<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the quarterly period ended November 6, 1999 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
COMMISSION FILE NUMBER 1-303
THE KROGER CO.
An Ohio Corporation I.R.S. Employer Identification
No. 31-0345740
1014 Vine Street, Cincinnati, OH 45202
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (513) 762-4000
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 834,337,245 shares of Common Stock ($1 par value) outstanding as of
December 6, 1999.
<PAGE> 2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
The unaudited information included in the consolidated financial statements for
the third quarter and three quarters ended November 6, 1999 include the results
of operations of the Company for the 12 week quarter and 40 week period ended
November 6, 1999. The information for the quarter ended October 3, 1998 includes
the results of operations of The Kroger Co. for the 16 week quarter ended
October 3, 1998, its wholly-owned subsidiary Dillon Companies, Inc. ("Dillon")
for the 13 week quarter ended September 26, 1998, and its wholly-owned
subsidiary Fred Meyer, Inc. ("Fred Meyer") for the 12 week quarter ended
November 7, 1998. The information for the three quarters ended October 3, 1998
includes the results of operations of The Kroger Co. for the 40 week period
ended October 3, 1998, Dillon for the 39 week period ended September 26, 1998,
and Fred Meyer for the 40 week period ended November 7, 1998. It was not
practicable to recast the 1998 quarterly amounts for The Kroger Co. or Dillon to
conform to the quarterly reporting periods of The Kroger Co.'s newly adopted
fiscal year. Because of these differing periods, 1999 results cannot be directly
compared to 1998 results. In the opinion of management, the information reflects
all adjustments (consisting only of normal recurring adjustments) which are
necessary for a fair presentation of results of operations for such periods but
should not be considered as indicative of results for a full year.
CONSOLIDATED STATEMENT OF OPERATIONS
(in millions, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
3rd Quarter Ended 3 Quarters Ended
November 6, October 3, November 6, October 3,
---------------------- -----------------------
1999 1998 1999 1998
----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10,329 $11,501 $34,111 $ 31,877
Merchandise costs, including warehousing and transportation . 7,606 8,552 25,158 23,785
-------- ------- ------- --------
Gross profit. . . . . . . . . . . . . . . . . . . . . . . . 2,723 2,949 8,953 8,092
Operating, general and administrative . . . . . . . . . . . . 1,889 2,105 6,240 5,819
Rent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156 165 498 467
Depreciation and amortization . . . . . . . . . . . . . . . . 221 223 723 646
Merger related costs. . . . . . . . . . . . . . . . . . . . . 69 31 304 238
-------- ------- ------- --------
Operating profit. . . . . . . . . . . . . . . . . . . . . . 388 425 1,188 922
Interest expense. . . . . . . . . . . . . . . . . . . . . . . 148 170 495 489
-------- ------- ------- --------
Earnings before income tax expense and extraordinary loss . 240 255 693 433
Tax expense . . . . . . . . . . . . . . . . . . . . . . . . . 111 104 301 202
-------- ------- ------- --------
Earnings before extraordinary loss. . . . . . . . . . . . . 129 151 392 231
Extraordinary loss, net of income tax benefit . . . . . . . . - (7) (10) (228)
-------- ------- ------- --------
Net earnings. . . . . . . . . . . . . . . . . . . . . . . . $ 129 $ 144 $ 382 $ 3
======== ======= ======= ========
Basic earnings per common share:
Earnings before extraordinary loss. . . . . . . . . . . . . $ 0.16 $ 0.18 $ 0.47 $ 0.28
Extraordinary loss. . . . . . . . . . . . . . . . . . . . . - (0.01) (0.01) (0.28)
------ ------ ------- --------
Net earnings . . . . . . . . . . . . . . . . . . . . . . $ 0.16 $ 0.17 $ 0.46 $ -
====== ====== ======= ========
Average number of common shares used in basic calculation . . 832 821 829 813
Diluted earnings per common share:
Earnings before extraordinary loss. . . . . . . . . . . . . $ 0.15 $ 0.18 $ 0.46 $ 0.27
Extraordinary loss. . . . . . . . . . . . . . . . . . . . . - (0.01) (0.01) (0.27)
------ ------ ------- --------
Net earnings . . . . . . . . . . . . . . . . . . . . . . $ 0.15 $ 0.17 $ 0.45 $ -
====== ====== ======= ========
Average number of common shares used in diluted calculation . 857 855 860 848
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
2
<PAGE> 3
CONSOLIDATED BALANCE SHEET
(in millions, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
November 6, January 2,
1999 1999
----------- ----------
<S> <C> <C>
ASSETS
Current assets
Cash. . . . . . . . . . . . . . . . . . . . . . . . . . $ 283 $ 299
Receivables . . . . . . . . . . . . . . . . . . . . . . 620 587
Inventories . . . . . . . . . . . . . . . . . . . . . . 4,276 3,493
Prepaid and other current assets. . . . . . . . . . . . 418 692
------- -------
Total current assets. . . . . . . . . . . . . . . . 5,597 5,071
Property, plant and equipment, net. . . . . . . . . . . . 8,058 7,220
Goodwill, net . . . . . . . . . . . . . . . . . . . . . . 3,800 3,847
Other assets. . . . . . . . . . . . . . . . . . . . . . . 483 503
------- -------
Total Assets. . . . . . . . . . . . . . . . . . . . $17,938 $16,641
======= =======
LIABILITIES
Current liabilities
Current portion of long-term debt . . . . . . . . . . . $ 530 $ 311
Accounts payable. . . . . . . . . . . . . . . . . . . . 3,292 2,926
Salaries and wages. . . . . . . . . . . . . . . . . . . 673 639
Other current liabilities . . . . . . . . . . . . . . . 1,804 1,574
------- -------
Total current liabilities . . . . . . . . . . . . . 6,299 5,450
Long-term debt. . . . . . . . . . . . . . . . . . . . . . 7,863 7,848
Other long-term liabilities . . . . . . . . . . . . . . . 1,368 1,426
------- -------
Total Liabilities . . . . . . . . . . . . . . . . . 15,530 14,724
------- -------
SHAREOWNERS' EQUITY
Preferred stock, $100 par, 5 million shares
authorized and unissued . . . . . . . . . . . . . . . . - -
Common stock, $1 par, 1 billion shares
authorized: 884 million shares issued in 1999 and
876 million shares issued in 1998 . . . . . . . . . . . 884 876
Additional paid-in capital. . . . . . . . . . . . . . . . 1,986 1,913
Accumulated deficit . . . . . . . . . . . . . . . . . . . (12) (421)
Common stock in treasury, at cost; 50 million shares. . . (450) (451)
------- -------
Total Shareowners' Equity 2,408 1,917
------- -------
Total Liabilities and Shareowners' Equity . . . . . . $17,938 $16,641
======= =======
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
3
<PAGE> 4
CONSOLIDATED STATEMENT OF CASH FLOWS
(in millions)
(unaudited)
<TABLE>
<CAPTION>
3 Quarters Ended
----------------------------
November 6, October 3,
1999 1998
---------- ---------
<S> <C> <C>
Cash Flows From Operating Activities:
Net earnings. . . . . . . . . . . . . . . . . . . . . . . . . . $ 382 $ 3
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Extraordinary loss . . . . . . . . . . . . . . . . . . . . . 10 229
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . 647 580
Goodwill amortization. . . . . . . . . . . . . . . . . . . . 76 66
Deferred income taxes. . . . . . . . . . . . . . . . . . . . 106 (13)
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . (8) 93
Changes in operating assets and liabilities net of effects from
acquisitions of businesses:
Inventories. . . . . . . . . . . . . . . . . . . . . . . (665) (38)
Receivables. . . . . . . . . . . . . . . . . . . . . . . (75) 14
Accounts payable . . . . . . . . . . . . . . . . . . . . 471 219
Other. . . . . . . . . . . . . . . . . . . . . . . . . . 367 312
------- ------
Net cash provided by operating activities. . . . . . . 1,311 1,465
------- ------
Cash Flows From Investing Activities:
Capital expenditures. . . . . . . . . . . . . . . . . . . . . . (1,470) (1,164)
Proceeds from sale of assets. . . . . . . . . . . . . . . . . . 101 64
Payments for acquisitions, net of cash acquired . . . . . . . . - (107)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (33) (106)
------- ------
Net cash used by investing activities. . . . . . . . . (1,402) (1,313)
------- ------
Cash Flows From Financing Activities:
Proceeds from issuance of long-term debt. . . . . . . . . . . . 1,718 5,140
Reductions in long-term debt. . . . . . . . . . . . . . . . . . (1,600) (4,663)
Debt prepayment costs . . . . . . . . . . . . . . . . . . . . . (2) (312)
Financing charges incurred. . . . . . . . . . . . . . . . . . . (10) (99)
Decrease in book overdrafts . . . . . . . . . . . . . . . . . . (58) (118)
Proceeds from issuance of capital stock . . . . . . . . . . . . 63 102
Treasury stock purchases. . . . . . . . . . . . . . . . . . . . - (122)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . - (2)
------- ------
Net cash provided (used) by financing activities . . . 111 (74)
------- ------
Net increase in cash and temporary cash investments . . . . . . . 20 78
Cash and temporary cash investments:
Beginning of year . . . . . . . . . . . . . . . . . . . . . . 263 183
------- ------
End of year . . . . . . . . . . . . . . . . . . . . . . . . . $ 283 $ 261
======= ======
Supplemental disclosure of cash flow information:
Cash paid during the year for interest. . . . . . . . . . . . $ 425 $ 497
Cash paid during the year for income taxes. . . . . . . . . . 75 149
Non-cash changes related to purchase acquisitions:
Fair value of assets acquired . . . . . . . . . . . . . . . - 2,166
Goodwill recorded . . . . . . . . . . . . . . . . . . . . . - 2,397
Value of stock issued . . . . . . . . . . . . . . . . . . . - (653)
Liabilities assumed . . . . . . . . . . . . . . . . . . . . - (3,737)
</TABLE>
The accompanying notes are an integral part
of the consolidated financial statements.
4
<PAGE> 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
-----------------------------------------------------
The year-end condensed balance sheet data was derived from audited
financial statements, and, due to its summary nature, does not include
all disclosures required by generally accepted accounting principles.
The accompanying financial statements include the consolidated accounts
of The Kroger Co. and its subsidiaries ("Kroger"), including Fred
Meyer, Inc. and its subsidiaries ("Fred Meyer") which were merged with
Kroger on May 27, 1999 (see note 2). The year-end condensed balance
sheet includes Kroger's January 2, 1999 balance sheet combined with
Fred Meyer's January 30, 1999 balance sheet. Amounts included in the
consolidated financial statements for the third quarter and three
quarters ended November 6, 1999 include the results of operations of
the Company for the 12 week quarter and 40 week period ended November
6, 1999. The information for the quarter ended October 3, 1998 includes
the results of operations of The Kroger Co. for the 16 week quarter
ended October 3, 1998, its wholly-owned subsidiary Dillon Companies,
Inc. ("Dillon") for the 13 week quarter ended September 26, 1998, and
its wholly-owned subsidiary Fred Meyer for the 12 week quarter ended
November 7, 1998. The information for the three quarters ended October
3, 1998 includes the results of operations of The Kroger Co. for the 40
week period ended October 3, 1998, Dillon for the 39 week period ended
September 26, 1998, and Fred Meyer for the 40 week period ended
November 7, 1998. It was not practicable to recast the 1998 quarterly
amounts for The Kroger Co. or Dillon to conform to the quarterly
reporting periods of The Kroger Co.'s newly adopted fiscal year.
Because of these differing periods, 1999 results cannot be directly
compared to 1998 results. Significant intercompany transactions and
balances have been eliminated. References to the "Company" in these
consolidated financial statements mean the consolidated company.
2. BUSINESS COMBINATIONS
---------------------
On May 27, 1999, Kroger issued 312 million shares of Kroger common
stock in connection with a merger, for all of the outstanding common
stock of Fred Meyer, Inc., which operates stores primarily in the
Western region of the United States. The merger was accounted for as a
pooling of interests, and the accompanying financial statements have
been restated to give effect to the consolidated results of Kroger and
Fred Meyer for all periods presented.
In conjunction with purchase acquisitions, the Company accrued certain
costs associated with closing and divesting of certain acquired
facilities and severance payments to terminate employees of the
acquired companies. The following table presents the activity in the
Company's accrued purchase liabilities:
<TABLE>
<CAPTION>
Facility
Closure Employee
(in millions) Costs Severance Total
----------------------------- -------- --------- -------
<S> <C> <C> <C>
Balance at December 27, 1997 $ 19 $ 8 $ 27
Additions 122 22 144
Payments (13) (2) (15)
Adjustments to severance accrual - (3) (3)
----- ----- -----
Balance at January 2, 1999 128 25 153
Payments (3) (7) (10)
----- ----- -----
Balance at November 6, 1999 $ 125 $ 18 $ 143
===== ===== =====
</TABLE>
5
<PAGE> 6
FACILITY CLOSURE COSTS
----------------------
The Company acquired certain idle facilities in its purchase
acquisitions including 63 closed stores, four closed warehouses and one
vacant parcel all of which are leased. The Company also acquired 16
stores that the California Attorney General required to be divested and
17 stores that were duplicate facilities. Divestitures of 15 stores
have been completed and 10 of the duplicate facilities have been
closed. The remaining 7 duplicate stores are expected to close by the
end of 1999. Facility closure costs accrued include obligations for
future contractual lease payments, net of sublease income, and closure
costs.
EMPLOYEE SEVERANCE
------------------
Employee severance relates to 46 employees that have been terminated
and 51 employees that will be terminated in the future. Under severance
agreements, the severance will be paid over a period not to exceed
three years following the date of termination.
3. MERGER RELATED COSTS
--------------------
The Company is in the process of implementing its integration plan
relating to recent mergers. The integration plan includes distribution
consolidation, systems integration, store conversions, transaction
costs, store closures, and administration integration. The following
table presents the components of the merger related costs:
<TABLE>
<CAPTION>
3rd Quarter Ended 3 Quarters Ended
-------------------------- -----------------------
November 6, October 3, November 6, October 3,
(in millions) 1999 1998 1999 1998
---------------------------------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
CHARGES RECORDED AS CASH EXPENDED
Distribution consolidation $ 14 $ - $ 24 $ 14
Systems integration 22 13 65 32
Store conversions 21 6 43 42
Transaction costs 4 1 91 33
Administration integration 6 4 19 11
----- ---- ----- ------
67 24 242 132
NONCASH ASSET WRITE-DOWN
Distribution consolidation - - - 29
Systems integration - 2 3 23
Store closures - - 3 25
Administration integration 1 - 14 3
----- ---- ----- ------
1 2 20 80
ACCRUED CHARGES
Distribution consolidation - - 5 -
Systems integration - - - 1
Transaction costs - 2 - 6
Store closures 1 - 5 7
Administration integration - 3 32 12
----- ---- ----- ------
1 5 42 26
----- ---- ----- ------
Total merger related costs $ 69 $ 31 $ 304 $ 238
===== ==== ===== ======
TOTAL CHARGES
Distribution consolidation $ 14 $ - $ 29 $ 43
Systems integration 22 15 68 56
Store conversions 21 6 43 42
Transaction costs 4 3 91 39
Store closures 1 - 8 32
Administration integration 7 7 65 26
----- ---- ----- ------
Total merger related costs $ 69 $ 31 $ 304 $ 238
===== ==== ===== ======
</TABLE>
6
<PAGE> 7
Distribution Consolidation
--------------------------
Represents costs to consolidate manufacturing and distribution
operations and eliminate duplicate facilities. Third quarter 1999
Tolleson warehouse expenses of $14 million were recorded as the cash
was expended. Severance costs of $5 million were accrued year-to-date
1999 for distribution employees in Phoenix. The year-to-date 1998 costs
include a $29 million write-down to estimated net realizable value for
a distribution center in Southern California. The facility is held for
sale. The year-to-date 1998 costs also include $13 million for
incremental labor incurred during the closing of the distribution
center and other incremental costs incurred as a part of the
realignment of the Company's distribution system.
