases and normal sales exception under SFAS No.
133 for those contracts, and required the contracts to be marked to
fair value through current-period earnings. The Company, therefore,
recorded a pre-tax non-cash charge of $81 in the third quarter 2001 to
accrue liabilities for the estimated fair value of these contracts
through December 2006. The remaining portion of the second contract was
re-designated as a cash flow hedge of future purchases. The other two
purchase commitments continue to qualify for the normal purchases and
normal sales exception under SFAS No. 133.
5
SFAS No. 133 requires the excess contracts to be marked to fair value
through current-period earnings each quarter. Due to an increase in the
forward market prices for electricity in southern California during the
first quarter 2002, the Company recorded pre-tax non-cash income of $7
to mark the excess contracts to estimated fair value as of May 25,
2002. Short-term forward market prices decreased in the second quarter
2002, and as a result, the Company recorded a $1 non-cash charge to
mark the excess contracts to fair value as of August 17, 2002. For the
first two quarters of 2002, the Company recorded $6 of pre-tax,
non-cash net income as a result of the changes in forward market
prices. Also, the Company made net cash payments totaling $8 to settle
the excess energy purchase commitments for the first two quarters of
2002. Details of these liabilities follow:
Balance at February 2, 2002 ..................................... $ 78
Net payments (settlement of excess purchase commitments) ...... (8)
Revaluation (net decrease in liabilities due to changes in
forward market prices) .................................... (6)
------
Balance at August 17, 2002 ...................................... $ 64
======
4. RESTRUCTURING CHARGES AND RELATED ITEMS
On December 11, 2001, the Company outlined a Strategic Growth Plan
("Plan") to support additional investment in its core business to
increase sales and market share. The Plan has three key elements:
reduction of operating, general and administrative expenses,
centralization and increased coordination of merchandising and
procurement activities, and targeted retail price reductions. As part
of the plan to reduce operating, general and administrative costs, the
Company has eliminated slightly over 1,500 positions. The Company also
has merged the Nashville division office and distribution center into
the Atlanta and Louisville divisions. As of August 17, 2002, execution
of the Plan had reduced expenses by approximately $178. Restructuring
charges related to the Plan totaled $2, pre-tax, in the second quarter
2002. These charges totaled $15, pre-tax, for the first two quarters of
2002. The majority of these expenses related to severance agreements,
distribution center consolidation and conversion costs. All of the
second quarter 2002 costs, and approximately $10 of the total 2002
costs, represented cash expenditures. Also during 2002, the Company
made cash payments totaling $33, primarily for severance agreements.
The Company does not expect to incur any additional expenses related to
the Plan.
The following table is a summary of changes in the accruals associated
with the Plan:
Severance & Other
Costs
-----------------
Balance at February 2, 2002 ................... $ 37
Additions .................................. 15
Payments ................................... (33)
-----------
Balance at August 17, 2002 .................... $ 19
===========
5. GOODWILL
As more fully described in Note 9, the Company adopted SFAS No. 142 on
February 3, 2002. Adoption of this standard eliminated the amortization
of goodwill. In 2001, goodwill generally was amortized over 40 years.
Goodwill amortization expense totaled $26, pre-tax, in the second
quarter 2001 and $57, pre-tax, for the first two quarters of 2001. The
transitional impairment review required by SFAS No. 142 resulted in a
$26 pre-tax non-cash loss to writeoff the jewelry store division
goodwill based on its implied fair value. Impairment primarily resulted
from the recent operating performance of the division and review of the
division's projected future cash flows on a discounted basis, rather
than on an undiscounted basis, as was the standard under SFAS No. 121,
prior to adoption of SFAS No. 142. This loss was recorded as a
cumulative effect of an accounting change, net of a $10 tax benefit, in
the first quarter 2002.
The following table summarizes changes in the Company's goodwill
balance during 2002:
Balance at February 2, 2002 ............................. $ 3,594
Cumulative effect of an accounting change ....... (26)
Reclassifications ............................... (2)
-------
Balance at August 17, 2002 .............................. $ 3,566
=======
6
The following table adjusts net earnings, net earnings per basic common
share and net earnings per diluted common share for the adoption of SFAS
No. 142:
Second Quarter Ended Two Quarters Ended
----------------------------- ----------------------------
August 17, August 18, August 17, August 18,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Reported net earnings ............................................ $ 264 $ 256 $ 626 $ 559
Add back:
Goodwill amortization (1) ............................... -- 23 -- 50
Cumulative effect of an accounting change (1) ........... -- -- 16 --
------- ------- ------- ------
Adjusted net earnings ............................................ 264 279 642 609
------- ------- ------- ------
Add back:
Extraordinary loss (1) .................................. 9 -- 12 --
------- ------- ------- ------
Adjusted earnings before extraordinary loss ...................... $ 273 $ 279 $ 654 $ 609
======= ======= ======= ======
Reported net earnings per basic common share ..................... $ 0.34 $ 0.32 $ 0.79 $ 0.69
Add back:
Goodwill amortization (1) ............................... -- 0.03 -- 0.06
Cumulative effect of an accounting change (1) ........... -- -- 0.02 --
------- ------- ------- ------
Adjusted net earnings per basic common share ..................... 0.34 0.35 0.81 0.75
------- ------- ------- ------
Add back:
Extraordinary loss (1) .................................. 0.01 -- 0.02 --
------- ------- ------- ------
Adjusted earnings before extraordinary loss ...................... $ 0.35 $ 0.35 $ 0.83 $ 0.75
======= ======= ======= ======
Average number of shares used in basic calculation ............... 786 805 790 809
Reported net earnings per diluted common share ................... $ 0.33 $ 0.31 $ 0.78 $ 0.67
Add back:
Goodwill amortization (1) ............................... -- 0.03 -- 0.06
Cumulative effect of an accounting change (1) ........... -- -- 0.02 --
------- ------- ------- ------
Adjusted net earnings per diluted common share ................... 0.33 0.34 0.80 0.73
------- ------- ------- ------
Add back:
Extraordinary loss (1) .................................. 0.01 -- 0.01 --
------- ------- ------- ------
Adjusted earnings before extraordinary loss ...................... $ 0.34 $ 0.34 $ 0.81 $ 0.73
======= ======= ======= ======
Average number of shares used in diluted calculation ............. 800 827 805 830
(1) Amounts are net of income tax benefit.
7
6. COMPREHENSIVE INCOME
Comprehensive income is as follows:
Second Quarter Ended Two Quarters Ended
---------------------------------- -------------------------------
August 17, August 18, August 17, August 18,
2002 2001 2002 2001
--------------- -------------- -------------- -------------
Net earnings ................................................. $ 264 $ 256 $ 626 $ 559
Cumulative effect of adoption of SFAS No. 133, net of tax .... -- -- -- (6)
Unrealized loss on hedging activities, net of tax ............ (2) (3) -- (3)
--------- --------- -------- ---------
Comprehensive income ......................................... $ 262 $ 253 $ 626 $ 550
========= ========= ======== =========
During 2002 and 2001, other comprehensive income consisted of market
value adjustments to reflect derivative instruments designated as cash
flow hedges at fair value, pursuant to SFAS No. 133.
7. INCOME TAXES
The effective income tax rate differs from the expected statutory rate
primarily because of the effect of certain state taxes.
8. 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 and warrants.
The following table provides a reconciliation of earnings before
extraordinary loss and cumulative effect of an accounting change and
shares used in calculating basic earnings per share to those used in
calculating diluted earnings per share:
Second Quarter Ended Second Quarter Ended
August 17, 2002 August 18, 2001
----------------------------------------- -----------------------------------------
Earnings Shares Per Share Earnings Shares Per Share
(Numer-ator) (Denomi-nator) Amount (Numer-ator) (Denomi-nator) Amount
-----------------------------------------------------------------------------------
Basic earnings per common share ...... $ 273 786 $ 0.35 $ 256 805 $ 0.32
Dilutive effect of stock options and
warrants .......................... -- 14 -- 22
-------- -------- -------- --------
Diluted earnings per common share ..... $ 273 800 $ 0.34 $ 256 827 $ 0.31
======== ======== ======== ========
Two Quarters Ended Two Quarters Ended
August 17, 2002 August 18, 2001
----------------------------------------- -----------------------------------------
Earnings Shares Per Share Earnings Shares Per Share
(Numer-ator) (Denomi-nator) Amount (Numer-ator) (Denomi-nator) Amount
-----------------------------------------------------------------------------------
Basic earnings per common share ...... $ 654 790 $ 0.83 $ 559 809 $ 0.69
Dilutive effect of stock options and
warrants .......................... -- 15 -- 21
-------- -------- -------- --------
Diluted earnings per common share ..... $ 654 805 $ 0.81 $ 559 830 $ 0.67
======== ======== ======== ========
8
The Company had options outstanding for approximately 27 shares and 9
shares in the second quarter 2002 and second quarter 2001,
respectively, that were excluded from the computation of diluted
earnings per share because their inclusion would have had an
anti-dilutive effect on earnings per share. For the first two quarters
of 2002 and 2001, the Company had options outstanding of approximately
23 shares and 13 shares, respectively, that were excluded from the
computation of diluted earnings per share because their inclusion would
have had an anti-dilutive effect on earnings per share.
