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SCHEDULE 14A
(RULE 14A-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934
(AMENDMENT NO. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
<TABLE>
<S> <C>
[ ] Preliminary Proxy Statement [ ] CONFIDENTIAL, FOR USE OF THE COMMISSION
ONLY (AS PERMITTED BY RULE 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12.
</TABLE>
THE KROGER CO.
(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
XXXXXXXXXXXXXXXX
(NAME OF PERSON(S) FILING PROXY STATEMENT, IF OTHER THAN THE REGISTRANT)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies: .......
(2) Aggregate number of securities to which transaction applies: ..........
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined): ............
(4) Proposed maximum aggregate value of transaction: ......................
(5) Total fee paid: .......................................................
[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid: ...............................................
(2) Form, Schedule or Registration Statement No.: .........................
(3) Filing Party: .........................................................
(4) Date Filed: ...........................................................
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PROXY
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
PROXY STATEMENT
AND
1998 ANNUAL REPORT
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Kroger Logo
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FINANCIAL HIGHLIGHTS
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<CAPTION>
PERCENT
CALENDER YEAR ENDED DECEMBER 31, 1998 1997 CHANGE
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(IN MILLIONS EXCEPT PER SHARE DATA AND RATIOS, AS REPORTED)
<S> <C> <C> <C>
Total return (share price appreciation) 65% 54%
Closing market price per share $ 60.50 $ 36.75 65%
Total market value of common stock $15,546 $ 9,370 66%
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JANUARY 2, DECEMBER 27, PERCENT
FISCAL YEAR ENDED 1999 1997 CHANGE
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<S> <C> <C> <C>
Total sales $28,203 $26,567 6%
EBITDA (1)(2)(3) $ 1,556 $ 1,385 12%
Earnings before extraordinary items (1) $ 538 $ 444 21%
Basic earnings per share before extraordinary items (1) $ 2.10 $ 1.75 20%
Diluted earnings per share before extraordinary items (1) $ 2.03 $ 1.69 20%
Average shares outstanding 256 254 1%
Average shares outstanding assuming dilution 265 263 1%
ERONOA (3)(4) 40% 39%
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</TABLE>
(1) Excludes one-time expenses and accounting changes for 1998.
(2) Earnings before interest, taxes, depreciation, amortization, and LIFO
charge.
(3) Not a GAAP measurement.
(4) EBITDA return on net operating assets.
(LOGO)COVER PRINTED ON RECYCLED
PAPER
<PAGE> 4
TO OUR FELLOW SHAREHOLDERS:
During Fiscal Year 1998, The Kroger Co. produced record financial results
and initiated strategic actions directed toward increasing the size, scope, and
cash flow of our Company. The key achievements included:
- Record sales of $28.2 billion;
- Record cash flow, earnings, and earnings per share after adjustment for
one time expenses;
- Rapid implementation of new technology and logistics systems;
- Growth in retail square footage of 4.3%, with 96 supermarkets opened or
expanded;
- Completion of a merger agreement with Fred Meyer, Inc.
These developments generated significant rewards for shareholders as the
price of Kroger stock rose 65% during calendar year 1998. During the past five
years, the price of our shares has increased at a compounded annual rate of 43%.
We are especially pleased for our employees, who hold approximately 25% of
Kroger stock in personal accounts and benefit plans.
OPERATING REVIEW
Earnings before extraordinary items, and excluding one-time expenses, were
a record $538 million, compared to $444 million in 1997. On the same basis,
earnings per diluted share rose to $2.03 from $1.69, a 20% increase. Operating
cash flow, excluding one-time expenses, increased 12.4% to $1.556 billion.
Sales reached $28.2 billion, a 6.2% increase over 1997. Adjusting for the
53rd week in 1998, total sales increased 4% to $27.6 billion. The convenience
store group posted a fine year with in-store sales increasing 7.6% on an
identical store basis.
At the end of 1998, the Company operated 1,410 food stores under nine
names and 797 convenience stores under six banners. Kroger retail operations are
supported by 34 manufacturing plants that produce high quality, low cost private
label products which are sold in our stores and supplied to other valued
customers. The manufacturing plants generated strong sales and cash flow in
1998.
FINANCIAL REVIEW
Kroger's financial structure has continued to improve. Net interest
expense totaled $267 million, a reduction of $19 million from 1997. Net total
debt declined by $66 million to $3.1 billion at year-end. Net operating working
capital decreased $11 million to $51 million. During 1998, the Company invested
a record $923 million in capital projects.
STRATEGIC INITIATIVES: OPERATIONS
Kroger's fundamental strategy is to achieve the responsiveness of
decentralized merchandising and operations combined with economies of scale
available from the coordination of volume based activities and consolidation of
support systems. During 1998, Kroger management executed this strategy through
initiatives designed to enhance Kroger's competitive advantage.
- Technology applications, including point of sale, time and attendance,
labor scheduling, and direct store delivery systems are producing
returns above projections. Computer assisted ordering and category
management programs are being installed at a rapid rate throughout
Kroger. These combined systems are achieving positive results in terms
of cash flow growth and working capital management. We expect them to
generate even stronger results in the future.
- Logistics initiatives have reduced the costs of acquiring and
distributing products. Kroger's logistics network has been restructured
and consolidated during the past four years. In 1998, three new
warehouses were opened and eight were closed. The consolidation permits
Kroger to purchase and
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distribute several key categories of merchandise at lowest cost volumes
while reducing working capital. Most of Kroger's divisional distribution
functions have been sold to third party logistics firms in order to
control costs and benchmark the performance of Company-operated
distribution centers.
- Consolidation of support activities continued during the year.
Divisional accounting and data processing functions have been
consolidated at regional centers to reduce costs and increase
efficiencies.
- Kroger brand sales and marketing programs received new emphasis to
increase sales and gross profits. Kroger label products provide the
Company with a substantial competitive edge by offering customers high
quality products at attractive prices. The Kroger brand now accounts for
nearly 25% of grocery department sales in dollar terms and 30% of
grocery sales in unit terms.
STRATEGIC INITIATIVES: MERGERS
On October 19, 1998 Kroger and Fred Meyer, Inc. announced the merger of
two premier food retailing companies with combined 1998 sales of $43.1 billion.
This transaction will create the nation's largest supermarket company,
encompassing the broadest geographic coverage and featuring the widest spectrum
of retail facilities in the industry.