Systems Integration
-------------------
Represents the costs of integrating systems and the related conversion
of all corporate office and store systems. Charges recorded as cash was
expended totaled $22 million and $13 million in the third quarter of
1999 and 1998, respectively, and $65 million and $32 million
year-to-date 1999 and 1998, respectively. These costs represent
incremental operating costs, principally labor, during the conversion
process, payments to third parties and training costs. The year-to-date
1998 costs include a $19 million write-down of computer equipment and
related software that have been abandoned and $2 million of
depreciation associated with computer equipment which is being written
off over 18 months at which time it will be abandoned.
Store Conversions
-----------------
Includes the cost to convert store banners. All costs represented
incremental cash expenditures for advertising and promotions to
establish the banner, changing store signage, labor required to
remerchandise the store inventory and other services which were
expensed as incurred.
Transaction Costs
-----------------
Represents fees paid to outside parties, employee bonuses that were
contingent upon the completion of the mergers, and an employee stay
bonus program. The Company incurred costs totaling $4 million and $1
million in the third quarter of 1999 and 1998, respectively, and $91
million and $33 million year-to-date 1999 and 1998, respectively,
related to fees and employee bonuses recorded as the cash was expended.
All accrued amounts relate to the employee stay bonus program.
Store Closures
--------------
Includes the costs to close stores identified as duplicate facilities
and to sell stores pursuant to settlement agreements. Year-to-date 1999
costs of $5 million were accrued to close seven stores identified as
duplicate facilities and to sell three stores pursuant to a settlement
with the Federal Trade Commission ("FTC Stores"). Included in the
year-to-date 1998 were costs to close four stores identified as
duplicate facilities and to sell three stores pursuant to a settlement
agreement with the State of California ("AG Stores"). The asset
write-down of $25 million year-to-date 1998 relates to the AG Stores.
Termination costs totaling $7 million were accrued year-to-date 1998.
Administration Integration
--------------------------
Includes labor and severance costs, charitable contributions, and costs
to conform accounting policies. Year-to-date 1999 the Company accrued
$12 million for severance costs and $20 million in connection with the
Fred Meyer merger for charitable contributions that will be made to a
foundation.
7
<PAGE> 8
The following table presents the activity in the reserve accounts.
<TABLE>
<CAPTION>
Lease
(in millions) Other Obligation Severance Total
---------------------------- ------- ---------- --------- -------
<S> <C> <C> <C> <C>
Balance at December 27, 1997 $ - $ - $ - $ -
Expense 6 7 13 26
Payments (6) (2) (8) (16)
---- ---- ---- ----
Balance at January 2, 1999 - 5 5 10
Expense 20 4 17 41
Payments - (2) (10) (12)
---- ---- ---- ----
Balance at November 6, 1999 $ 20 $ 7 $ 12 $ 39
==== ==== ==== ====
</TABLE>
Severance
---------
Relates to administrative, systems, and distribution employees. All of
the employees have been terminated or notified of their terminations.
Under severance agreements, the amounts of severance will be paid over
a period following the date of termination.
Lease Obligation
----------------
The lease obligation represents future contractual lease payments on a
closed store and several AG Stores and FTC Stores over the expected
holding period, net of any sublease income. The Company is actively
marketing the stores to potential buyers and sub-lease tenants.
Other
-----
The 1998 costs represent amounts that were paid under a stay bonus
program in the fourth quarter of 1998. The Company accrued $20 million
in 1999 in connection with the Fred Meyer merger for charitable
contributions that will be made to a foundation.
4. ONE-TIME EXPENSES
-----------------
In the second quarter of 1998, the Company incurred a $41 million
one-time expense for logistics projects. This expense included the
costs associated with ending a joint venture related to a warehouse
operation that formerly served the Company's Michigan stores and
several independent customers. The warehouse is now operated by a third
party that distributes the Company's inventory to its Michigan stores.
These expenses also included the transition costs related to one of the
Company's new warehouses, and one new warehouse facility operated by an
unaffiliated entity that provides services to the Company. These costs
included carrying costs of the facilities idled as a result of these
new warehouses and the associated employee severance costs. The
expenses described above included non-cash asset writedowns of $16
million and were included in merchandise costs, including warehouse and
transportation. The remaining $25 million of expenses are summarized as
follows:
<TABLE>
<CAPTION>
Facility
Employee Carrying Joint
(in millions) Severance Costs Venture Total
- -------------------------------------- --------- -------- ------- -----
<S> <C> <C> <C> <C>
Balance at December 27, 1997 $ - $ - $ - $ -
Expense 11 9 5 25
Payments (7) (3) (5) (15)
--- --- --- ---
Balance at January 2, 1999 4 6 $ - 10
===
Payments (4) (4) (8)
--- --- ---
Balance at November 6, 1999 $ - $ 2 $ 2
=== === ===
</TABLE>
The carrying costs of the idled warehouse facilities will be paid
through 2001.
8
<PAGE> 9
Additionally, in the second quarter of 1998, the Company incurred
one-time expenses of $12 million associated with accounting, data and
operations consolidations in Texas. These included the cost of closing
eight stores and relocating the remaining Dallas office employees to a
smaller facility. These expenses, which included non-cash asset
writedowns of $2 million, were included in operating, general and
administrative expenses. Cash expenses paid to date are $3 million and
the remaining accrual of $7 million at November 6, 1999 represents
estimated rent or lease termination costs that will be paid on closed
stores through 2013.
5. ACCOUNTING CHANGE
-----------------
In the second quarter of 1998, Kroger changed its application of the
Last-In, First-Out, or LIFO method of accounting for store inventories
from the retail method to the item cost method. The change was made to
more accurately reflect inventory value by eliminating the averaging
and estimation inherent in the retail method. The cumulative effect of
this change on periods prior to December 28, 1997 cannot be determined.
The effect of the change on the December 28, 1997 inventory valuation,
which includes other immaterial modifications in inventory valuation
methods, was included in restated results for the quarter ended March
21, 1998. This change increased merchandise costs by $90 million and
reduced earnings before extraordinary loss and net earnings by $56
million. The item cost method did not have a material impact on
earnings subsequent to its initial adoption.
6. INCOME TAXES
------------
The effective income tax rate differs from the expected statutory rate
primarily due to the effect of certain state taxes and non-deductible
goodwill.
7. EARNINGS PER COMMON SHARE
-------------------------
Earnings per common share equals net earnings divided by the weighted
average number of common shares outstanding, after giving effect to
dilutive stock options.
The following table provides a reconciliation of earnings before
extraordinary loss and shares used in calculating basic earnings per
share to those used in calculating diluted earnings per share.