9. RECENTLY ISSUED ACCOUNTING STANDARDS
Emerging Issues Task Force (EITF) Issue Nos. 00-22, "Accounting for
`Points' and Certain Other Time-Based or Volume-Based Sales and
Incentive Offers, and Offers for Free Products or Services to be
Delivered in the Future;" and 01-09, "Accounting for Consideration
Given by a Vendor to a Customer (Including a Reseller of Vendor's
Products)," became effective for the Company on February 3, 2002. These
issues address the appropriate accounting for certain vendor contracts
and loyalty programs. The adoption of this standard did not have a
material effect on the Company's financial statements.
SFAS No. 141, "Business Combinations," was issued by the Financial
Accounting Standards Board ("FASB") in June of 2001. This standard
requires that all business combinations initiated after June 30, 2001
be accounted for under the purchase method of accounting. The Statement
also addresses the recognition of intangible assets in a business
combination. Adoption of SFAS No. 141 did not have a material effect on
the Company's financial statements.
SFAS No. 142, "Goodwill and Other Intangible Assets," was issued by the
FASB in June of 2001. The Statement addresses the accounting for
intangible assets acquired outside of a business combination. The
Statement also addresses the accounting for goodwill and other
intangible assets subsequent to initial recognition. SFAS No. 142
provides that goodwill no longer will be amortized and instead will be
tested for impairment on an annual basis.
The Company adopted SFAS No. 142 on February 3, 2002. Accordingly, the
Company performed a transitional impairment review of its goodwill.
Goodwill totaled $3,594 as of February 3, 2002. The review was
performed at the operating division level. Generally, fair value
represented a multiple of earnings before interest, taxes,
depreciation, amortization, LIFO charge, extraordinary items and
one-time items ("EBITDA") or discounted projected future cash flows.
Impairment was indicated when the carrying value of a division,
including goodwill, exceeded its fair value. The Company determined
that the carrying value of the jewelry store division, which included
$26 of goodwill, exceeded its fair value. Impairment was not indicated
for the goodwill associated with the other operating divisions.
The fair value of the jewelry store division was subsequently measured
against the fair value of its underlying assets and liabilities,
excluding goodwill, to estimate an implied fair value of the division's
goodwill. As a result of this analysis, the Company determined that the
jewelry store division goodwill was entirely impaired. Impairment
primarily resulted from the recent operating performance of the
division and review of the division's projected future cash flows on a
discounted basis, rather than on an undiscounted basis, as was the
standard under SFAS No. 121, prior to adoption of SFAS No. 142.
Accordingly, the Company recorded a $16 charge, net of a $10 tax
benefit, as a cumulative effect of an accounting change in the first
quarter, 2002.
SFAS No. 143, "Asset Retirement Obligations," was issued by the FASB in
August of 2001. This standard addresses obligations associated with the
retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 will become effective for the Company on
February 2, 2003. The Company currently is analyzing the effect this
standard will have on its financial statements.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," was issued by the FASB in August of 2001. This standard
replaces SFAS No. 121 and APB No. 30 and amends APB No. 51. SFAS No.
144 became effective for the Company on February 3, 2002. Adoption of
this standard did not have a material effect on the Company's financial
statements.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections," was
issued by the FASB in April 2002. SFAS No. 145 becomes effective for
the Company on February 2, 2003. The Company currently is analyzing the
effect this standard will have on its financial statements.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," was issued by the FASB in June of 2002. SFAS No. 146
addresses significant issues relating to the recognition, measurement
and reporting of costs associated with exit
9
and disposal activities. SFAS No. 146 is effective for exit or disposal
activities initiated after December 31, 2002. The Company currently is
analyzing the effect this standard will have on its financial
statements.
10. GUARANTOR SUBSIDIARIES
The Company's outstanding public debt (the "Guaranteed Notes") is
jointly and severally, fully and unconditionally guaranteed by The
Kroger Co. and certain of its subsidiaries (the "Guarantor
Subsidiaries"). At August 17, 2002, a total of approximately $6,810 of
Guaranteed Notes was outstanding. The Guarantor Subsidiaries and
non-guarantor subsidiaries are direct or indirect wholly owned
subsidiaries of The Kroger Co. Separate financial statements of The
Kroger Co. and each of the Guarantor Subsidiaries are not presented
because the guarantees are full and unconditional and the Guarantor
Subsidiaries are jointly and severally liable. The Company believes
that separate financial statements and other disclosures concerning the
Guarantor Subsidiaries would not be material to investors.
The non-guaranteeing subsidiaries 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 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. laws requiring adequate capital to
pay dividends).
10
The following tables present summarized financial information as of August 17,
2002 and February 2, 2002 and for the quarters ended, and two quarters ended,
August 17, 2002 and August 18, 2001:
Condensed Consolidating
Balance Sheets
As of August 17, 2002
Guarantor
The Kroger Co. Subsidiaries Eliminations Consolidated
----------------- ----------------- -------------- --------------
Current assets
Cash ...................................................... $ 20 $ 147 $ -- $ 167
Receivables ............................................... 220 384 -- 604
Net inventories ........................................... 385 3,691 -- 4,076
Prepaid and other current assets .......................... (33) 333 -- 300
---------- ---------- ---------- ----------
Total current assets ................................. 592 4,555 -- 5,147
Property, plant and equipment, net ............................ 1,215 9,011 -- 10,226
Goodwill, net ................................................. 21 3,545 -- 3,566
Fair value interest rate hedges ............................... 65 -- -- 65
Other assets .................................................. 603 (309) -- 294
Investment in and advances to subsidiaries .................... 10,721 -- (10,721) --
---------- ---------- ---------- ----------
Total assets ......................................... $ 13,217 $ 16,802 $ (10,721) $ 19,298
========== ========== ========== ==========
Current liabilities
Current portion of long-term debt including
obligations under capital leases ........................ $ 424 $ 13 $ -- $ 437
Accounts payable .......................................... 176 3,117 -- 3,293
Other current liabilities ................................. 388 1,661 -- 2,049
---------- ---------- ---------- ----------
Total current liabilities ............................ 988 4,791 -- 5,779
Long-term debt including obligations
under capital leases
Face value long-term debt including obligations
under capital leases .................................... 7,504 344 -- 7,848
Adjustment to reflect fair value interest rate hedges ..... 65 -- -- 65
---------- ---------- ---------- ----------
Long-term debt including obligations
under capital leases .................................... 7,569 344 -- 7,913
Other long-term liabilities ................................... 932 946 -- 1,878
---------- ---------- ---------- ----------
Total liabilities .................................... 9,489 6,081 -- 15,570
---------- ---------- ---------- ----------
Shareowners' Equity ........................................... 3,728 10,721 (10,721) 3,728
---------- ---------- ---------- ----------
Total liabilities and shareowners' equity ............ $ 13,217 $ 16,802 $ (10,721) $ 19,298
========== ========== ========== ==========
11
Condensed Consolidating
Balance Sheets
As of February 2, 2002
Guarantor
The Kroger Co. Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------
Current assets
Cash ............................................................. $ 25 $ 136 $ -- $ 161
Receivables ...................................................... 145 534 -- 679
Net inventories .................................................. 386 3,792 -- 4,178
Prepaid and other current assets ................................. 236 258 -- 494
-------- -------- -------- --------
Total current assets ........................................ 792 4,720 -- 5,512
Property, plant and equipment, net ................................... 1,151 8,506 -- 9,657
Goodwill, net ........................................................ 21 3,573 -- 3,594
Fair value interest rate hedges ...................................... 18 -- -- 18
Other assets ......................................................... 621 (315) -- 306
Investment in and advances to subsidiaries ........................... 11,173 -- (11,173) --
-------- -------- -------- --------
Total assets ................................................ $ 13,776 $ 16,484 $(11,173) $ 19,087
======== ======== ======== ========
Current liabilities
Current portion of long-term debt including
obligations under capital leases ............................... $ 412 $ 24 $ -- $ 436
Accounts payable ................................................. 246 2,759 -- 3,005
Other current liabilities ........................................ 685 1,359 -- 2,044
-------- -------- -------- --------
Total current liabilities ................................... 1,343 4,142 -- 5,485
Long-term debt including obligations under
capital leases .................................................