Our formats will include multi-department stores, combination food and
drug stores, price impact warehouse stores, and convenience stores. Together we
will operate 2,200 supermarkets, 797 convenience stores and 384 fine jewelry
stores. Our supermarkets will have a presence in 10 of the nation's 15 fastest
growing markets and range across 31 states. The company will employ more than
300,000 associates.
The combination of Fred Meyer and Kroger will generate extraordinary
profit potential in merchandising, store operations and distribution. The merger
offers opportunities to increase shareholder value through greater economies of
scale, expanded geographic diversity, and entry into new markets of substantial
size. Kroger management is delighted by the transaction and looks forward to
working with our Fred Meyer colleagues. As this Annual Report goes to press,
Kroger is awaiting regulatory approval of the merger.
Also during 1998, Kroger merged with the five-store Hilander Foods, Inc.
in Rockford, Illinois and the seven-store Owens Markets in northern Indiana. We
welcome these strong and respected franchises to our Company. Kroger is awaiting
regulatory approval of a merger with The John C. Groub Company, Inc. of Indiana,
which operates thirty stores under the banners of Jay C Food Stores, Foods Plus
and Ruler.
LABOR RELATIONS
The Company successfully negotiated a number of collective bargaining
agreements in the past year. During 1999, contracts will be negotiated with the
United Food and Commercial Workers (UFCW) in several markets including
Cincinnati, Denver, Louisville, and Memphis. The Company reached agreement on
the Indianapolis UFCW and the International Brotherhood of Teamsters Master
contracts well before they expired. The Company's relations with the unions
representing our employees remain sound and we intend to complete the remainder
in a timely fashion.
YEAR 2000 READINESS
By early 1999, the Company will complete our program to ensure that
critical operating systems are compliant for the Year 2000. We believe that our
stores, pharmacies, plants, offices, and distribution centers will function
normally on January 1, 2000. We are also confident that our major vendors will
be Year 2000 compliant before the end of 1999.
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COMMUNITY ACTIVITIES
Kroger encourages the involvement of associates in organizations to
benefit the communities we serve. These activities also enhance the Company's
reputation among customers, civic and charitable organizations, public
officials, and employees.
One of the Company's focus areas is supporting programs that feed the
hungry. In 1998, Kroger donated 5.3 million pounds of product to Second Harvest
affiliated food banks and was the largest retail donor of food for the hungry in
the nation.
The Kroger Co. Foundation provides the communities served by our plants
and retail divisions with a stable source of non-operating funds for charitable
contributions. In 1998, the Foundation contributed $2.8 million to a wide
variety of non-profit and community organizations. In addition, Kroger stores,
divisions, plants, and associates contributed millions of dollars of cash and
product to community and charitable organizations.
THE YEAR AHEAD
Management believes that Kroger will continue to create strong growth in
our business and increased value for our shareholders. The Company is well
positioned geographically, strategically and financially to maintain our record
of performance. Kroger's traditional strength will be complemented by the merger
with Fred Meyer.
Kroger's strongest assets are our 213,000 associates whose daily
commitment to service is the foundation of our success. We extend sincere thanks
to them for their dedication to Kroger customers, communities, and shareholders.
DIRECTOR AND EXECUTIVE CHANGES
The Kroger Co. Board and Management were saddened by the death of Patricia
Shontz Longe, a Company director since 1977. Dr. Longe passed away in July,
1998. John D. Ong, a Company director since 1975, retired from the Board in
December, 1998. Both of these Board members provided valuable leadership and
wise counsel to the Company, especially during the restructuring in 1988. We are
deeply grateful for their service. Bobby S. Shackouls, President and Chief
Executive Officer of Burlington Resources Inc., was elected to the Board in
February, 1999.
Ronald R. Rice, Senior Vice President and President of Kroger
Manufacturing retired in June, 1998 after an outstanding 41 year career. David
G. Osborne, President, Mid-Atlantic Market Area retired in September, 1998
concluding 38 years of dedicated service. Dan McMullin, President of Mini-Mart
retired in December after devoting 15 years with the Company. We extend our
appreciation to Ron, Dave and Dan.
David R. Cook, co-founder and President of Turkey Hill Minit Markets,
passed away in May, 1998. David was an industry leader, a valued member of
management, and a dear friend.
PROMOTIONS
Geoffrey J. Covert, formerly Vice President Grocery Product Group, was
promoted to Group Vice President and President -- Kroger Manufacturing following
the retirement of Ronald R. Rice. R. Pete Williams was promoted to President of
the Mid-Atlantic Marketing Area from the position of Vice President with the
Atlanta Marketing Area. Jim Leonard joined the Company as President, Turkey Hill
Minit Markets.
/s/ Joseph A. Pichler
JOSEPH A. PICHLER
Chairman and
Chief Executive Officer
/s/ David B. Dillon
DAVID B. DILLON
President and
Chief Operating Officer
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<PAGE> 7
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
Cincinnati, Ohio, April 13, 1999
To All Shareholders
of The Kroger Co.:
The annual meeting of shareholders of The Kroger Co. will be held at the
REGAL HOTEL, 150 W. 5TH STREET, Cincinnati, Ohio, on May 20, 1999, at 11 A.M.,
for the following purposes:
1. To elect five directors or, in the event the merger with Fred Meyer,
Inc. has been completed prior to the date of the annual meeting, seven
directors, to serve until the annual meeting of shareholders in 2002 or
until their successors have been elected and qualified;
2. To consider and act upon a proposal to authorize an amendment to the
Amended Articles of Incorporation to increase the authorized shares of
Common Stock from 1,000,000,000 to 2,000,000,000;
3. To consider and act upon a proposal to approve the 1999 Long-Term
Incentive Plan;
4. To consider and act upon a proposal to ratify the selection of auditors
for the Company for the year 1999;
5. To act upon a shareholder proposal, if properly presented at the annual
meeting, to recommend that the Board take the necessary steps to cause
all directors to be elected annually as opposed to in classes; and
6. To transact such other business as may properly be brought before the
meeting;
all as set forth in the Proxy Statement accompanying this Notice. Holders of
common shares of record at the close of business on March 23, 1999, will be
entitled to vote at the meeting.
YOUR MANAGEMENT DESIRES TO HAVE A LARGE NUMBER OF SHAREHOLDERS REPRESENTED
AT THE MEETING, IN PERSON OR BY PROXY. PLEASE SIGN AND DATE THE ENCLOSED PROXY
AND MAIL IT AT ONCE IN THE ENCLOSED SELF-ADDRESSED ENVELOPE. NO POSTAGE IS
REQUIRED IF MAILED WITHIN THE UNITED STATES.