9
<PAGE> 10
<TABLE>
<CAPTION>
For the quarter ended For the quarter ended
November 6, 1999 October 3, 1998
---------------------------- -------------------------
Income Shares Per Income Shares Per
(Numer- (Denomi- Share (Numer- (Denomi- Share
ator) nator) Amount ator) nator) Amount
------- -------- ----- ------- -------- -----
(in millions, except per share amounts)
--------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per
common share . . . . . . . $129 832 $0.16 $ 151 821 $ 0.18
Dilutive effect of stock
options and warrants . . . . - 25 - 34
---- ----- ----- -----
Diluted earnings per
common share . . . . . . . $129 857 $0.15 $ 151 855 $ 0.18
==== ===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
For the 3 quarters ended For the 3 quarters ended
November 6, 1999 October 3, 1998
--------------------------- --------------------------
Income Shares Per Income Shares Per
(Numer- (Denomi- Share (Numer- (Denomi- Share
ator) nator) Amount ator) nator) Amount
------- -------- ----- ------- -------- -----
(in millions, except per share amounts)
--------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Basic earnings per
common share . . . . . . . $392 829 $0.47 $ 231 813 $ 0.28
Dilutive effect of stock
options and warrants . . . - 31 - 35
---- ----- ----- -----
Diluted earnings per
common share . . . . . . . $392 860 $0.46 $ 231 848 $ 0.27
==== ===== ===== =====
</TABLE>
On May 20, 1999, the Company announced a distribution in the nature of
a two-for-one stock split, to shareholders of record of common stock on
June 7, 1999. All share amounts prior to this date have been restated
to reflect the split.
8. SEGMENTS
--------
The Company operates retail food and drug stores, multi-department
stores and convenience stores in the Midwest, South and West. The
Company's retail operations, which represent approximately 98% of
consolidated sales, are its only reportable segment. All of the
Company's operations are domestic.
9. COMPREHENSIVE INCOME
--------------------
The Company has no items of other comprehensive income in any period
presented. Therefore, net earnings as presented in the Consolidated
Statement of Operations equals comprehensive income.
10. RECENTLY ISSUED ACCOUNTING STANDARDS
------------------------------------
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities". This standard, as amended, is
effective for fiscal years beginning after June 15, 2000. Given current
activities, the Company expects that the adoption of the standard will
not have a material impact on the financial statements.
10
<PAGE> 11
11. GUARANTOR SUBSIDIARIES
----------------------
Certain of the Company's Senior Notes and Senior Subordinated Notes
(the "Guaranteed Notes") are jointly and severally, fully and
unconditionally guaranteed by certain Kroger subsidiaries (the
"Guarantor Subsidiaries"). At November 6, 1999 a total of approximately
$4.8 billion of Guaranteed Notes were outstanding. The Guarantor
Subsidiaries and non-guarantor subsidiaries are wholly-owned
subsidiaries of Kroger. Separate financial statements of Kroger and
each of the Guarantor Subsidiaries are not presented because the
guarantees are full and unconditional and the Guarantor Subsidiaries
are jointly and severally liable. The Company believes that separate
financial statements and other disclosures concerning the Guarantor
Subsidiaries would not be material to investors.
The non-guaranteeing subsidiaries represent less than 3% on an
individual and aggregate basis of consolidated assets, pretax earnings,
cash flow, and equity. Therefore, the non-guarantor subsidiaries'
information is not separately presented in the tables below.
There are no current restrictions on the ability of the Guarantor
Subsidiaries to make payments under the guarantees referred to above,
except, however, the obligations of each guarantor under its guarantee
are limited to the maximum amount as will result in obligations of such
guarantor under its guarantee not constituting a fraudulent conveyance
or fraudulent transfer for purposes of Bankruptcy Law, the Uniform
Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act, or any
similar Federal or state law (e.g. adequate capital to pay dividends
under corporate laws).
The following tables present summarized financial information as of
November 6, 1999 and for the three quarters ended November 6, 1999 and
October 3, 1998. For the summarized financial information as of
November 6, 1999 and for the three quarters then ended, the Kroger
column includes approximately $3.1 billion of debt issued by Fred Meyer
that has been jointly and severally guaranteed by Kroger. As a result,
this amount is not also included in the Guarantor Subsidiaries column.
SUMMARIZED FINANCIAL INFORMATION AS OF NOVEMBER 6, 1999 AND FOR THE
THREE QUARTERS THEN ENDED:
<TABLE>
<CAPTION>
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------------ ---------- -------------- ---------------- --------------
<S> <C> <C> <C> <C>
Current assets $ 724 $ 4,873 $ - $ 5,597
Non-current assets 11,156 10,838 (9,653) 12,341
Current liabilities 1,437 4,862 - 6,299
Non-current liabilities 8,035 1,196 - 9,231
Sales 7,062 27,520 (471) 34,111
Gross profit 1,491 7,500 (38) 8,953
Operating profit (22) 1,210 - 1,188
Net earnings 382 691 (691) 382
</TABLE>
SUMMARIZED FINANCIAL INFORMATION FOR THE THREE QUARTERS ENDED OCTOBER
3, 1998:
<TABLE>
<CAPTION>
Guarantor
(in millions of dollars) Kroger Subsidiaries Eliminations Consolidated
------------------------------ ---------- -------------- ---------------- --------------
<S> <C> <C> <C> <C>
Sales $ 7,273 $ 25,076 $ (472) $ 31,877
Gross profit 1,402 6,762 (72) 8,092
Operating profit 72 850 - 922
Net earnings 3 61 (61) 3
</TABLE>
12. COMMITMENTS AND CONTINGENCIES
-----------------------------
The Company is a 50% owner of Santee Dairies, L.L.C. ("Santee") and has
a 10 year product supply agreement with Santee that requires 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 Company is currently engaged in efforts to dispose of its
interest in Santee that may result in a loss.
11
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RESULTS OF OPERATIONS
The following discussion summarizes our operating results for the third quarter
and first three quarters of 1999 compared to the third quarter and first three
quarters of 1998. Amounts included in the consolidated financial statements for
the third quarter and three quarters ended November 6, 1999 include the results
of operations of the Company for the 12 week quarter and 40 week period ended
November 6, 1999. The information for the quarter ended October 3, 1998 includes
the results of operations of The Kroger Co. for the 16 week quarter ended
October 3, 1998, its wholly-owned subsidiary Dillon Companies, Inc. ("Dillon")
for the 13 week quarter ended September 26, 1998, and its wholly-owned
subsidiary Fred Meyer, Inc. ("Fred Meyer") for the 12 week quarter ended
November 7, 1998. The information for the three quarters ended October 3, 1998,
includes the results of operations of The Kroger Co. for the 40 week period
ended October 3, 1998, Dillon for the 39 week period ended September 26, 1998
and Fred Meyer for the 40 week period ended November 7, 1998. It was not
practicable to recast the 1998 quarterly amounts for The Kroger Co. or Dillon to
conform to the quarterly reporting periods of Kroger's newly adopted fiscal
year. Because of these differing periods, 1999 results cannot be directly
compared to 1998 results.
BUSINESS COMBINATIONS
On May 27, 1999 Kroger issued 312 million shares of Kroger common stock in
connection with a merger, for all of the outstanding common stock of Fred Meyer,
Inc., which operates stores primarily in the Western region of the United
States. The merger was accounted for as a pooling of interests, and the
accompanying financial statements have been restated to give effect to the
consolidated results of Kroger and Fred Meyer for all years presented.