Face value long-term debt including obligations
under capital leases ........................................... 8,022 390 -- 8,412
Adjustment to reflect fair value interest rate hedges ............ 18 -- -- 18
-------- -------- -------- --------
Long-term debt including obligations
under capital leases ........................................... 8,040 390 -- 8,430
Other long-term liabilities .......................................... 891 779 -- 1,670
-------- -------- -------- --------
Total liabilities ........................................... 10,274 5,311 -- 15,585
-------- -------- -------- --------
Shareowners' Equity .................................................. 3,502 11,173 (11,173) 3,502
-------- -------- -------- --------
Total liabilities and shareowners' equity ................... $ 13,776 $ 16,484 $(11,173) $ 19,087
======== ======== ======== ========
12
Condensed Consolidating
Statements of Income
For the Quarter Ended August 17, 2002
Guarantor
The Kroger Co. Subsidiaries Eliminations Consolidated
-------------- ------------ ------------ ------------
Sales .................................................. $ 1,660 $10,466 $ (199) $11,927
Merchandise costs, including warehousing and
transportation ...................................... 1,408 7,517 (187) 8,738
Operating, general and administrative .................. 330 1,886 -- 2,216
Rent ................................................... 38 125 (12) 151
Depreciation and amortization .......................... 18 229 -- 247
Merger-related costs, restructuring charges and
related items ....................................... 11 (10) -- 1
------- ------- ------- -------
Operating profit (loss) ......................... (145) 719 -- 574
Interest expense ....................................... (126) (11) -- (137)
Equity in earnings of subsidiaries ..................... 443 -- (443) --
------- ------- ------- -------
Earnings before tax expense ............................ 172 708 (443) 437
Tax expense (benefit) .................................. (101) 265 -- 164
------- ------- ------- -------
Earnings before extraordinary loss ..................... 273 443 (443) 273
Extraordinary loss, net of income tax benefit .......... (9) -- -- (9)
------- ------- ------- -------
Net earnings .................................... $ 264 $ 443 $ (443) $ 264
======= ======= ======= =======
13
Condensed Consolidating
Statements of Income
For the Quarter Ended August 18, 2001
Guarantor
The Kroger Co. Subsidiaries Eliminations Consolidated
---------------- -------------- -------------- --------------
Sales .................................................... $ 1,588 $ 10,092 $ (195) $ 11,485
Merchandise costs, including warehousing and
transportation ....................................... 1,274 7,239 (183) 8,330
Operating, general and administrative .................... 316 1,868 -- 2,184
Rent ..................................................... 39 125 (12) 152
Depreciation and amortization ............................ 6 240 -- 246
Merger-related costs, restructuring charges and
related items ........................................ 2 -- -- 2
-------- -------- -------- --------
Operating profit (loss) ......................... (49) 620 -- 571
Interest expense ......................................... (142) (10) -- (152)
Equity in earnings of subsidiaries ....................... 372 -- (372) --
-------- -------- -------- --------
Earnings before tax expense .............................. 181 610 (372) 419
Tax expense (benefit) .................................... (75) 238 -- 163
-------- -------- -------- --------
Earnings before extraordinary loss ....................... 256 372 (372) 256
Extraordinary loss, net of income tax benefit ............ -- -- -- --
-------- -------- -------- --------
Net earnings .................................... $ 256 $ 372 $ (372) $ 256
======== ======== ======== ========
14
Condensed Consolidating
Statements of Income
For the Two Quarters Ended August 17, 2002
Guarantor
The Kroger Co. Subsidiaries Eliminations Consolidated
-------------- -------------- -------------- --------------
Sales ....................................................... $ 3,871 $ 24,183 $ (460) $ 27,594
Merchandise costs, including warehousing and
transportation ............................................ 3,210 17,399 (432) 20,177
Operating, general and administrative ....................... 694 4,410 -- 5,104
Rent ........................................................ 89 293 (28) 354
Depreciation and amortization ............................... 45 525 -- 570
Merger-related costs, restructuring charges and
related items ............................................. 10 6 -- 16
-------- -------- ------- --------
Operating profit (loss) ............................... (177) 1,550 -- 1,373
Interest expense ............................................ (306) (20) -- (326)
Equity in earnings of subsidiaries .......................... 940 -- (940) --
-------- -------- ------- --------
Earnings before tax expense ................................. 457 1,530 (940) 1,047
Tax expense (benefit) ....................................... (181) 574 -- 393
-------- -------- ------- --------
Earnings before extraordinary loss and cumulative
effect of an accounting change ........................ 638 956 (940) 654
Extraordinary loss, net of income tax benefit ............... (12) -- -- (12)
-------- -------- ------- --------
Earnings before cumulative effect of an accounting
change ................................................ 626 956 (940) 642
Cumulative effect of an accounting change ................... -- (16) -- (16)
-------- -------- ------- --------
Net earnings .......................................... $ 626 $ 940 $ (940) $ 626
======== ======== ======= ========
15
Condensed Consolidating
Statements of Income
For the Two Quarters Ended August 18, 2001
Guarantor
The Kroger Co. Subsidiaries Eliminations Consolidated
---------------- ----------------- ---------------- ----------------
Sales ................................................... $ 3,712 $ 23,319 $ (444) $ 26,587
Merchandise costs, including warehousing and
transportation ...................................... 2,961 16,819 (416) 19,364
Operating, general and administrative ................... 607 4,418 -- 5,025
Rent .................................................... 92 290 (28) 354
Depreciation and amortization ........................... 39 527 -- 566
Merger-related costs, restructuring charges and
related items ....................................... 4 -- -- 4
---------- ---------- ---------- ----------
Operating profit (loss) ........................ 9 1,265 -- 1,274
Interest expense ........................................ (336) (21) -- (357)
Equity in earnings of subsidiaries ...................... 758 -- (758) --
---------- ---------- ---------- ----------
Earnings before tax expense ............................. 431 1,244 (758) 917
Tax expense (benefit) ................................... (128) 486 -- 358
---------- ---------- ---------- ----------
Earnings before extraordinary loss ...................... 559 758 (758) 559
Extraordinary loss, net of income tax benefit ........... -- -- -- --
---------- ---------- ---------- ----------
Net earnings ................................... $ 559 $ 758 $ (758) $ 559
========== ========== ========== ==========
16
Condensed Consolidating
Statements of Cash Flows
For the Two Quarters Ended August 17, 2002
Guarantor
The Kroger Co. Subsidiaries Consolidated
----------------- ---------------- -----------------
Net cash provided by operating activities .................. $ 1,471 $ 690 $ 2,161
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures ................................ (94) (935) (1,029)
Other ............................................... 25 (78) (53)
----------- ----------- -----------
Net cash used by investing activities ...................... (69) (1,013) (1,082)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt ............ 853 -- 853
Reductions in long-term debt ........................ (1,365) (57) (1,422)
Proceeds from issuance of capital stock ............. 28 -- 28
Capital stock reacquired ............................ (453) -- (453)
Other ............................................... (18) (61) (79)
Net change in advances to subsidiaries .............. (452) 452 --
----------- ----------- ----------
Net cash provided (used) by financing activities ........... (1,407) 334 (1,073)
----------- ----------- -----------
Net (decrease) increase in cash and temporary cash
investments ............................................ (5) 11 6
Cash and temporary investments:
Beginning of year ................................... 25 136 161
----------- ----------- ----------
End of year ......................................... $ 20 $ 147 $ 167
=========== =========== ==========
Condensed Consolidating
Statements of Cash Flows
For the Two Quarters Ended August 18, 2001
Guarantor
The Kroger Co. Subsidiaries Consolidated
----------------- ---------------- -----------------
Net cash provided by operating activities .................. $ 805 $ 1,020 $ 1,825
----------- ----------- -----------
Cash flows from investing activities:
Capital expenditures ................................ (85) (1,063) (1,148)
Other ............................................... (80) 32 (48)
----------- ----------- -----------
Net cash used by investing activities ...................... (165) (1,031) (1,196)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of long-term debt ............ 1,290 -- 1,290
Reductions in long-term debt ........................ (1,262) (30) (1,292)
Proceeds from issuance of capital stock ............. 46 -- 46
Capital stock reacquired ............................ (485) -- (485)
Other ............................................... (214) 2 (212)
Net change in advances to subsidiaries .............. (19) 19 --
----------- ----------- ----------
Net used by financing activities ........................... (644) (9) (653)
----------- ----------- -----------
Net decrease in cash and temporary cash
investments ............................................ (4) (20) (24)
Cash and temporary investments:
Beginning of year ................................... 25 136 161
----------- ----------- ----------
End of year ......................................... $ 21 $ 116 $ 137
=========== =========== ==========
17
11. COMMITMENTS AND CONTINGENCIES
The Company continuously evaluates contingencies based upon the best
available evidence.