By order of the Board of
Directors,
Paul W. Heldman, Secretary
PROXY STATEMENT
Cincinnati, Ohio, April 13, 1999
The accompanying proxy is solicited by the Board of Directors of The
Kroger Co., and the cost of solicitation will be borne by the Company. The
Company will reimburse banks, brokers, nominees, and other fiduciaries for
postage and reasonable expenses incurred by them in forwarding the proxy
material to their principals. The Company has retained The Altman Group, 60 E.
42nd Street, New York, New York to assist in the solicitation of proxies and
will pay that firm a fee estimated at present not to exceed $15,000. Proxies may
be solicited personally, or by telephone, as well as by use of the mails.
Joseph A. Pichler, John T. LaMacchia, and T. Ballard Morton, Jr., all of
whom are directors of the Company, have been named members of the Proxy
Committee.
The principal executive offices of The Kroger Co. are located at 1014 Vine
Street, Cincinnati, Ohio 45202-1100. Its telephone number is 513-762-4000. This
Proxy Statement and Annual Report, and the accompanying proxy, were first sent
or given to shareholders on April 13, 1999.
As of the close of business on March 23, 1999, the Company's outstanding
voting securities consisted of 257,856,756 shares of common stock, the holders
of which will be entitled to one vote per share at the annual meeting. The
shares represented by each proxy will be voted unless the proxy is revoked
before it is exercised. Revocation may be in writing to the Secretary of the
Company or in person at the meeting or by appointment of a subsequent proxy. The
laws of Ohio, under which the Company is organized, provide for cumulative
voting for the election of directors. If notice in writing is given by any
shareholder to the President, a Vice President, or the
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Secretary of the Company not less than 48 hours before the time fixed for
holding the meeting that the shareholder intends to cumulate votes for the
election of directors and, if an announcement of the giving of that notice is
made by or on behalf of the shareholder or by the Chairman or Secretary upon the
convening of the meeting, each shareholder will have the right to cumulate votes
at the election. If cumulative voting is in effect, a shareholder voting for the
election of directors may cast a number of votes equal to the number of
directors being elected times the number of shares held on the record date for a
single nominee or divide them among nominees in full votes in any manner. Any
vote "FOR" the election of directors will constitute discretionary authority to
the Proxy Committee to cumulate votes, as the Proxy Committee determines, if
cumulative voting is requested.
The effect of broker non-votes and abstentions on matters presented for
shareholder vote is as follows:
- The election of directors is, pursuant to Ohio law, determined by
plurality; broker non-votes and abstentions, therefore, will have no
effect on that proposal.
- Amendments to the Company's Amended Articles of Incorporation
authorizing additional shares of Common Stock require approval of
holders of a majority of the shares. Broker non-votes and
abstentions, therefore, will have the effect of a vote against that
proposal.
- The 1999 Long-Term Incentive Plan is to be approved by a majority of
the shares participating in the voting. Therefore, broker non-votes
and abstentions will have no effect.
- Ratification by shareholders of the selection of auditors requires
the affirmative vote of the majority of shares participating in the
voting. Accordingly, abstentions will have no effect on the
proposal.
- The affirmative vote of a majority of shares participating in the
voting on the shareholder proposal is required for adoption of the
resolution. Proxies will be voted AGAINST the resolution unless the
Proxy Committee is otherwise instructed on a proxy properly executed
and returned. Abstentions and broker non-votes will have no effect
on the proposal.
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PROPOSALS TO SHAREHOLDERS
ELECTION OF DIRECTORS
(ITEM NO. 1)
The Board of Directors, as now authorized, consists of 13 members divided
into three classes. When the merger with Fred Meyer, Inc. is completed, the size
of the Board will be increased to 19 members. Under the Agreement and Plan of
Merger dated October 18, 1998 with Fred Meyer, Inc., six designated directors of
Fred Meyer will become members of the Board of Directors after the merger is
completed. Five directors, or in the event the merger with Fred Meyer, Inc. is
completed prior to the annual meeting, seven directors, are to be elected at the
annual meeting to serve until the annual meeting in 2002 or until their
successors have been elected by the shareholders or by the Board of Directors
pursuant to the Company's Regulations, and qualified. Candidates for director
receiving the greatest number of votes cast by holders of shares entitled to
vote at a meeting at which a quorum is present are elected, up to the maximum
number of directors to be chosen at the meeting. The committee memberships
stated below are those in effect as of the date of this proxy statement. It is
intended that, except to the extent that authority is withheld, the accompanying
proxy will be voted for the election of the following persons:
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PROFESSIONAL DIRECTOR
NAME OCCUPATION (1) AGE SINCE
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NOMINEES FOR DIRECTOR FOR TERMS OF OFFICE CONTINUING UNTIL 2002
JOHN T. LAMACCHIA Mr. LaMacchia is the retired President and Chief 57 1990
Executive Officer of Cincinnati Bell Inc., a
telecommunications holding company. He is a director
of Cincinnati Bell Inc., Burlington Resources, Inc.
and FORE Systems, Inc. Mr. LaMacchia is vice chair of
the Compensation Committee and a member of the
Corporate Governance and Executive Committees.
EDWARD M. LIDDY Mr. Liddy is Chairman of the Board, President and 53 1996
Chief Executive Officer of The Allstate Corporation,
the parent of Allstate Insurance Company, a personal
lines insurance company. Prior to this he was
President and Chief Operating Officer of the Allstate
Corporation from 1994-1998 and Senior Vice President
and Chief Financial Officer of Sears, Roebuck and Co.,
where he held a variety of senior operating and
financial positions since 1988. Mr. Liddy is chair of
the Financial Policy Committee and a member of the
Corporate Governance Committee.
T. BALLARD MORTON, JR. Mr. Morton is Executive in Residence of the College of 66 1968
Business & Public Administration of the University of
Louisville. He is a director of LG&E Energy Corp. Mr.
Morton is chair of the Compensation Committee, vice
chair of the Audit Committee, and a member of the
Executive Committee.