MERGER RELATED COSTS
We are in the process of implementing our integration plan relating to recent
mergers. The integration plan includes distribution consolidation, systems
integration, store conversions, transaction costs, store closures, and
administration integration. The following table presents the components of the
merger related costs:
<TABLE>
<CAPTION>
3rd Quarter Ended 3 Quarters Ended
---------------------- -----------------------
November 6, October 3, November 6, October 3,
(in millions) 1999 1998 1999 1998
--------------------------------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
CHARGES RECORDED AS CASH EXPENDED
Distribution consolidation $ 14 $ - $ 24 $ 14
Systems integration 22 13 65 32
Store conversions 21 6 43 42
Transaction costs 4 1 91 33
Administration integration 6 4 19 11
------ ----- ------ -----
67 24 242 132
NONCASH ASSET WRITE-DOWN
Distribution consolidation - - - 29
Systems integration - 2 3 23
Store closures - - 3 25
Administration integration 1 - 14 3
------ ----- ------ -----
1 2 20 80
</TABLE>
12
<PAGE> 13
<TABLE>
<S> <C> <C> <C> <C>
ACCRUED CHARGES
Distribution consolidation - - 5 -
Systems integration - - - 1
Transaction costs - 2 - 6
Store closures 1 - 5 7
Administration integration - 3 32 12
------ ----- ------ -----
1 5 42 26
------ ----- ------ -----
Total merger related costs $ 69 $ 31 $ 304 $ 238
====== ===== ====== =====
TOTAL CHARGES
Distribution consolidation $ 14 $ - $ 29 $ 43
Systems integration 22 15 68 56
Store conversions 21 6 43 42
Transaction costs 4 3 91 39
Store closures 1 - 8 32
Administration integration 7 7 65 26
------ ----- ------ -----
Total merger related costs $ 69 $ 31 $ 304 $ 238
====== ===== ====== =====
</TABLE>
Distribution Consolidation
- --------------------------
Represents costs to consolidate manufacturing and distribution operations and
eliminate duplicate facilities. Third quarter 1999 Tolleson warehouse expenses
of $14 million were recorded as the cash was expended. Severance costs of $5
million were accrued year-to-date 1999 for distribution employees in Phoenix.
The year-to-date 1998 costs include a $29 million write-down to estimated net
realizable value for a distribution center in Southern California. The facility
is held for sale. The year-to-date 1998 costs also include $13 million for
incremental labor incurred during the closing of the distribution center and
other incremental costs incurred as a part of the realignment of our
distribution system.
Systems Integration
- -------------------
Represents the costs of integrating systems and the related conversion of all
corporate office and store systems. Charges recorded as cash was expended
totaled $22 million and $13 million in the third quarter of 1999 and 1998,
respectively, and $65 million and $32 million year-to-date 1999 and 1998,
respectively. These costs represent incremental operating costs, principally
labor, during the conversion process, payments to third parties and training
costs. The year-to-date 1998 costs include a $19 million write-down of computer
equipment and related software that have been abandoned and $2 million of
depreciation associated with computer equipment which is being written off over
18 months at which time it will be abandoned.
Store Conversions
- -----------------
Includes the cost to convert store banners. All costs represented incremental
cash expenditures for advertising and promotions to establish the banner,
changing store signage, labor required to remerchandise the store inventory and
other services which were expensed as incurred.
13
<PAGE> 14
Transaction Costs
- -----------------
Represents fees paid to outside parties, employee bonuses that were contingent
upon the completion of the mergers, and an employee stay bonus program. The
Company incurred costs totaling $4 million and $1 million in the third quarter
of 1999 and 1998, respectively, and $91 million and $33 million year-to-date
1999 and 1998, respectively, related to fees and employee bonuses recorded as
the cash was expended. All accrued amounts relate to the employee stay bonus
program.
Store Closures
- --------------
Includes the costs to close stores identified as duplicate facilities and to
sell stores pursuant to settlement agreements. Year-to-date 1999 costs of $5
million were accrued to close seven stores identified as duplicate facilities
and to sell three stores pursuant to a settlement with the Federal Trade
Commission ("FTC Stores"). Included in the year-to-date 1998 were costs to close
four stores identified as duplicate facilities and to sell three stores pursuant
to a settlement agreement with the State of California ("AG Stores"). The asset
write-down of $25 million year-to-date 1998 relates to the AG Stores.
Termination costs totaling $7 million were accrued year-to-date 1998.
Administration Integration
- --------------------------
Includes labor and severance costs, charitable contributions, and costs to
conform accounting policies. Year-to-date 1999 we accrued $12 million for
severance costs and $20 million in connection with the Fred Meyer merger for
charitable contributions that will be made to a foundation.
The following table presents the activity in the reserve accounts.
<TABLE>
<CAPTION>
Lease
(in millions) Other Obligation Severance Total
---------------------------- ------- ---------- -------------- -------
<S> <C> <C> <C> <C>
Balance at December 27, 1997 $ - $ - $ - $ -
Expense 6 7 13 26
Payments (6) (2) (8) (16)
--- --- --- ---
Balance at January 2, 1999 - 5 5 10
Expense 20 4 17 41
Payments - (2) (10) (12)
--- --- --- ---
Balance at November 6, 1999 $20 $ 7 $12 $39
=== === === ===
</TABLE>
Severance
- ---------
Relates to administrative, systems, and distribution employees. All of the
employees have been terminated or notified of their terminations. Under
severance agreements, the amounts of severance will be paid over a period
following the date of termination.
Lease Obligation
- ----------------
The lease obligation represent future contractual lease payments on a closed
store and several AG Stores and FTC Stores over the expected holding period, net
of any sublease income. The Company is actively marketing the stores to
potential buyers and sub-lease tenants.
14
<PAGE> 15
Other
- -----
The 1998 costs represent amounts that were paid under a stay bonus program in
the fourth quarter of 1998. The Company accrued $20 million in 1999 in
connection with the Fred Meyer merger for charitable contributions that will be
made to a foundation.
In addition to the merger related costs mentioned above, we incurred costs
related to the merger of $18 million in the third quarter of 1999, $3 million in
the third quarter of 1998, $36 million for the first three quarters of 1999 and
$7 million for the first three quarters of 1998. These costs related to
inventory adjustments to inventory made obsolete or marked down for liquidation
as a result of the store integration program. These costs were reported in
merchandise costs. We also incurred incremental labor costs of $6 million in the
third quarter of 1999 and costs from unwinding specific interest rate swap
contracts of $17 million in the second quarter of 1999. These costs were
reported as operating, general and administrative expenses.
ONE-TIME EXPENSES
In the second quarter of 1998, we incurred a $41 million one-time expense
associated with logistics projects. This expense included the costs associated
with ending a joint venture related to a warehouse operation that formerly
served our Michigan stores and several independent customers. The warehouse is
now operated by a third party that distributes our inventory to our Michigan
stores. These expenses also included the transition costs related to one of our
new warehouses, and one new warehouse facility operated by an unaffiliated
entity that provides services to us. These costs included carrying costs of the
facilities idled as a result of these new warehouses and the associated employee
severance costs. The expenses described above included non-cash asset writedowns
of $16 million and were included in merchandise costs, including warehouse and
transportation. The remaining $25 million of expenses are summarized as follows:
<TABLE>
<CAPTION>
Facility
Employee Carrying Joint
(in millions) Severance Costs Venture Total
---------------------------- --------- -------- ------- -----
<S> <C> <C> <C> <C>
Balance at December 27, 1997 $ - $ - $ - $ -
Expense 11 9 5 25
Payments (7) (3) (5) (15)
--- --- --- ---
Balance at January 2, 1999 4 6 $ - 10
===
Payments (4) (4) (8)
--- --- ---
Balance at November 6, 1999 $ - $ 2 $ 2
=== === ===
</TABLE>
The carrying costs of the idled warehouse facilities will be paid through 2001.