Management believes that allowances for loss have been provided to the
extent necessary and that its assessment of contingencies is reasonable.
Allowances for loss are included in other current liabilities and other
long-term liabilities. To the extent that resolution of contingencies
results in amounts that vary from management's estimates, future earnings
will be charged or credited.
The principal contingencies are described below.
Insurance - The Company's workers' compensation risks are self-insured in
certain states. In addition, other workers' compensation risks and certain
levels of insured general liability risks are based on retrospective
premium plans, deductible plans and self-insured retention plans. The
liability for workers' compensation risks is accounted for on a present
value basis. 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 effect on the financial position of
the Company.
Purchase Commitment - The Company indirectly owns a 50% interest in the
Santee Dairy ("Santee") and has a product supply arrangement 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 joint venture is managed independently and
has a board comprised of an equal number of members from each partner, plus
one independent member. When there is a split vote, this member generally
votes with the other partner. The other partner has filed suit against the
Company claiming, among other things, that the Company is obligated to
purchase its requirements of fluid milk from Santee as opposed to minimum
gallons.
12. OTHER EVENTS
On June 17, 2002, the Company issued $350, 6.20% Senior Notes due in 2012.
On June 27, 2002, the Company filed a shelf registration statement with the
SEC for the issuance of up to $2,000 of securities. The SEC declared the
registration statement effective on July 23, 2002.
On August 16, 2002, the Company retired early $250 of Puttable Reset
Securities. The Company incurred a termination fee as a result of the early
retirement of these securities and therefore recorded an after-tax
extraordinary loss of $9 in the second quarter 2002.
18
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.
RESULTS OF OPERATIONS
Sales for the second quarter of 2002 totaled $11.9 billion, an increase of
3.8% over the second quarter of 2001. Sales for the first two quarters of
2002 totaled $27.6 billion, an increase of 3.8% over the first two quarters
of 2001. The increases in sales are attributable to increases in comparable
and identical store sales, an increase in the number of stores and the
implementation of Kroger's Strategic Growth Plan. Identical food store
sales, which include stores that have been in operation and have not been
expanded or relocated for four quarters, grew 0.8% from the second quarter
of 2001. Comparable food store sales, which include relocations and
expansions, increased 1.7% over the prior year. We estimate that our
product cost deflation was negative 0.7% for the second quarter 2002.
A portion of the increase in sales was due to an increase in the number of
stores. During the second quarter of 2002, we opened, acquired, relocated
or expanded 39 food stores versus 38 food stores in the second quarter of
2001. Additionally, we remodeled 26 food stores and closed 19 food stores.
We operated 2,447 food stores as of August 17, 2002 compared to 2,392 food
stores as of August 18, 2001. As of August 17, 2002, food store square
footage totaled 133 million. This represents an increase of 4.1% over
August 18, 2001.
As of the second quarter 2002, we operated 307 supermarket fuel centers
compared to 143 supermarket fuel centers at the end of the second quarter
2001. Excluding sales at supermarket fuel centers, identical food store
sales increased 0.2% and comparable food store sales grew 0.9%. Without
supermarket fuel centers, we estimate that our product cost deflation was
negative 0.6%.
The tables below summarizes our identical and comparable food store sales
information:
IDENTICAL FOOD STORE SALES
Estimated inflation (deflation)
-----------------------------------
Second Quarter Second Quarter Second Quarter Second Quarter
2002 2001 2002 2001
-------------------------------------------------------------------------
Including supermarket fuel centers 0.8% 0.8% (0.7)% 0.2%
Excluding supermarket fuel centers 0.2% 0.3% (0.6)% 0.2%
Total supermarket fuel centers 307 143 307 143
COMPARABLE FOOD STORE SALES
Estimated inflation (deflation)
-----------------------------------
Second Quarter Second Quarter Second Quarter Second Quarter
2002 2001 2002 2001
-------------------------------------------------------------------------
Including supermarket fuel centers 1.7% 1.6% (0.7)% 0.2%
Excluding supermarket fuel centers 0.9% 1.0% (0.6)% 0.2%
Total supermarket fuel centers 307 143 307 143
The FIFO gross profit rate was 26.7% in the second quarter 2002 versus
27.5% in the second quarter 2001. Year-to-date, the FIFO gross profit rate
was 26.9% and 27.2% in 2002 and 2001, respectively. During 2002, no
one-time items were included in merchandise costs compared to $5 million of
one-time expense incurred during 2001. In 2001, $2 million of the one-time
expenses were incurred in the second quarter. Excluding these costs, the
second quarter 2001 FIFO gross profit rate was 27.6% and the year-to-date
2001 rate was 27.3%. The decrease in the FIFO gross profit rate in 2002
from 2001 was primarily the result of Kroger's investment in lower retail
prices as part of the Strategic Growth Plan. Approximately 18 basis points
of the decrease in the second quarter 2002 versus the second quarter 2001
was related to the increase in the percent of total sales from supermarket
fuel centers in 2002 versus 2001. Supermarket fuel center sales have a
negative impact on our overall FIFO gross profit rate. In the second
quarter 2002, Kroger's private-label grocery market share in terms of units
sold increased approximately 0.8%, but decreased approximately 0.3% in
terms of dollar sales, compared to the second quarter of 2001.
Operating, general and administrative expenses as a percent of sales were
18.6% in the second quarter of 2002, 19.0% in the second quarter of 2001,
18.5% year-to-date 2002, and 18.9% year-to-date 2001. We recorded one-time
expenses of $4 million
19
and $7 million in operating, general and administrative expense in the
second quarters of 2002 and 2001, respectively. For the first two quarters
of 2002, one-time items included in operating, general and administrative
expense netted zero. For the first two quarters of 2001, one-time expenses
included in operating, general and administrative expense totaled $19
million. Excluding these one-time items, operating, general and
administrative expenses as a percent of sales were 18.6% during the second
quarter of 2002, 19.0% during the second quarter of 2001, 18.5%
year-to-date 2002, and 18.8% year-to-date 2001. Operating, general and
administrative expenses decreased as a percent of sales partially due to
our successful cost reduction and productivity initiatives. Approximately
11 basis points of the decrease in the second quarter 2002 versus the
second quarter 2001 was related to the increase in the percent of total
sales from supermarket fuel centers in 2002 versus 2001. Supermarket fuel
center sales have a positive impact on our overall operating, general and
administrative expense rate. These results were achieved despite the
negative impact of higher health care benefit costs, pension costs and
credit card fees.
Depreciation expense totaled $247 million in the second quarter of 2002, an
increase of $27 million over $220 million in the second quarter of 2001.
For the first two quarters of 2002, depreciation expense totaled $570
million, an increase of $61 million compared to $509 million during the
same period of 2001. The increases in depreciation expense primarily were
due to Kroger's capital investment program.
Net interest expense totaled $137 million for the second quarter of 2002, a
decrease of approximately 9.4% from the second quarter of 2001. For the
first two quarters of 2002, net interest expense totaled $326 million, a
decrease of approximately 8.7% compared to the same period of 2001. These
decreases resulted from lower interest rates on our floating-rate debt in
2002 and an overall reduction of outstanding debt versus the second quarter
2001.
The effective tax rate differs from the expected statutory rate primarily
because of the effect of certain state taxes.