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<TABLE>
<CAPTION>
PROFESSIONAL DIRECTOR
NAME OCCUPATION (1) AGE SINCE
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<S> <C> <C> <C>
KATHERINE D. ORTEGA Ms. Ortega served as an Alternate Representative of 64 1992
the United States to the 45th General Assembly of the
United Nations in 1990-1991. Prior to that, she served
as Treasurer of the United States. Ms. Ortega is a
director of Ultramar Diamond Shamrock Corporation;
Ralston Purina Co.; and Rayonier Inc.; and an Advisory
Board Member of Washington Mutual Investors Fund. She
is chair of the Audit Committee and a member of the
Social Responsibility Committee.
BOBBY S. SHACKOULS Mr. Shackouls has been Chairman of the Board of 48 1999
Burlington Resources Inc., a natural resources
business, since July 1997 and its President and Chief
Executive Officer since December 1995. He has been a
director of that company since 1995 and President and
Chief Executive Officer of Burlington Resources Oil
and Gas Company (formerly known as Meridian Oil Inc.),
a wholly-owned subsidiary of Burlington Resources,
since 1994. Mr. Shackouls was Executive Vice President
and Chief Operating Officer of Meridian Oil Inc. from
1993 to 1994. Prior to that he was President and Chief
Operating Officer of Torch Energy Advisors, Inc. Mr.
Shackouls is a director of American Residential
Services, Inc. He is a member of the Financial Policy
Committee.
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ROBERT D. BEYER Mr. Beyer has been the Group Managing Director at 39 1999(2)(3)
Trust Company of the West, an investment management
firm, since 1995. From 1991 to 1995, he was the
co-Chief Executive Officer of Crescent Capital
Corporation, which was acquired by TCW Asset
Management Company in 1995. Mr. Beyer is also a member
of the Board of Directors of TCW Asset Management
Company and American Restaurant Group, Inc. and was a
member of the Fred Meyer, Inc. Board of Directors
since 1998.
CARLTON J. JENKINS Mr. Jenkins has served as Chairman, President and 43 1999(2)(3)
Chief Executive Officer of Founders National Bank of
Los Angeles since January 1991. He was a member of the
Fred Meyer, Inc. Board of Directors since 1998.
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PROFESSIONAL DIRECTOR
NAME OCCUPATION (1) AGE SINCE
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<S> <C> <C> <C>
DIRECTORS WHOSE TERMS OF OFFICE CONTINUE UNTIL 2001
JOHN L. CLENDENIN Mr. Clendenin is Chairman Emeritus of BellSouth 64 1986
Corporation, a holding company with subsidiaries in
the telecommunications business. From January 1984
through December 1996 he was its Chairman of the Board
and Chief Executive Officer. Mr. Clendenin is a
director of Wachovia Corp.; Equifax Incorporated; RJR
Nabisco Holdings Corp.; Springs Industries, Inc.; Coca
Cola Enterprises, Inc.; The Home Depot, Inc.;
Powerwave Technologies, Inc.; and National Service
Industries, Inc. He is chair of the Corporate
Governance Committee and a member of the Compensation
Committee.
DAVID B. DILLON Mr. Dillon was elected President and Chief Operating 48 1995
Officer of Kroger in 1995. He was elected Executive
Vice President in 1990; Chairman of the Board of
Dillon Companies, Inc., a wholly-owned subsidiary of
Kroger, in 1992; and President of Dillon Companies,
Inc., in 1986. After the merger with Fred Meyer is
completed, Mr. Dillon will remain President of Kroger.
He is an advisory director of the First National Bank
of Hutchinson, Kansas. Mr. Dillon is vice chair of the
Executive Committee.
THOMAS H. O'LEARY Mr. O'Leary is the retired Chairman of Burlington 65 1977
Resources Inc., a natural resources business. He is a
member of the Compensation and the Corporate
Governance Committees.
JAMES D. WOODS Mr. Woods is Chairman Emeritus and Consultant of Baker 67 1994
Hughes Incorporated, a company that provides equipment
and services to the petroleum and process industries.
From 1989-1997 he was Chairman of the Board of Baker
Hughes Incorporated, and its President and Chief
Executive Officer from 1987-1996. Mr. Woods is a
director of Howmet International Inc.; Varco
International; OMI Corporation; and Wynn's
International Inc. He is vice chair of the Social
Responsibility Committee and a member of the Financial
Policy Committee.
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<TABLE>
<CAPTION>
PROFESSIONAL DIRECTOR
NAME OCCUPATION (1) AGE SINCE
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<S> <C> <C> <C>
BRUCE KARATZ Mr. Karatz has been the Chairman of the Board, 53 1999(3)
President, and Chief Executive Officer of Kaufman &
Broad Home Corporation since July 1993 and its
President, Chief Executive Officer and a director
since 1986. He is also a director of Honeywell, Inc.
and National Golf Properties, Inc. and a Trustee of
the RAND Corporation, and was a member of the Fred
Meyer, Inc. Board of Directors since 1997.
ROBERT G. MILLER Mr. Miller becomes Vice Chairman of the Board of 54 1999(3)
Directors and Chief Operating Officer of Kroger,
effective as of the completion of the merger of Kroger
and Fred Meyer. He had been Chief Executive Officer of
Fred Meyer since 1991. Before that time Mr. Miller was
employed by Albertson's, Inc., where his most recent
positions were Executive Vice President of Retail
Operations from 1989 to 1991 and Senior Vice President
and Regional Manager from 1985 to 1989. He is a
director of PacifiCorp, Pathmark Stores, Inc. and
Supermarkets General Holdings Corp., and was a member
of the Fred Meyer, Inc. Board of Directors since 1991.
DIRECTORS WHOSE TERMS OF OFFICE CONTINUE UNTIL 2000
REUBEN V. ANDERSON Mr. Anderson is a member, in the Jackson, Mississippi 56 1991
office, of Phelps Dunbar, a New Orleans law firm.
Prior to joining this law firm, he was a justice of
the Supreme Court of Mississippi. Mr. Anderson is a
director of Trustmark National Bank and BellSouth
Corporation. He is chair of the Social Responsibility
Committee and a member of the Audit Committee.
CLYDE R. MOORE Mr. Moore is President and Chief Executive Officer of 45 1997
Thomas & Betts Corporation, a manufacturer of
electrical and electronic components. He is also one
of its directors. Mr. Moore served as President and
Chief Operating Officer of Thomas & Betts Corporation
from 1994-1997 and as its President-Electrical
Division from 1992-1994. He is vice chair of the
Financial Policy Committee and a member of the Audit
and Financial Policy Committees.