Additionally, in the second quarter of 1998, we incurred one-time expenses of
$12 million associated with accounting, data and operations consolidations in
Texas. These included the cost of closing eight stores and relocating the
remaining Dallas office employees to a smaller facility. These expenses, which
included non-cash asset writedowns of $2 million, were included in operating,
general and administrative expenses. Cash expenses paid to date are $3 million
and the remaining accrual of $7 million at November 6, 1999 represents estimated
rent or lease termination costs that will be paid on closed stores through 2013.
ACCOUNTING CHANGE
In the second quarter of 1998, Kroger changed its application of the Last-In,
First-Out, or LIFO method of accounting for store inventories from the retail
method to the item cost method. The
15
<PAGE> 16
change was made to more accurately reflect inventory value by eliminating the
averaging and estimation inherent in the retail method. The cumulative effect of
this change on periods prior to December 28, 1997 cannot be determined. The
effect of the change on the December 28, 1997 inventory valuation, which
includes other immaterial modifications in inventory valuation methods, was
included in restated results for the quarter ended March 21, 1998. This change
increased merchandise costs by $90 million and reduced earnings before
extraordinary loss and net earnings by $56 million. The item cost method did not
have a material impact on earnings subsequent to its initial adoption.
THIRD QUARTER 1999 VS. THIRD QUARTER 1998; AND FIRST THREE QUARTERS 1999 VS.
FIRST THREE QUARTERS 1998.
Sales
- -----
Adjusting for the change in our fiscal calendar and excluding sales from
divested stores, total sales for the third quarter of 1999 increased 6.6% to
$10.3 billion and total sales year-to-date increased 5.7% to $34.0 billion.
Identical food stores sales, which include stores in operation and not expanded
or relocated for five quarters, grew 1.6%. Comparable food stores sales, which
include relocations and expansions, rose 2.5%. Identical and comparable sales
include stores that changed names during the past year. Excluding our Fry's
division, which has converted 35 former Smith's stores to the Fry's banner,
identical food store sales grew 1.9% and comparable food store sales rose 2.8%.
Merchandise Costs
- -----------------
Merchandise costs include advertising, warehousing and transportation expenses.
Merchandise costs, net of one-time items and LIFO, as a percent of sales were
73.5% in the third quarter of 1999 and 74.3% in the second quarter of 1998. On
this same basis, year-to-date merchandise costs as a percent of sales were 73.6%
in 1999 and 74.1% in 1998. Merchandise costs were affected positively by strong
private label sales, strategic initiatives in coordinated purchasing, category
management and operating improvements due to logistics and technology related
efficiencies.
Operating, General and Administrative Expenses
- ----------------------------------------------
Operating, general and administrative expenses as a percent of sales were 18.2%
in the third quarter of 1999 and 18.3% in the third quarter of 1998. No specific
cost reduction caused the decline. Year-to-date operating, general and
administrative expenses, net of one-time items, as a percent of sales were 18.2%
in 1999 and 18.2% in 1998.
Income Taxes
- ------------
The effective tax rate differs from the expected statutory rate primarily due to
the effect of certain taxes and non-deductible goodwill. Goodwill amortization
was $23 million in the third quarter of 1999 and $23 million in the third
quarter of 1998. Year-to-date goodwill amortization was $76 million in 1999 and
$66 million in 1998.
Net Earnings
- ------------
Earnings before extraordinary loss, excluding one-time items, were $202 million
or $0.24 per diluted share in the third quarter of 1999. These results represent
an increase of approximately 33% over estimated earnings before extraordinary
loss of $0.18 per diluted share for the third quarter of
16
<PAGE> 17
1998. On this same basis, year-to-date 1999 earnings before extraordinary loss
were $635 million or $0.74 per diluted share. These results represent an
increase of approximately 25% over estimated year-to-date 1998 earnings before
extraordinary loss of $0.59 per diluted share. The prior year estimate includes
the actual results, net of one-time items, of Fred Meyer and an estimate of
Kroger's results, net of one-time items, to reflect the change to our new fiscal
year.
EBITDA
- ------
Our bank credit facilities and the indentures underlying our publicly issued
debt, contain various restrictive covenants. Many of these covenants are based
on earnings before interest, taxes, depreciation, amortization, LIFO,
extraordinary losses and one-time items or EBITDA. 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 Credit Agreement. 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 November 6, 1999.
The following is a summary of the calculation of EBITDA for the third quarters
of 1999 and 1998 and for the first three quarters of 1999 and 1998.
<TABLE>
<CAPTION>
3rd Quarter Ended 3 Quarters Ended
---------------------- ----------------------
November 6, October 3, November 6, October 3,
(in millions) 1999 1998 1999 1998
- --------------------------------------------------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Earnings before tax expense and extraordinary loss. $ 240 $ 255 $ 693 $ 433
Interest........................................... 148 170 495 489
Depreciation....................................... 198 200 647 580
Goodwill amortization.............................. 23 23 76 66
LIFO............................................... (6) 9 6 28
One-time items included in merchandise costs....... 18 3 36 138
One-time items included in operating, general and
administrative expenses.......................... 6 - 23 12
Merger related costs............................... 69 31 304 238
----- ----- ------ ------
EBITDA............................................. $ 696 $ 691 $2,280 $1,984
===== ===== ====== ======
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
Debt Management
- ---------------
We had several lines of credit totaling $4.0 billion, with $1.3 billion in
unused balances at November 6, 1999. In addition, we had a $500 million
synthetic lease credit facility and a $100 million money market line with unused
balances of $56 million and $100 million, respectively, at November 6, 1999.
Net debt increased $247 million to $8.7 billion at the end of the third quarter
of 1999 compared to the prior year. Net debt is defined as long-term debt,
including capital leases and current portion thereof, less investments in debt
securities and prefunded employee benefits.
Cash Flow
- ---------
We generated $1,311 million of cash from operating activities year-to-date 1999
compared to $1,465 million year-to-date 1998. Cash flow from operating
activities decreased in 1999 largely due to increased inventory for the holiday
season in anticipation of our customers' needs for the millennium.
17
<PAGE> 18
Investing activities used $1,402 million of cash year-to-date 1999 compared to
$1,313 million year-to-date 1998.
Financing activities provided $111 million of cash year-to-date 1999 compared to
$74 million used year-to-date 1998. Debt prepayment costs and new financing
charges used $12 million of cash year-to-date 1999 compared to $411 million
year-to-date 1998. The change in the balance of book overdrafts used $58 million
of cash year-to-date 1999 compared to $118 million year-to-date 1998.
CAPITAL EXPENDITURES
Capital expenditures totaled $625 million in the third quarter of 1999 compared
to $495 million in the third quarter of 1998. During the third quarter of 1999
we opened, acquired, expanded, or relocated 104 stores. We had 11 operational
closings and completed 40 within the wall remodels. Square footage increased
5.9% excluding divested stores.
Year-to-date capital expenditures totaled $1,470 million compared to $1,164
million year-to-date 1998. Year-to-date we opened, acquired, expanded, or
relocated 167 stores. We had 55 operational closings and completed 107 within
the wall remodels.
EFFECT OF INFLATION
While management believes that some portion of the increase in sales is due to
inflation, it is difficult to segregate and to measure the effects of inflation
because of changes in the types of merchandise sold year-to-year and other
pricing and competitive influences. By attempting to control costs and
efficiently utilize resources, we strive to minimize the effects of inflation on
operations.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities". This standard, as amended, is effective for all fiscal
years beginning after June 15, 2000. Given current activities, we expect that
the adoption of the standard will not have a material impact on the financial
statements.
OTHER ISSUES
On May 20, 1999, we announced a distribution in the nature of a two-for-one
stock split, to shareholders of record of common stock on June 7, 1999. All
share amounts prior to this date have been restated to reflect the split.