Net earnings were $264 million or $0.33 per diluted share for the second
quarter of 2002. These results represent an increase of approximately 6.5%
over net earnings of $0.31 per diluted share for the second quarter of
2001. For the first two quarters of 2002, net earnings totaled $626
million, or $0.78 per diluted share, an increase of 16.4% over net earnings
of $0.67 per diluted share for the first two quarters of 2001. As described
below in "Other Issues," Kroger's adoption of Statement of Financial
Accounting Standards ("SFAS") No. 142 eliminated the amortization of
goodwill beginning in fiscal 2002. Goodwill amortization expense totaled
$26 million, pre-tax, in the second quarter of 2001 and $57 million,
pre-tax, year-to-date, 2001. In the first quarter 2002, we performed a
transitional impairment review of goodwill in accordance with SFAS No. 142,
and as a result, we recorded a $16 million after-tax impairment loss as a
cumulative effect of an accounting change. Adjusting 2002 results to
eliminate the cumulative effect of the accounting change, and 2001 results
to eliminate the amortization of goodwill and its tax effect, net earnings
were $0.33 per diluted share in the second quarter 2002, a decrease of
approximately 2.9% from net earnings of $0.34 per diluted share for the
second quarter, 2001. On this basis, year-to-date, 2002, net earnings were
$0.80 per diluted share, an increase of approximately 9.6% over net
earnings of $0.73 per diluted share for the same period of 2001.
As described below in "Merger-Related Costs and Other One-Time Items,"
Kroger incurred pre-tax one-time expenses totaling $5 million and $11
million in the second quarters of 2002 and 2001, respectively.
Year-to-date, these items totaled $16 million and $28 million, pre-tax, in
2002 and 2001, respectively. Also, we incurred an after-tax loss of $16 as
a result of the implementation of SFAS No. 142. This loss was recorded as
the cumulative effect of an accounting change, in the first quarter of
2002. We incurred after-tax extraordinary losses related to the early
retirement of debt totaling $9 million and $12 million in the second
quarter 2002, and year-to-date 2002, respectively. Excluding these items,
earnings were $276 million, or $0.35 per diluted share, in the second
quarter of 2002, and $665 million, or $0.83 per diluted share, for the
first two quarters of 2002. On this basis, and adjusting 2001 results to
eliminate the amortization of goodwill and its tax effect, earnings per
diluted share for the second quarter were flat compared to the second
quarter of 2001, and earnings per diluted for the first two quarters of
2002 increased 10.7% over earnings of $0.75 for the first two quarters of
2001.
20
MERGER-RELATED COSTS AND OTHER ONE-TIME ITEMS
Merger-related costs
We are continuing the process of implementing our integration plan relating
to recent mergers. During the first and second quarters of 2001, and the
first quarter of 2002, we recorded pre-tax, non-cash merger-related costs
of $2 million resulting from the issuance of restricted stock. The market
value adjustment of the restricted stock resulted in a pre-tax, non-cash
credit of $1 million in the second quarter of 2002. Restrictions on the
stock awards lapsed based on the achievement of synergy goals. All
synergy-based awards were earned provided that recipients were still
employed by Kroger on the stated restriction lapsing date.
One-time items
In addition to the merger-related costs that are shown separately on the
Consolidated Statement of Income, we incurred pre-tax one-time expenses of
$4 million and $9 million during the second quarters of 2002 and 2001,
respectively. Second quarter 2002 amounts included $1 million of expense
resulting from the market value adjustment of excess energy purchase
contracts. In the first quarter 2002, we recorded pre-tax one-time income
of $7 million from the market value adjustment of these contracts. For the
first two quarters of 2002, pre-tax one-time items netted to zero. Pre-tax
one-time expense totaled $24 million for the first two quarters of 2001.
The one-time items were included in merchandise costs and operating,
general and administrative expense in 2001 and in operating, general and
administrative expense in 2002. Pre-tax expenses of $4 million and $7
million were included in operating, general and administrative expense in
the second quarters of 2002 and 2001, respectively. Pre-tax expenses of $2
million were included in merchandise costs in the second quarter, 2001. For
the first two quarters of 2002, the pre-tax one-time items included in
operating, general and administrative expense netted to zero. For the first
two quarters of 2001, the one-time items included in operating, general and
administrative expense totaled $19 million of pre-tax expense. The
remaining $5 million of pre-tax expense recorded in the first two quarters
of 2001 was included in merchandise costs.
All of the items included as merchandise costs in 2001 were product costs
for excess capacity. The remaining $19 million of expense in 2001 primarily
related to employee severance and system conversion costs and was included
as operating, general and administrative expenses. In 2002, approximately
$6 million of expense related to system conversion costs and was included
in operating, general and administrative expense. All of the costs in 2001
and $5 million of the costs in 2002 represented cash expenditures.
During March through May 2001, we entered into four separate commitments to
purchase electricity from one of our utility suppliers in southern
California. At the inception of the contracts, forecasted electricity usage
indicated that it was probable that all of the electricity would be
utilized in the operations of the company. We, therefore, accounted for the
contracts in accordance with the normal purchases and normal sales
exception under SFAS No. 133, as amended, and no amounts were initially
recorded in the financial statements related to these purchase commitments.
During the third quarter 2001, we determined that one of the contracts, and
a portion of a second contract, provided for supplies in excess of our
expected demand for electricity. This precluded use of the normal purchases
and normal sales exception under SFAS No. 133 for those contracts, and
required the contracts to be marked to fair value through current-period
earnings. We therefore recorded a pre-tax charge of $81 million in the
third quarter 2001 to accrue liabilities for the estimated fair value of
these contracts through December 2006. The remaining portion of the second
contract was re-designated as a cash flow hedge of future purchases. The
other two purchase commitments continue to qualify for the normal purchases
and normal sales exception under SFAS No. 133.
SFAS No. 133 requires the excess contracts to be marked to fair value
through current-period earnings each quarter. Due to an increase in the
forward market prices for electricity in southern California during the
first quarter 2002, we recorded pre-tax income of $7 million to mark the
excess contracts to estimated fair value as of May 25, 2002. Short-term
forward market prices decreased in the second quarter 2002, and as a
result, we recorded a $1 million non-cash charge to mark the excess
contracts to fair value as of August 17, 2002. For the first two quarters
of 2002, we recorded $6 of pre-tax, non-cash net income as a result of the
changes in forward market prices. Also, we made net cash payments totaling
$8 to settle the excess energy purchase commitments for the first two
quarters of 2002.
21
Restructuring charges
On December 11, 2001, we outlined a Strategic Growth Plan ("Plan") to
support additional investment in our core business to increase sales and
market share. The Plan has three key elements: reduction of operating,
general and administrative expenses, centralization and increased
coordination of merchandising and procurement activities, and targeted
retail price reductions. As part of the plan to reduce operating, general
and administrative costs, we have eliminated slightly over 1,500 positions.
We also have merged the Nashville division office and distribution center
into the Atlanta and Louisville divisions. As of August 17, 2002, execution
of the Plan had reduced expenses by approximately $178 million.
Restructuring charges related to the Plan totaled $2 million, pre-tax, in
the second quarter 2002. These charges totaled $15 million, pre-tax, for
the first two quarters of 2002. The majority of these expenses related to
severance agreements, distribution center consolidation and conversion
costs. All of the second quarter 2002 costs, and approximately $10 million
of the total 2002 costs, represented cash expenditures. Also during 2002,
we made cash payments totaling $33, primarily for severance agreements. We
do not expect to incur any additional expenses related to the Plan.
Cumulative effect of an accounting change
As described below in "Other Issues," adoption of SFAS No. 142 required
Kroger to perform a transitional impairment review of goodwill in 2002.
This review has been completed and resulted in a $16 million after-tax
impairment loss, recorded as a cumulative effect of an accounting change in
the first quarter 2002.
The table below details our merger-related costs and other one-time items.
Amounts shown are pre-tax, except for the cumulative effect of an
accounting change, which is shown net of tax:
Second Quarter Ended Two Quarters Ended
--------------------------- --------------------------
August 17, August 18, August 17, August 18,
2002 2001 2002 2001
--------------------------- --------------------------
(in millions) (in millions)
Merger-related costs ........................................... $ (1) $ 2 $ 1 $ 4
----- ----- ----- -----
One-time items related to mergers included in:
Merchandise costs ........................................... -- 2 -- 5
Operating, general and administrative ....................... 3 7 6 19
Other one-time items included in:
Operating, general and administrative - energy contracts .... 1 -- (6) --
----- ----- ----- -----
Total one-time items ........................................... 4 9 -- 24
Restructuring charges and related items ........................ 2 -- 15 --
Cumulative effect of an accounting change, net of tax .......... -- -- 16 --
----- ----- ----- -----
Total merger-related costs and other one-time items ............ $ 5 $ 11 $ 32 $ 28
===== ===== ===== =====
Refer to Notes two, three, four and nine to the financial statements for
more information on these costs.