JOSEPH A. PICHLER Mr. Pichler is Chairman of the Board and Chief 59 1983
Executive Officer of Kroger. He is a director of
Milacron Inc., and Federated Department Stores, Inc.
Mr. Pichler is chair of the Executive Committee.
</TABLE>
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<TABLE>
<CAPTION>
PROFESSIONAL DIRECTOR
NAME OCCUPATION (1) AGE SINCE
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<S> <C> <C> <C>
MARTHA ROMAYNE SEGER Dr. Seger is a Financial Economist and currently is a 67 1991
Distinguished Visiting Professor at Central Michigan
University. From 1991-1993 she was the John M. Olin
Distinguished Fellow at The Karl Eller Center of the
University of Arizona. Dr. Seger was a member of the
Board of Governors of the Federal Reserve System from
1984-1991. She is a director of Amerisure Companies;
Fluor Corporation; UniSource Energy Corporation;
Tucson Electric Power Company; and Xerox Corporation.
Dr. Seger is a member of the Financial Policy and
Social Responsibility Committees.
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RONALD W. BURKLE Mr. Burkle becomes Chairman of the Executive Committee 46 1999(3)
of the Board of Directors of Kroger, effective as of
the completion of the merger of Kroger and Fred Meyer.
He had been Chairman of the Board of Fred Meyer since
September 1997. Mr. Burkle is the Managing General
Partner of The Yucaipa Companies, a private investment
firm that invests primarily its own capital and was
the largest shareholder of Fred Meyer. He also serves
as a director of Kaufman & Broad Home Corporation, and
a Trustee of the National Urban League, and was a
member of the Fred Meyer, Inc. Board of Directors
since 1997.
STEVEN R. ROGEL Mr. Rogel has been President and Chief Executive 56 1999(3)
Officer and a director of Weyerhaeuser Company since
December 1997. Before that time he was Chief Executive
Officer, President and a director of Willamette
Industries, Inc. Mr. Rogel served as Chief Operating
Officer of Willamette Industries, Inc. until October
1995 and, before that time, as an executive and group
vice president for more than five years. He was a
member of the Fred Meyer, Inc. Board of Directors
since 1996.
</TABLE>
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(1) Except as noted, each of the directors has been employed by his or her
present employer (or a subsidiary) in an executive capacity for at least
five years.
(2) These individuals will be nominated and stand for election at the 1999
annual meeting only if the merger with Fred Meyer is completed prior to the
date of the annual meeting.
(3) This disclosure is included and should be considered only in the event that
the merger with Fred Meyer is completed prior to the date of the annual
meeting. If the merger has not occurred you should disregard this disclosure
in its entirety.
10
<PAGE> 14
INFORMATION CONCERNING THE BOARD OF DIRECTORS
DIRECTORS' COMPENSATION
Each non-employee director is currently paid an annual retainer of $28,000
plus fees of $1,500 for each board meeting and $1,000 for each committee meeting
attended. Committee chairs receive an additional annual retainer of $4,000.
Directors who are employees of the Company receive no compensation for service
as directors. The Company provides accidental death and disability insurance for
directors at a cost to the Company in 1998 of $138 per director. The Company
also provides a major medical plan for directors.
Under the 1997 Long-Term Incentive Plan, in 1998 the Company granted to
each of its non-employee directors owning a minimum of 1,000 shares of Company
common stock as of the date of the annual meeting of shareholders, options to
purchase 2,000 shares of common stock at an option price equal to the fair
market value of the stock at the date of the grant, and each non-employee
director received a grant on that date. The options vest in equal share amounts
on the five annual anniversaries of the date of grant. Based on the closing
price of Kroger stock on the New York Stock Exchange, as of January 2, 1999, the
value of each grant of options made in 1998, none of which were exercisable, was
$37,750.
The Company has an unfunded retirement program for outside directors first
elected to the Board prior to July 1, 1997. The Board has adopted no retirement
plan for directors newly elected after that date but may consider additional
stock option grants in lieu of a retirement plan. The retirement benefit is the
average compensation for the five calendar years preceding retirement. Directors
who retire from the Board prior to age 70 will be credited with 50% vesting
after five years of service and an additional 10% for each year served
thereafter, up to a maximum 100%. Benefits for directors who retire prior to age
70 will commence at the time of retirement from the Board or age 65, whichever
comes later.
COMMITTEES OF THE BOARD
The Board of Directors has a number of standing committees including
Audit, Compensation, and Corporate Governance Committees. During 1998, the Audit
Committee met three times, the Compensation Committee met two times, and the
Corporate Governance Committee met three times. Committee memberships are shown
on pages 6 through 10 of this Proxy Statement. The Audit Committee reviews
external and internal auditing matters and recommends the selection of the
Company's independent auditors for approval by the Board and ratification by
shareholders. The Compensation Committee determines the compensation of the
Company's senior management and administers its stock option and benefit
programs. The Corporate Governance Committee is responsible for developing
criteria for selecting and retaining members of the Board; seeks out qualified
candidates for the Board; and reviews the performance of the Company, the Chief
Executive Officer, and the Board. The Board of Directors met nine times in 1998.
During 1998, all incumbent directors attended at least 75% of the aggregate
number of Board meetings and committee meetings on which that director was a
member.
The Corporate Governance Committee will consider shareholder
recommendations for nominees for membership on the Board of Directors.
Recommendations relating to the Company's annual meeting in June 2000, together
with a description of the proposed nominee's qualifications and other relevant
information, must be submitted in writing to Paul W. Heldman, Secretary of the
Company, and received at the Company's executive offices not later than December
15, 1999.
CERTAIN TRANSACTIONS
The law firm of Phelps Dunbar, of which Reuben V. Anderson is a partner,
rendered legal services to the Company that resulted in fees paid to the law
firm by the Company in 1998 of $94,237. The management of the Company has
determined that amounts paid by the Company for the services are fair and
competitive.
11
<PAGE> 15
MERGER WITH FRED MEYER
On October 18, 1998, the Company signed an Agreement and Plan of Merger
with Fred Meyer Inc., under which Fred Meyer will become a wholly-owned
subsidiary of Kroger. The Agreement provides that six designated members of Fred
Meyer's Board of Directors will become members of Kroger's Board of Directors
after the merger is completed. In order to satisfy this commitment, upon
completion of the merger, the Board of Directors will increase the size of the
Board by six members. The disclosure on pages 6 through 10 above related to
directors to which footnote (2) or (3) is appended applies only in the event the
merger is completed prior to the date of the annual meeting. If the merger is
completed after the annual meeting of shareholders, the six designated
individuals will be elected by the Board to fill the vacancies created when the
merger is completed.