On January 6, 1999, we changed our fiscal year-end to the Saturday nearest
January 31 of each year. This change is disclosed in our Current Report on Form
8-K dated January 15, 1999. Our first new fiscal year will end January 29, 2000.
It includes a 16-week first quarter ending May 22, 1999, and 12-week second,
third and fourth quarters ending August 14, 1999, November 6, 1999 and January
29, 2000, respectively. We filed separate audited financial statements covering
the transition period from January 3, 1999 through January 30, 1999 on a Current
Report of Form 8-K dated May 10, 1999. These financial statements include Kroger
and its consolidated subsidiaries before the merger with Fred Meyer.
We are a 50% owner of Santee Dairies, L.L.C. ("Santee") and have a 10 year
product supply agreement with Santee that requires us to purchase 9 million
gallons of fluid milk and other products annually. The product supply agreement
expires on July 29, 2007. Upon acquisition of Ralphs/Food 4 Less, Santee became
excess capacity and a duplicate facility. We are currently engaged in efforts to
dispose of our interest in Santee that may result in a loss.
18
<PAGE> 19
OUTLOOK
Statements elsewhere in this report and below regarding our expectations, hopes,
beliefs, intentions or strategies are forward looking statements within the
meaning of Section 21E of the Securities Exchange Act of 1934. While we believe
that the statements are accurate, uncertainties and other factors could cause
actual results to differ materially from those statements. In particular:
- We obtain sales growth from new square footage, as well as from
increased productivity from existing locations. We expect 1999 full
year square footage to grow 4.0% to 4.5%. We expect to continue to
realize savings from economies of scale in technology and logistics,
some of which may be reinvested in retail price reductions to increase
sales volume and enhance market share.
- We expect combination stores to generate higher sales per customer by
the inclusion of numerous specialty departments, such as pharmacies,
seafood shops, floral shops and bakeries. We believe the combination
store format will allow us to withstand continued competition from
other food retailers, supercenters, mass merchandisers and restaurants.
- We believe we have adequate coverage of our debt covenants to continue
to respond effectively to competitive conditions.
- We expect to continue capital spending in technology focusing on
improved store operations, logistics, manufacturing procurement,
category management, merchandising and buying practices, which should
continue to reduce merchandising costs as a percent of sales.
- We expect to reduce working capital by a total of $500 million over the
next 5 years.
- Our earnings per share target is a 16%-18% average annual increase over
the next three years effective with the year 2000.
- We expect capital expenditures for the year to total $1.7-$1.8 billion,
net of acquisitions, compared to $1.6 billion during 1998. Capital
expenditures reflect Kroger's strategy of growth through expansion and
acquisition as well as our emphasis, whenever possible, on
self-development and ownership of store real estate, and on logistics
and technology improvements.
- We are dependent on computer hardware, software, systems and processes
("IT Systems") and non-information technology systems such as
telephones, clocks, scales and refrigeration controllers, and other
equipment containing embedded microprocessor technology ("Non-IT
Systems"). These systems are used in several critical operating areas
including store and distribution operations, product merchandising and
procurement, manufacturing plant operations, inventory and labor
management, and accounting and administrative systems.
- We expect to achieve $380 million in synergy savings over the next
three years as a result of our mergers. We project the timing of the
annual savings by fiscal year to be as follows: $155 million in 1999,
$260 million in 2000, $345 million in 2001, and $380 million in 2002
and beyond.
YEAR 2000 READINESS DISCLOSURE
We are currently working to resolve the potential effect of the year 2000 on the
processing of date- sensitive information within our various systems. The year
2000 problem is the result of computer programs being written using two digits
(rather than four) to define the applicable year. Any of our programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000, which could result in miscalculations or system failures.
We have developed a plan to assess and update our IT Systems and Non-IT Systems
for year 2000 compliance requirements and provide for continued functionality.
The plan consists of three major
19
<PAGE> 20
phases:
1) create an inventory of systems subject to the year 2000 problem and
assess the scope of the problem as it relates to those systems
2) remediate any year 2000 problems
3) test and implement systems subsequent to remediation
The chart below shows the estimated completion status of each of these
phases expressed as a percent of completion as of November 6, 1999.
Phase 1 2 3
---------------- ---- ---- ----
IT Systems 99% 99% 97%
Non-IT Systems 99% 99% 98%
Our ability to timely execute our Plan may be adversely affected by a variety of
factors, some of which are beyond our control, including the potential for
unseen implementation problems, delays in the delivery of products, or
inefficiencies in store operations resulting from loss of power or communication
links between stores, distribution centers, and headquarters.
Critical business partners have been contacted for their status on year 2000
readiness. Based on our assessment of their responses, we believe that the
majority of our business partners are taking action for year 2000 readiness.
Notwithstanding the substantial efforts by us and our key business partners, we
could potentially experience disruptions to some aspects of our various
activities and operations. Consequently, in conjunction with the Plan,
management is formulating contingency plans for critical functions and
processes, which may be implemented to minimize the risk of interruption to our
business in the event of a year 2000 occurrence.
Contingency planning, which utilizes a business process approach, focuses on the
following priorities: ability to sell products to customers, continuously
replenish stores with goods (ordering and distribution), pay employees, collect
and remit on outstanding accounts, meet other regulatory and administrative
needs, and address merchandising objectives. Documented contingency plans for
critical business processes are in place.
The total estimated cost for the project, over a four year period, is $47
million. This cost is being funded through operating cash flow. This represents
an immaterial part of our information technology budget over the period. Costs
incurred to date totaled $44 million at November 6, 1999.
If we, our customers or vendors are unable to resolve processing issues in a
timely manner, it could result in the disruption of the operation of IT Systems
and or Non-IT Systems, and in a material financial risk. We believe that we have
allocated the resources necessary to mitigate all significant year 2000 issues
in a timely manner.
Our ability to achieve the expected increases in sales and earnings could be
adversely affected by the increasingly competitive environment in which we
operate. In addition any labor dispute, delays in opening new stores, or changes
in the economic climate could cause us to fall short of our sales and earnings
targets. Sales per square footage expectation may not be achieved if the impact
of new square footage on our other stores is greater than anticipated or if our
competitors are able to increase their share of market. While we expect to
reduce working capital, our ability to do so may be impaired by any changes in
vendor payment terms or systems problems that result in increases in inventory
levels. Our capital expenditures could fall outside of the expected range if we
are unsuccessful in acquiring suitable sites for new stores, if development
costs exceed those budgeted, or if our logistics and technology projects are not
completed in the time frame expected or on
20
<PAGE> 21
budget. While we expect to achieve benefits through logistics and technology,
development of new systems and integration of systems due to our merger with
Fred Meyer carry inherent uncertainties, and we may not achieve the expected
benefits. Unforeseen difficulties in integrating Fred Meyer with Kroger, or any
other acquired entity could cause us to fail to achieve the anticipated synergy
savings, and could otherwise adversely affect our ability to meet our other
expectations.
21
<PAGE> 22
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On September 13, 1996, a class action lawsuit titled McCampbell, et al. v.
Ralphs Grocery Company, et al, was filed in the Superior Court of the State of
California, County of San Diego, against Ralphs Grocery Company ("Ralphs/Food 4
Less") and two other grocery store chains operating in the Southern California
area. The complaint alleged, among other things, that Ralphs/Food 4 Less and
others conspired to fix the retail price of eggs in Southern California. The
plaintiffs claimed that the defendants' actions violated provisions of the
California Cartwright Act and constituted unfair competition. The plaintiffs
sought damages they purported to have sustained as a result of the defendants'
alleged actions, which damages were subject to trebling under the applicable
statute, and an injunction from future actions in restraint of trade and unfair
competition. A class was certified consisting of all retail purchasers of white
chicken eggs sold by the dozen in Los Angeles, Riverside, San Diego, San
Bernardino, Imperial and Orange counties from September 13, 1992.