LIQUIDITY AND CAPITAL RESOURCES
Debt Management
During the second quarter 2002, we invested $337 million to repurchase 17.2
million shares of Kroger stock at an average price of $19.60 per share. For
the first two quarters of 2002, we repurchased 22.7 million shares of
Kroger stock for a total investment of $458 million. These amounts include
shares acquired by Kroger in connection with awards of shares and exercises
of stock options by participants in Kroger's stock option and long-term
incentive plans. In the second quarter 2002, we purchased 16.4 million
shares under our $1 billion stock repurchase plan and we purchased an
additional 0.8 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 with borrowing capacity totaling
approximately $2.76 billion at August 17, 2002. Outstanding credit
agreement and commercial paper borrowings, and certain outstanding letters
of credit, reduce funds available under our lines of credit. In addition,
we had a $75 million money market line, borrowings under which also reduce
the funds available under our lines of credit. At August 17, 2002, our
outstanding commercial paper borrowings totaled $557 million and our money
market line borrowings totaled $21 million. The outstanding letters of
credit that reduced the funds available under our
22
credit agreement totaled $118 million. We did not have any outstanding
credit agreement borrowings as of August 17, 2002. In addition, we had a
$202 million synthetic lease credit facility as further described below.
On June 17, 2002, we issued $350 million, 6.20% Senior Notes due in 2012.
On June 27, 2002, we filed a shelf registration statement with the SEC for
the issuance of up to $2.0 billion of securities. The SEC declared the
registration statement effective on July 23, 2002.
On August 16, 2002, we retired early $250 million of Puttable Reset
Securities. We incurred a termination fee as a result of the early
retirement of these securities and therefore recorded an after-tax
extraordinary loss of $9 million in the second quarter 2002.
As part of the Fred Meyer merger, we became party to a financing
transaction related to 16 properties constructed for total costs of
approximately $202 million. Under the terms of the financing transaction,
which was structured as a synthetic lease, a special purpose trust owns the
properties and leases them to subsidiaries of Kroger. The lease expires in
February 2003. We pay a variable lease rate that was approximately 2.7% at
August 17, 2002.
The synthetic lease qualifies as an operating lease and the owner of the
special purpose trust has made a substantive residual equity investment.
The transaction, therefore, is accounted for off-balance sheet and the
related costs are reported as rent expense. As of August 17, 2002, the
assets and liabilities of the special purpose trust were composed primarily
of the properties and $187 million of bank debt used to fund the
construction of the properties.
In connection with these financing transactions, we have made a residual
value guarantee for the leased property equal to 85% of the financing, or
$172 million. We believe the market value of the property subject to this
financing exceeded the residual value guarantee at August 17, 2002.
Approximately $202 million were outstanding under the synthetic lease at
August 17, 2002.
Net total debt decreased $260 million to $8.2 billion at the end of the
second quarter of 2002 compared to $8.5 billion at the end of the second
quarter of 2001. Net total debt is defined as long-term debt, including
capital leases and current portion thereof, less investments in debt
securities, prefunded employee benefits and mark-to-market adjustments
necessary to record fair value interest rate hedges of our fixed rate debt,
pursuant to SFAS No. 133. Net total debt decreased $293 million from
year-end 2001. Total debt decreased $213 million to $8.4 billion at the end
of the second quarter of 2002 compared to $8.6 billion at the second
quarter of 2001. Total debt decreased $498 million versus year-end 2001.
These decreases are the result of the use of cash flow to reduce
outstanding debt.
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
August 17, 2002.
23
The following is a summary of the calculation of EBITDA for the second
quarters of 2002 and 2001 and for the two-quarter periods then-ended.
Second Quarter Ended Two Quarters Ended
---------------------------- --------------------------
August 17, August 18, August 17, August 18,
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in millions) (in millions)
Earnings before tax expense, extraordinary loss and
the cumulative effect of an accounting change .......... $ 437 $ 419 $1,047 $ 917
Interest .................................................. 137 152 326 357
Depreciation .............................................. 247 220 570 509
Goodwill amortization ..................................... -- 26 -- 57
LIFO ...................................................... -- 8 12 20
One-time items included in merchandise costs .............. -- 2 -- 5
One-time items included in operating, general and
administrative expenses ................................ 4 7 -- 19
Merger-related costs ...................................... (1) 2 1 4
Restructuring charges and related items ................... 2 -- 15 --
Rounding .................................................. -- 1 -- --
------ ------ ------ ------
EBITDA .................................................... $ 826 $ 837 $1,971 $1,888
====== ====== ====== ======
Cash Flow
We generated $2.2 billion of cash from operating activities during the
first two quarters of 2002 compared to $1.8 billion in the first two
quarters of 2001. Cash flow from operating activities increased in the
first two quarters of 2002 primarily due to increased earnings and
decreased working capital.
Investing activities used $1.1 billion of cash during the first two
quarters of 2002 compared to $1.2 billion in 2001. This decrease in the use
of cash was due to decreased capital spending.
Financing activities used $1.1 billion of cash in the first two quarters of
2002 compared to $653 million in the first two quarters of 2001. This
increase in the use of cash was due primarily to a reduction in the
issuance of debt and the use of free cash flow to pay down outstanding debt
balances.
CAPITAL EXPENDITURES
Capital expenditures excluding acquisitions totaled $420 million for the
second quarter of 2002 compared to $530 million for the second quarter of
2001. Including acquisitions, capital expenditures totaled $420 million and
$540 million in the second quarters of 2002 and 2001, respectively. For the
first two quarters of 2002 and 2001, capital expenditures including
acquisitions totaled $1.1 billion and $1.2 billion, respectively.
Year-to-date expenditures in 2002 include the first quarter purchase of
$192 million of assets previously financed under a synthetic lease. During
the second quarter of 2002, we opened, acquired, expanded or relocated 39
food stores versus 38 food store openings during the same period of 2001.
We had 19 operational closings and completed 26 within the wall remodels.
Square footage increased 4.1% versus the second quarter of 2001.
OTHER ISSUES
As of August 17, 2002, we had $254 million remaining under Kroger's $1
billion stock repurchase program authorized in March of 2001. At current
prices, we continue to repurchase common stock under this program and the
program funded by the proceeds and tax benefits from stock option
exercises.
We indirectly own a 50% interest in the Santee Dairy ("Santee") and have a
product supply arrangement 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 acquisition of Ralphs/Food
4 Less, Santee became excess capacity and a duplicate facility. The joint
venture is managed independently and has a board composed of an equal
number of members from each partner, plus one
24
independent member. When there is a split vote, this member generally votes
with the other partner. The other partner has filed suit against Kroger
claiming, among other things, that Kroger is obligated to purchase its
requirements of fluid milk from Santee as opposed to minimum gallons.
We are a party to 345 collective bargaining agreements with local unions
representing approximately 205,000 employees. We have agreements that have
expired covering store employees in Oregon and North Carolina and the
Southern California Teamsters. We cannot be certain that agreements will be
reached without work stoppage. A prolonged work stoppage affecting a
substantial number of stores could have a material effect on the results of
our operations.
Emerging Issues Task Force (EITF) Issue Nos. 00-22, "Accounting for
'Points' and Certain Other Time-Based or Volume-Based Sales and Incentive
Offers, and Offers for Free Products or Services to be Delivered in the
Future;" and 01-09, "Accounting for Consideration Given by a Vendor to a
Customer (Including a Reseller of Vendor's Products)," became effective for
Kroger on February 3, 2002. These issues address the appropriate accounting
for certain vendor contracts and loyalty programs. The adoption of this
standard did not have a material effect on our financial statements.
SFAS No. 141, "Business Combinations," was issued by the Financial
Accounting Standards Board ("FASB") in June of 2001. This standard requires
that all business combinations initiated after June 30, 2001 be accounted
for under the purchase method of accounting. The Statement also addresses
the recognition of intangible assets in a business combination. Adoption of
SFAS No. 141 did not have a material effect on our financial statements.
SFAS No. 142, "Goodwill and Other Intangible Assets," was issued by the
FASB in June of 2001. The Statement addresses the accounting for intangible
assets acquired outside of a business combination. The Statement also
addresses the accounting for goodwill and other intangible assets
subsequent to initial recognition. SFAS No. 142 provides that goodwill no
longer will be amortized and instead will be tested for impairment on an
annual basis.