12
<PAGE> 16
COMPENSATION OF EXECUTIVE OFFICERS
- --------------------------------------------------------------------------------
SUMMARY COMPENSATION
The following table shows the compensation for the past three years of the
Chief Executive Officer and each of the Company's four most highly compensated
executive officers, excluding the Chief Executive Officer (the "named executive
officers"):
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
- --------------------------------------------------------------------------------------------------------------
LONG TERM
ANNUAL COMPENSATION COMPENSATION(1)
---------------------------------- -------------------------
AWARDS
-------------------------
RESTRICTED SECURITIES
OTHER ANNUAL STOCK UNDERLYING ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION AWARDS OPTIONS/SARS COMPENSATION
POSITION YEAR ($) ($) ($) ($) (#) ($)
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
(2) (3) (4) (5)
Joseph A. Pichler 1998 $560,385 $634,550 $32,133 50,000 $ 45,974
Chairman and Chief 1997 $471,508 $381,688 $21,441 45,000 $ 30,575
Executive Officer 1996 $452,400 $486,893 $18,741 60,000 $ 26,760
David B. Dillon 1998 $409,615 $407,925 $ 7,702 35,000 $ 12,157
President and Chief 1997 $351,477 $254,458 $ 5,934 30,000 $ 9,280
Operating Officer 1996 $326,977 $321,773 $ 5,186 36,000 $504,955(6)
Michael S. Heschel 1998 $332,452 $216,488 $14,525 $533,626 22,500 $ 21,255
Executive Vice
President 1997 $291,292 $207,548 $11,703 22,500 $ 16,020
and Chief Information 1996 $268,100 $258,455 $ 9,275 50,000 $ 13,470
Officer
Warren F. Bryant 1998 $302,296 $208,257 $ 5,839 22,500 $ 12,511
President and Chief 1997 $292,972 $ 36,492 $ 5,087 22,500 $ 10,630
Executive Officer of 1996 $282,639 $ 78,767 $ 4,655 30,000 $ 9,807
Dillon Companies, Inc.
W. Rodney McMullen 1998 $268,462 $181,300 $ 2,709 $667,032 30,000 $ 5,147
Senior Vice President 1997 $205,769 $114,506 $ 1,578 $ 79,375 25,000 $ 3,524
and Chief Financial 1996 $181,923 $138,740 $ 1,315 30,000 $ 3,045
Officer
</TABLE>
- ------------
(1) During the period presented, the Company has made no long-term incentive
plan payouts other than restricted stock and stock options.
(2) Represents reimbursement for the tax effects of payment for certain premiums
on a policy of life insurance.
(3) Messrs. Pichler, Dillon, Heschel, Bryant, and McMullen had 200,000, 9,600,
32,000, 4,000, and 21,000 shares outstanding, respectively, at January 2,
1999. These shares had an aggregate value of $12,100,000, $580,800,
$1,936,000, $242,000, and $1,270,500, respectively, based on the market
price of the Company's common stock on January 2, 1999. Restrictions
remaining on outstanding restricted stock awards to Mr. Pichler in 1995,
previously reported as a long-term incentive plan award, lapse in January
2000, based on performance goals achieved in 1995 through 1999 and more
particularly described in the Compensation Committee Report that follows.
The shares will vest immediately if Mr. Pichler leaves the Company due to
death or disability or in the event of a change in control of the Company.
The restrictions lapse on Mr. Dillon's award equally over the next two
years. The restrictions on Mr. Heschel's awards lapse as to 18,000 shares in
1999, 4,000 shares in 2000, 2,000 shares in 2001, 4,000 shares in 2002, and
4,000 shares in 2003. The restrictions on Mr. Bryant's award lapse equally
over the next two years. The restrictions on Mr. McMullen's awards lapse as
to 4,500 shares in 1999, 4,500 shares in 2000, 3,500 shares in 2001, 3,500
shares in 2002, and 5,000 shares in 2003. The Company is currently
prohibited by contract from paying cash dividends on its common stock but,
should this prohibition be lifted, dividends, as and when declared, would be
payable on these shares.
(4) Represents options granted during the respective fiscal year. Options
granted in 1996 vest for equal number of shares in the three succeeding
years from the date of grant. Half of the options granted in 1997 and 1998
vest for equal number of shares in the five succeeding years from the date
of grant. The other half vest based on the performance of the Company's
common stock, as more particularly described on page 14. Options terminate
in 10 years if not earlier exercised or terminated. No stock appreciation
rights ("SARs") were granted in any of the three years presented.
(5) For 1998, these amounts include the Company's matching contribution under
The Kroger Co. Savings Plan in the amounts of $864, $1,344, $864, $1,400,
and $1,344, respectively, for Messrs. Pichler, Dillon, Heschel, Bryant, and
McMullen and reimbursement of certain premiums for policies of life
insurance in the amounts of $45,110, $10,813, $20,391, $11,111, and $3,803,
respectively, for Messrs. Pichler, Dillon, Heschel, Bryant, and McMullen.
(6) $496,775 of this amount represents an additional payment to Mr. Dillon
pursuant to the Company's relocation program.
13
<PAGE> 17
STOCK OPTION/STOCK APPRECIATION RIGHT GRANTS
The Company has in effect employee stock option plans pursuant to which
options to purchase common stock of the Company are granted to officers and
other employees of the Company and its subsidiaries. Half of the stock option
grants made in 1998 to key executives of the Company, including the named
executive officers, are performance-based options. Those options vest during the
first four years from the date of grant only if the Company's stock price has
achieved a 63% appreciation from the option price. Thereafter, those options
vest only if the Company's stock price has achieved a minimum of a 13%
appreciation per annum from the date of grant or 200% appreciation, whichever is
less. The following table shows option grants in fiscal year 1998 to the named
executive officers:
<TABLE>
<CAPTION>
OPTION/SAR GRANTS IN LAST FISCAL YEAR
- -----------------------------------------------------------------------------------------------------------
POTENTIAL REALIZABLE VALUE AT
ASSUMED RATES OF STOCK PRICE
INDIVIDUAL GRANTS APPRECIATION FOR OPTION TERM
- --------------------------------------------------------------------------- -----------------------------
NUMBER OF
SECURITIES % OF TOTAL
UNDERLYING OPTIONS/SARS EXERCISE
OPTIONS/SARS GRANTED TO OR BASE
GRANTED (1) EMPLOYEES IN PRICE EXPIRATION
NAME (#) FISCAL YEAR ($/SHARE) DATE 0% 5% (2) 10% (2)
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Joseph A. Pichler 50,000 1.66% $44.47 4/16/2008 $0 $ 699,155 $1,771,795
David B. Dillon 35,000 1.16% $44.47 4/16/2008 $0 $ 489,408 $1,240,257
Michael S. Heschel 22,500 0.75% $44.47 4/16/2008 $0 $ 314,620 $ 797,308
Warren F. Bryant 22,500 0.75% $44.47 4/16/2008 $0 $ 314,620 $ 797,308
W. Rodney McMullen 30,000 1.00% $44.47 4/16/2008 $0 $ 419,493 $1,063,077
</TABLE>
- ------------
(1) No SARs were granted or outstanding during the fiscal year. Half of these
options vest in equal number of shares on the five annual anniversary dates
of the date of grant. The other half vest as described above this chart. The
options terminate in 10 years if not earlier exercised or terminated.