The case proceeded to trial before a jury in July and August 1999. On September
2, 1999, the jury returned a verdict in favor of Ralphs/Food 4 Less and against
the plaintiffs. Judgment was entered in favor of Ralphs/Food 4 Less on November
1, 1999. Ralphs/Food 4 Less anticipates that plaintiffs will appeal the
judgment.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT 3.1 - Amended Articles of Incorporation of the Company
are hereby incorporated by reference to Exhibit 3.1 of the
Company's Quarterly Report on Form 10-Q for the quarter ended
October 3, 1998. The Company's Regulations are incorporated by
reference to Exhibit 4.2 of the Company's Registration
Statement on Form S-3 as filed with the Securities and
Exchange Commission on January 28, 1993, and bearing
Registration No. 33-57552.
EXHIBIT 4.1 - Instruments defining the rights of holders of
long-term debt of the Company and its subsidiaries are not
filed as Exhibits because the amount of debt under each
instrument is less than 10% of the consolidated assets of the
Company. The Company undertakes to file these instruments with
the Commission upon request.
EXHIBIT 27.1 - Financial Data Schedule.
EXHIBIT 27.2 - Financial Data Schedule.
EXHIBIT 99.1 - Additional Exhibits - Statement of Computation
of Ratio of Earnings to Fixed Charges.
22
<PAGE> 23
(b) The Company disclosed and filed an indenture and supplemental
indentures related to issuance of $900,000,000 of Senior Notes
in three tranches, and supplemental indentures to add the
Company and subsidiary guarantors to indentures of certain
outstanding debt of subsidiaries in its Current Report on Form
8-K dated August 20, 1999; the text of prepared remarks for a
presentation to analysts in its Current Report on Form 8-K
dated September 10, 1999; its earnings release for the second
quarter 1999, and the text of prepared remarks for an investor
conference call, in its Current Report on Form 8-K dated
September 14, 1999; pricing agreements, supplemental
indentures, and a calculation agency agreement related to the
issuance of $775,000,000 of debt securities in three tranches
in its Current Report on Form 8-K dated September 22, 1999;
the text of prepared remarks for a presentation to analysts in
its Current Report on Form 8-K dated October 21, 1999; and its
audited consolidated financial statements for fiscal years
ended January 2, 1999, December 28, 1997, and December 28,
1996, in its Current Report on Form 8-K dated October 29,
1999.
23
<PAGE> 24
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: December 20, 1999 By: (Joseph A. Pichler)
Joseph A. Pichler
Chairman of the Board and
Chief Executive Officer
Dated: December 20, 1999 By: (J. Michael Schlotman)
J. Michael Schlotman
Vice President and
Corporate Controller
24
<PAGE> 25
Exhibit Index
-------------
Exhibit 3.1 - Amended Articles of Incorporation of the Company are
hereby incorporated by reference to Exhibit 3.1 of
the Company's Quarterly Report on Form 10-Q for the
quarter ended October 3, 1998. The Company's
Regulations are incorporated by reference to Exhibit
4.2 of the Company's Registration Statement on Form
S-3 as filed with the Securities and Exchange
Commission on January 28, 1993, and bearing
Registration No. 33-57552.
Exhibit 4.1 - Instruments defining the rights of holders of
long-term debt of the Company and its subsidiaries
are not filed as Exhibits because the amount of debt
under each instrument is less than 10% of the
consolidated assets of the Company. The Company
undertakes to file these instruments with the
Commission upon request.
Exhibit 27.1 - Financial Data Schedule.
Exhibit 27.2 - Financial Data Schedule.
Exhibit 99.1 - Additional Exhibits - Statement of Computation of
Ratio of Earnings to Fixed Charges.
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF NOVEMBER 6, 1999 AND THE CONSOLIDATED STATEMENT
OF OPERATIONS FOR THE THREE QUARTERS THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-29-2000
<PERIOD-START> JAN-31-1999
<PERIOD-END> NOV-06-1999
<CASH> 283
<SECURITIES> 0
<RECEIVABLES> 620
<ALLOWANCES> 0
<INVENTORY> 4,276
<CURRENT-ASSETS> 5,597
<PP&E> 12,723
<DEPRECIATION> 4,665
<TOTAL-ASSETS> 17,938
<CURRENT-LIABILITIES> 6,299
<BONDS> 8,815
0
0
<COMMON> 884
<OTHER-SE> 1,524
<TOTAL-LIABILITY-AND-EQUITY> 17,938
<SALES> 34,111
<TOTAL-REVENUES> 34,111
<CGS> 25,158
<TOTAL-COSTS> 25,158
<OTHER-EXPENSES> 7,765
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 495
<INCOME-PRETAX> 693
<INCOME-TAX> 301
<INCOME-CONTINUING> 392
<DISCONTINUED> 0
<EXTRAORDINARY> (10)
<CHANGES> 0
<NET-INCOME> 382
<EPS-BASIC> 0.46
<EPS-DILUTED> 0.45
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED STATEMENT OF OPERATIONS FOR THE THREE QUARTERS ENDED OCTOBER 3,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-02-1999
<PERIOD-START> DEC-28-1997
<PERIOD-END> OCT-03-1998
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 0
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 31,877
<TOTAL-REVENUES> 31,877
<CGS> 23,785
<TOTAL-COSTS> 23,785
<OTHER-EXPENSES> 7,170
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 489
<INCOME-PRETAX> 433
<INCOME-TAX> 202
<INCOME-CONTINUING> 231
<DISCONTINUED> 0
<EXTRAORDINARY> (228)
<CHANGES> 0
<NET-INCOME> 3
<EPS-BASIC> 0.00
<EPS-DILUTED> 0.00
</TABLE>
<PAGE> 1
EXHIBIT 99.1
Schedule of computation of ratio of earnings to fixed charges of The Kroger Co.
and consolidated subsidiary companies for the five fiscal years ended January 2,
1999 and for the three quarters ended November 6, 1999 and October 3, 1998.
<TABLE>
<CAPTION>
3 Quarters Ended Fiscal Years Ended
------------------------------------- ---------------------------------------------------
November 6, October 3, January 2, December 27, December 28, December 30, December 31,
1999 1998 1999 1997 1996 1995 1994
(40 Weeks) (40 Weeks) (53 Weeks) (52 Weeks) (52 Weeks) (52 weeks) (52 weeks)
----------- ---------- ------------ ------------ ----------- ------------ ------------
(in millions of dollars)
<S> <C> <C> <C> <C> <C> <C> <C>
Earnings
Earnings (loss) from
continuing operations
before tax expense
and extraordinary loss . $ 693 $ 433 $ 871 $ 954 $ 701 $ 591 $ 473
Fixed charges. . . . . . 794 773 1,038 679 595 596 582
Capitalized interest . . (5) (8) (9) (10) (12) (11) (5)
------ ------ ------ ------ ------ ------ ------
$1,482 $1,198 $1,900 $1,623 $1,284 $1,176 $1,050
====== ====== ====== ====== ====== ====== ======
Fixed Charges
Interest . . . . . . . . $ 500 $ 497 $ 654 $ 397 $ 361 $ 369 $ 356
Portion of rental
payments deemed to be
interest . . . . . . . . 294 276 384 282 234 227 226
------ ------ ------ ------ ------ ------ ------
$ 794 $ 773 $1,038 $ 679 $ 595 $ 596 $ 582
====== ====== ====== ====== ====== ====== ======
Ratio of earnings to
fixed charges . . . . . 1.9 1.5 1.8 2.4 2.2 2.0 1.8
</TABLE>
26