Kroger adopted SFAS No. 142 on February 3, 2002. Accordingly, we performed
a transitional impairment review of our goodwill. Goodwill totaled $3.6
billion as of February 3, 2002. The review was performed at the operating
division level. Generally, fair value represented a multiple of earnings
before interest, taxes, depreciation, amortization, LIFO charge,
extraordinary items and one-time items ("EBITDA") or discounted projected
future cash flows. Impairment was indicated when the carrying value of a
division, including goodwill, exceeded its fair value. We determined that
the carrying value of the jewelry store division, which included $26
million of goodwill, exceeded its fair value. Impairment was not indicated
for the goodwill associated with the other operating divisions.
The fair value of the jewelry store division was subsequently measured
against the fair value of its underlying assets and liabilities, excluding
goodwill, to estimate an implied fair value of the division's goodwill. As
a result of this analysis, we determined that the jewelry store division
goodwill was entirely impaired. Impairment primarily resulted from the
recent operating performance of the division and review of the division's
projected future cash flows on a discounted basis, rather than on an
undiscounted basis, as was the standard under SFAS No. 121, prior to
adoption of SFAS No. 142. Accordingly, we recorded a $16 million charge,
net of a $10 million tax benefit, as a cumulative effect of an accounting
change in the first quarter, 2002.
SFAS No. 143, "Asset Retirement Obligations," was issued by the FASB in
August of 2001. This standard addresses obligations associated with the
retirement of tangible long-lived assets and the associated asset
retirement costs. SFAS No. 143 will become effective for Kroger on February
2, 2003. We currently are analyzing the effect this standard will have on
its financial statements.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," was issued by the FASB in August of 2001. This standard replaces
SFAS No. 121 and APB No. 30 and amends APB No. 51. SFAS No. 144 became
effective for Kroger on February 3, 2002. Adoption of this standard did not
have a material effect on our financial statements.
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
of FASB Statement No. 13, and Technical Corrections," was issued by the
FASB in April 2002. SFAS No. 145 becomes effective for Kroger on February
2, 2003. We currently are analyzing the effect this standard will have on
our financial statements.
SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," was issued by the FASB in June of 2002. SFAS No. 146 addresses
significant issues relating to the recognition, measurement and reporting
of costs associated with exit and disposal activities. SFAS No. 146 is
effective for exit or disposal activities initiated after December 31,
2002. We currently are analyzing the effect this standard will have on its
financial statements.
25
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:
. On December 11, 2001, we outlined a Strategic Growth Plan
("Plan") to support additional investment in core business,
through targeted retail price reductions, to grow sales and
increase market share. We intend to achieve identical supermarket
store sales growth of 2% to 3% above product cost inflation and
to reduce operating, general and administrative costs by more
than $500 million over the next two years. We had expected to
achieve approximately two-thirds of this reduction by the end of
fiscal 2002. We now believe our fiscal 2002 savings will be
slightly less than this goal because shrink reduction has proven
more difficult to achieve than originally anticipated. As of
August 17, 2002, we had reduced costs by approximately $178
million. We have eliminated slightly over 1,500 positions
targeted for reduction under the Plan. We also have merged the
Nashville division office and distribution center into the
Atlanta and Louisville divisions. We remain committed to
achieving the $500 million cost reduction by the end of fiscal
2003.
As a result of the Plan, we established a long-term, sustainable
annual earnings-per-share ("EPS") growth target of 13% - 15%,
before one-time items, beginning in fiscal 2004, and 10% - 12%,
before one-time items, for fiscal 2002 and 2003. For fiscal 2002,
we have lowered our EPS growth estimate to 5% to 7%, before
one-time items. For the remaining quarters of fiscal 2002, we
expect EPS growth, before one-time items, to be flat to slightly
positive. At this time, we do not plan to modify our EPS growth
guidance for 2003 and beyond. Additionally, we believe identical
food store sales for the third quarter of 2002 may increase less
than the 0.8% growth achieved in the second quarter of 2002
because of continued product cost deflation and the unusually
strong sales in the third quarter of 2001 during the weeks
immediately following September 11, 2001.
As of August 17, 2002, restructuring costs related to the Plan
totaled approximately $52 million. These charges consisted
primarily of severance agreements, distribution center
consolidation and conversion costs. We believe there will not be
any additional expenses associated with the Plan. The cumulative
total of restructuring charges is below our original estimate of
$85 million to $100 million.
. We expect to reduce net operating working capital as compared to
the third quarter of 1999 by a total of $500 million by the end
of the third quarter 2004. Our ability to achieve this reduction
will depend on results of our programs to improve net operating
working capital management. We calculate net operating working
capital as detailed in the table below. As of the end of the
second quarter 2002, net operating working capital decreased $138
million compared to the second quarter of 2001. A calculation of
net operating working capital based on our definition for the
second quarters of 2002, 2001 and 2000 is shown below.
26
Second Second Second
Quarter Quarter Quarter
2002 2001 2000
------------ ---------- -----------
(in millions)
Cash ................................ $ 167 $ 137 $ 155
Receivables ......................... 604 649 583
FIFO inventory ...................... 4,428 4,375 4,133
Operating prepaid and other assets .. 244 256 252
Accounts payable .................... (3,293) (3,118) (2,940)
Operating accrued liabilities ....... (1,858) (1,851) (1,932)
Prepaid VEBA ........................ -- (18) (56)
--------- --------- ---------
Net operating working capital ...... $ 292 $ 430 $ 195
========= ========= ========
.. We obtain sales growth from new square footage, as well as from increased
productivity from existing locations. We expect full year 2002 square
footage to grow 3.5% to 4.5%. We expect combination stores to increase our
sales per customer by including numerous specialty departments, such as
pharmacies, natural food products, supermarket fuel centers, 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, club or warehouse stores, drug stores and
restaurants.
.. We are a party to 345 collective bargaining agreements with local unions
representing approximately 205,000 employees. We have agreements that have
expired covering store employees in Oregon and North Carolina and the
Southern California Teamsters. We cannot be certain that agreements will be
reached without work stoppage. A prolonged work stoppage affecting a
substantial number of stores could have a material effect on the results of
our operations.
.. We define free cash flow as a rolling four quarters total of earnings before
interest, taxes, depreciation, amortization and one-time items ("EBITDA"),
less capital expenditures excluding the $192 million purchase of assets
previously financed under a synthetic lease, less cash paid for interest and
taxes, plus improvement in net operating working capital. During the past
four quarters, we generated free cash flow of $1.1 billion, after capital
expenditures of $1.7 billion, excluding the purchase of assets previously
financed under a synthetic lease. We expect fiscal 2002 free cash flow to
total approximately $650 million to $750 million, excluding the purchase of
assets previously financed under a synthetic lease.
.. Capital expenditures reflect our strategy of growth through expansion and
acquisition as well as our emphasis on self-development and ownership of
real estate, and on logistics and technology improvements. The continued
capital spending in technology focusing on improved store operations,
logistics, manufacturing procurement, category management, merchandising and
buying practices, should reduce merchandising costs as a percent of sales.
For fiscal 2002, we expect capital spending to be approximately $100 million
less than our prior forecast of $2.4 billion to $2.5 billion. This estimate
includes acquisitions and the purchase of assets previously financed under a
synthetic lease. We intend to use the combination of free cash flow 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.
.. This analysis contains certain forward-looking statements about Kroger's
future performance. These statements are based on management's assumptions
and beliefs in light of the information currently available. Such statements
relate to, among other things: projected growth in earnings per share
("EPS"); working capital reduction; a decline in our net total
debt-to-EBITDA ratio; our ability to generate free cash flow; and our
strategic growth plan, and are indicated by words or phrases such as
"comfortable," "committed," "expects," "goal," and similar words or phrases.
These forward-looking statements are subject to uncertainties and other
factors that could cause actual results to differ materially. Our ability to
achieve annual EPS growth goals will be affected primarily by customer
response to lower retail prices offered through our Strategic Growth Plan,
pricing and promotional activities of existing and new competitors,
including non-traditional food retailers, and our response to these actions
intended to increase market share. In addition, Kroger's EPS growth goals
could be affected by: increases in product costs; newly opened or
27
consolidated distribution centers; our stock repurchase program; our ability
to obtain sales growth from new square footage; competitive activity in the
markets in which we operate; changes in our product mix; and changes in laws
and regulations. Our ability to reduce our net total debt-to-EBITDA ratio
could be adversely affected by: our ability to generate sales growth and
free cash flow; interest rate fluctuations and other changes in capital
market conditions; Kroger's stock repurchase activity; unexpected increases
in the cost of capital expenditures; acquisitions; and other factors. The
results of our strategic growth plan and our ability to generate free cash
flow to the extent expected could be adversely affected if any of the
factors identified above negatively impact our operations. In addition, the
timing of the execution of the plan could adversely impact our EPS and sales
results.