(2) At these levels of assumed annual appreciation of stock price, none of the
performance-based options will vest.
The assumptions set forth in the chart above are merely examples and do
not represent predictions of future stock prices or a forecast by the Company
with regard to stock prices.
AGGREGATED OPTION/SAR EXERCISES IN FISCAL YEAR AND OPTION/SAR VALUES
The following table shows information concerning the exercise of stock
options during fiscal year 1998 by each of the named executive officers and the
fiscal year-end value of unexercised options:
<TABLE>
<CAPTION>
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES TABLE
- --------------------------------------------------------------------------------------------------------
NUMBER OF
SECURITIES
UNDERLYING VALUE OF UNEXERCISED
SHARES UNEXERCISED IN-THE-MONEY
ACQUIRED OPTIONS/SARS AT OPTIONS/SARS
ON F/Y END (1) (#) AT F/Y END (1) ($)
EXERCISE VALUE EXERCISABLE/ EXERCISABLE/
NAME (#) REALIZED ($) UNEXERCISABLE UNEXERCISABLE
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Joseph A. Pichler 50,000 $2,053,564 451,000/88,000 $22,069,443/$2,201,720
David B. Dillon 50,000 $2,136,932 268,000/59,000 $12,956,605/$1,441,532
Michael S. Heschel 41,669 $1,066,857 18,500/48,167 $ 652,676/$1,325,795
Warren F. Bryant 24,000 $ 903,346 149,500/41,500 $ 7,045,906/$1,060,782
W. Rodney McMullen 3,000 $ 147,368 181,000/50,000 $ 8,588,723/$1,214,636
</TABLE>
- ------------
(1) No SARs were granted or outstanding during the fiscal year.
14
<PAGE> 18
LONG-TERM INCENTIVE PLAN AWARDS
The Company made no Long-Term Incentive Plan awards, excluding stock
options and restricted stock, to any named executive officer during fiscal year
1998.
COMPENSATION COMMITTEE REPORT
The Company's compensation policies are applicable to virtually all levels
of its work force, including its executive officers. These policies require the
Company to:
- be competitive in total compensation;
- include, as part of total compensation, opportunities for equity
ownership;
- use incentives that offer more than competitive compensation when the
Company achieves superior results;
- base incentive payments on earnings before interest, taxes, depreciation
and LIFO charges ("EBITD") and on sales results.
Accordingly, the Company's compensation plans include grants of stock
options for executive, management, and hourly employees. In determining the size
of option grants to the Chief Executive Officer and the other executive
officers, the Compensation Committee considers, without use of a formula,
competitive practices among retailers, the individual executive officer's level
within Kroger and the level of past awards of stock options and restricted stock
to the individual.
The 1997 Long-Term Incentive Plan, approved by the shareholders at the
Annual Meeting in 1997, authorized the issuance of 10,000,000 shares of common
stock. During 1998, Kroger granted 3,099,710 stock options to approximately
4,750 employees throughout the Company. The number of options granted and the
number of employees receiving options was typical of grants made in the past
several years. The Company expects to continue to use a broad-based stock option
program as a means of attracting and retaining employees, due to the direct
relationship between value received by the optionee and shareholder return.
The Compensation Committee establishes the fixed portion of executive
officer cash compensation, or salary, by considering internal equity and
competitor salary data as described below. Additionally, a large percentage of
employees at all levels of the organization, including executive officers, are
eligible to receive a bonus incentive based upon Company or unit performance.
Bonus potentials for executives are established by level within the Company, and
actual payouts are based on achievement of sales and EBITD targets. Actual
payouts can exceed these potentials if results exceed the targets. Approximately
50% of total potential cash compensation of the executive officers is based on
Company or unit EBITD and sales performance.
The Committee establishes salaries for executive officers that generally
are at the median of compensation paid by peer group companies for comparable
positions (where data for comparable positions are available) with a bonus
potential that, if realized, would cause their total cash compensation to be in
the upper quartile of peer group compensation. In 1998, the Compensation
Committee engaged two outside consultants to determine whether the compensation
of executive officers continued to meet this compensation philosophy. Each
consultant independently concluded that cash compensation for the Chief
Executive Officer and the other executive officers fell short of the Committee's
goal. Accordingly, the Committee has determined to make appropriate adjustments
to salaries and bonuses over a 2-year period. The Committee has engaged the same
consultants for 1999.
The Company's outstanding performance in 1998 is reflected by bonuses paid
for all executive officers. Bonus payouts for Messrs. Dillon, McMullen, and
Pichler are based on combined Kroger and Dillon operations and represented 90.7%
of their potentials. Mr. Bryant's bonus payout is based in total on Dillon
operations and represented 121.7% of his potential. Mr. Covert's bonus payout is
based in part on the manufacturing group's
15
<PAGE> 19
operations and represented 105.4% of his potential. All other executive officers
received bonus payouts of 78.7% of their respective potentials.
The compensation of Kroger's Chief Executive Officer is determined
annually pursuant to the policies described above. Mr. Pichler's variable
compensation or bonus for the last fiscal year, which represented 90.7% of his
bonus potential, reflects the extent to which the Company achieved the EBITD and
sales targets that were established by this Committee at the beginning of the
year. The value of stock options granted to Mr. Pichler in the last fiscal year
fluctuates based on the Company's performance in the stock market.