.. The results of our Strategic Growth Plan, including the amount and timing of
cost savings expected, could be adversely affected due to pricing and
promotional activities of existing and new competitors, including
non-traditional food retailers; our response actions; the state of the
economy, including deflationary trends in certain commodities; recessionary
times in the economy; our ability to achieve the cost reductions that we
have identified, including those to reduce shrink and operating, general and
administrative expense; increases in health care, pension and credit card
fees; and the success of our capital investments.
.. The amount and timing of future merger-related and other one-time costs
could be adversely affected by our ability to convert remaining systems as
planned and on budget. The cost associated with implementation of our
Strategic Growth Plan, as well as the amount and timing of our expected cost
reductions, could be affected by a worsening economy; increased competitive
pressures; and an inability on our part to implement the Strategic Growth
Plan when expected.
.. Based on current operating results, we believe that operating cash flow and
other sources of liquidity, including borrowings under our commercial paper
program and bank credit facilities, will be adequate to meet anticipated
requirements for working capital, capital expenditures, interest payments
and scheduled principal payments for the foreseeable future. We also believe
we have adequate coverage of our debt covenants to continue to respond
effectively to competitive conditions.
.. A decline in the generation of sufficient cash flows to support capital
expansion plans, share repurchase programs and general operating activities
could cause our growth to slow significantly and may cause us to miss our
earnings per share growth targets, because we obtain some of our sales
growth from new square footage.
.. The grocery retailing industry continues to experience fierce competition
from other food retailers, supercenters, mass merchandisers, club or
warehouse stores, and drug stores. Our continued success is dependent upon
our ability to compete in this industry and continue to reduce operating
expenses, including health care and pension costs contained in our
collective bargaining agreements. The competitive environment may cause us
to reduce our prices in order to gain or maintain share of sales, thus
reducing margins. While we believe our opportunities for sustained,
profitable growth are considerable, unanticipated actions of competitors
could impact our share of sales and net income.
.. Changes in laws and regulations, including changes in accounting standards,
taxation requirements, and environmental laws may have a material impact on
our financial statements.
.. Changes in the general business and economic conditions in our operating
regions, including the rate of inflation, population growth, and employment
and job growth in the markets in which we operate may affect our ability to
hire and train qualified employees to operate our stores. This would
negatively affect earnings and sales growth. General economic changes may
also effect the shopping habits of our customers, which could affect sales
and earnings.
.. Changes in our product mix may negatively affect certain financial
indicators. For example, we have added and will continue to add supermarket
fuel centers. Since gasoline is a low profit margin item with high sales
dollars, we expect to see our gross profit margins decrease as we sell more
gasoline. Although this negatively affects our gross profit margin, gasoline
provides a positive effect on operating, general and administrative expense
as a percent of sales.
.. Our ability to integrate any companies we acquire or have acquired and
achieve operating improvements at those companies will affect our
operations.
.. We retain a portion of the exposure for our workers' compensation and
general liability claims. It is possible that these claims may cause
significant expenditures that would affect our operating cash flows.
28
. 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.
. Adverse weather conditions could increase the cost our suppliers charge
for their products, or may decrease the customer demand for certain
products. Additionally, increases in the cost of inputs, such as utility
costs or raw material costs, could negatively impact financial ratios
and net earnings.
. Although we presently operate only in the United States, civil unrest in
foreign countries in which our suppliers do business may affect the
prices we are charged for imported goods. If we are unable to pass these
increases on to our customers, our gross margin and net earnings will
suffer.
. Interest rate fluctuation and other capital market conditions may cause
variability in earnings. Although we use derivative financial
instruments to reduce our net exposure to financial risks, we are still
exposed to interest rate fluctuations and other capital market
conditions.
. We cannot fully foresee the effects of the general economic downtown on
Kroger's business. We have assumed the economic situation and
competitive situations will not change significantly for 2002 and 2003.
Other factors and assumptions not identified above could also cause actual
results to differ materially from those set forth in the forward-looking
information. Accordingly, actual events and results may vary significantly from
those included in or contemplated or implied by forward-looking statements made
by us or our representatives.
29
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.
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 10-K filed with the SEC on May 1,
2002.
30
ITEM 4. Controls and Procedures.
There have been no significant changes in our internal controls or in other
factors that could have significantly affected those controls subsequent to
the date of our most recent evaluation of internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
31
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
(a) June 27, 2002 - Annual Meeting
(b) The shareholders elected five directors to serve until the annual
meeting of shareholders in 2005, and one director to serve until the
annual meeting of shareholders in 2004, or until their successors have
been elected and qualified, approved the 2002 Long-Term Incentive Plan,
and ratified the selection of PricewaterhouseCoopers LLP, as Company
auditors for 2002. The shareholders also adopted a shareholder proposal
requesting that the Board of Directors take steps to implement the
annual election of all Board members as opposed to election in classes
and defeated a shareholder proposal recommending the Company label and
identify all products sold under its brand names or private labels that
may contain genetically engineered crops, organisms or products.
Votes were cast as follows:
To Serve Until 2005 For Withheld
------------------- -------------- --------------
Robert D. Beyer 524,489,099 168,468,981
John T. LaMacchia 522,374,319 170,583,761
Edward M. Liddy 524,586,676 168,371,404
Katherine D. Ortega 522,871,873 170,086,207
Bobby S. Shackouls 528,321,911 164,636,169
To Serve Until 2004 For Withheld
------------------- -------------- --------------
David B. Lewis 648,384,449 44,573,631
For Against Withheld Broker Non-Votes
----------- ---------- ------------ --------------------
2002 Long-Term Incentive Plan 629,994,362 56,600,551 6,363,167 --
For Against Withheld Broker Non-Votes
PricewaterhouseCoopers LLP 663,454,639 25,674,758 3,828,683 --
For Against Withheld Broker Non-Votes
Shareholder proposal
(declassify Board) 399,663,862 190,206,086 20,381,245 82,706,887
For Against Withheld Broker Non-Votes
Shareholder proposal
(genetically engineered items) 32,000,436 523,630,923 54,619,834 82,706,887
32
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 10.1 - Material Contracts. Executive Employment Agreement
dated as of June 7, 2002, between the Company and Michael S.
Heschel.
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 Fourteenth Supplemental Indenture
related to the issuance of $350,000,000, 6.20% Senior Notes in
its Current Report on Form 8-K dated June 17, 2002; announcement
of first quarter 2002 earnings results in its Current Report on
Form 8-K dated June 25, 2002; and a disclosure of amendments to
its Annual Report on Form 10-K for the fiscal year ended February
2, 2002, and its Quarterly Report on Form 10-Q for the quarter
ended May 25, 2002, both filed with the SEC on August 14, 2002,
in its Current Report on Form 8-K dated August 14, 2002, and its
CEO and CFO certifications with respect thereto.
33
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: September 30, 2002 By: /s/ Joseph A. Pichler
-------------------------------
Joseph A. Pichler
Chairman of the Board and
Chief Executive Officer
Dated: September 30, 2002 By: /s/ M. Elizabeth Van Oflen
-------------------------------
M. Elizabeth Van Oflen
Vice President and
Corporate Controller
34
CERTIFICATIONS
I, Joseph A. Pichler, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Kroger Co.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary in
order to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
Date: September 30, 2002
(Joseph A. Pichler)
Joseph A. Pichler
Chairman of the Board and
Chief Executive Officer
(principal executive officer)
I, J. Michael Schlotman, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Kroger Co.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary in
order to make the statements made, in light of the circumstances under
which such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
Date: September 30, 2002
(J. Michael Schlotman)
J. Michael Schlotman
Group Vice President and
Chief Financial Officer
(principal financial officer)
35
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 10.1 - Material Contracts. Executive Employment Agreement dated as of
June 7, 2002, between the Company and Michael S. Heschel.
Exhibit 99.1 - Additional Exhibits - Statement of Computation of Ratio of
Earnings to Fixed Charges.