In 1995, the Compensation Committee engaged Towers Perrin to compare the
Chief Executive Officer's compensation to that of CEOs of other retailers and
found that Mr. Pichler's compensation was not competitive. As a result, the
Board made a performance based restricted stock award under which Mr. Pichler
could earn as many as 100,000 shares over a five-year period. As with all other
shares of Company common stock, these were adjusted to 200,000 shares to reflect
the effect of the 2-for-1 stock split in 1997. The restrictions on these shares
lapse on January 1, 2000, but only as to that number of shares remaining after
certain reductions based on a comparison of the Company's shareholder return to
that of a group including the Peer Group (see Performance Graph, below). In
general, each fiscal year the Chief Executive Officer can earn up to 40,000 of
the shares depending upon the extent to which the Company's performance exceeds
that of the reference group. On the other hand, up to 20,000 otherwise
previously earned shares will be forfeited in those years in which the Company's
performance does not exceed the median compared to that same group. In 1995,
1996, 1997, and 1998, Mr. Pichler tentatively earned 40,000, 20,000, 40,000, and
40,000 shares, respectively. Mr. Pichler also is party to an employment contract
with the Company that is more particularly described elsewhere in the Proxy
statement. (See p.19). That agreement establishes minimum compensation at levels
below his total compensation determined in consideration of the factors
identified above.
The Omnibus Budget Reconciliation Act of 1993 places a $1,000,000 limit on
the amount of certain types of compensation for each of the executive officers
that is tax deductible by the Company. The Company believes that its 1997
Long-Term Incentive Plan, under which stock option grants and restricted stock
awards were made to the executive officers, complies with the Internal Revenue
Service's regulations on the deductibility limit. Accordingly, the compensation
expense incurred thereunder should be deductible. The Company continues to
consider modifications to its other compensation programs based on the
regulations. The Company's policy is, primarily, to design and administer
compensation plans that support the achievement of long-term strategic
objectives and enhance shareholder value. Where it is material and supports the
Company's compensation philosophy, the Committee also will attempt to maximize
the amount of compensation expense that is tax deductible by the Company.
Compensation Committee:
T. Ballard Morton, Jr., Chair
John T. LaMacchia, Vice-Chair
John L. Clendenin
Thomas H. O'Leary
16
<PAGE> 20
PERFORMANCE GRAPH
Set forth below is a line graph comparing the five year cumulative total
shareholder return on the Company's common stock, based on the market price of
the common stock and assuming reinvestment of dividends, with the cumulative
total return of companies on the Standard & Poor's 500 Stock Index and the Peer
Group comprised of major food companies:
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN*
OF THE KROGER CO., S&P 500 AND PEER GROUP**
<TABLE>
<CAPTION>
KROGER S&P 500 PEER GROUP
------ ------- ----------
<S> <C> <C> <C>
'1993' 100 100 100
'1994' 120 101 106
'1995' 186 139 139
'1996' 230 171 171
'1997' 329 229 222
'1998' 601 294 347
</TABLE>
For the period presented, the Company's fiscal year ends generally on the
Saturday closest to December 31.
- ------------
*Total assumes $100 invested on January 2, 1994 in The Kroger Co., S&P 500
Index, and major food companies (the "Peer Group"), with reinvestment of
dividends.
**The Peer Group consists of Albertson's, Inc., American Stores Company,
Fleming Companies, Inc., Giant Food Inc. (Class A), Great Atlantic & Pacific
Tea Company, Inc., Safeway Inc., Supervalu Inc., The Vons Companies, Inc.,
and Winn-Dixie Stores, Inc. The Vons Companies, Inc. was acquired by Safeway
Inc. on June 16, 1997. Giant Food Inc. was acquired by Koninklijke Ahold
N.V. on December 14, 1998. As a result, both companies are excluded from
this performance graph beginning with the year of the acquisition.
The Company's peer group is composed of major food companies with which
the Company competes.
Neither the foregoing Compensation Committee Report nor the foregoing
Performance Graph will be deemed incorporated by reference into any other
filing, absent an express reference thereto.
17
<PAGE> 21
COMPENSATION PURSUANT TO PLANS
The Company maintains various benefit plans that are available to
management and certain other employees. The Company derives the benefit of
certain tax deductions as a result of its contributions to some of the plans.
Each of the executive officers of the Company was eligible to participate in one
or more of the following plans.
THE KROGER CO. EMPLOYEE PROTECTION PLAN
The Company adopted The Kroger Co. Employee Protection Plan ("KEPP")
during fiscal 1988 and renewed the plan in 1993 and in 1998. All management
employees, including the executive officers, and administrative support
personnel of the Company with at least one year of service are covered. KEPP
provides for severance benefits and the extension of Company paid health care in
the event an eligible employee actually or constructively is terminated from
employment without cause within two years following a change of control of the
Company (as defined in the plan). For persons over 40 years of age with more
than six years of service, severance pay ranges from approximately 9 to 18
months' salary and bonus, depending upon Company pay level and other benefits.
KEPP may be amended or terminated by the Board of Directors at any time prior to
a change of control, and will expire in 2003 unless renewed by the Board of
Directors.
PENSION PLANS
The Company maintains the Kroger Retirement Benefit Plan, a defined
benefit plan, to provide pension benefits to retired or disabled management
employees and certain groups of hourly personnel. The Plan generally provides
for benefits at age 62 or later equal to 1 1/2% times the years of service,
after attaining age 21, (or, for participants prior to January 1, 1986, after
attaining age 25) times the highest average earnings for any five years during
the ten calendar years preceding retirement, less an offset tied to Social
Security benefits. The Company also maintains an Excess Benefits Plan under
which the Company pays benefits which exceed the maximum benefit payable under
ERISA by defined benefit plans. The following table gives examples of annual
retirement benefits payable on a straight-life basis under the Company's
retirement program.
<TABLE>
<CAPTION>
YEARS OF SERVICE
FIVE YEAR ---------------------------------------------------------------
AVERAGE REMUNERATION 15 20 25 30 35 40
-------------------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
$ 150,000 $ 33,750 $ 45,000 $ 56,250 $ 67,500 $ 78,750 $ 90,000
250,000 56,250 75,000 93,750 112,500 131,250 150,000
450,000 101,250 135,000 168,750 202,500 236,250 270,000
650,000 146,250 195,000 243,750 292,500 341,250 390,000
850,000 191,250 255,000 318,750 382,500 446,250 510,000
900,000 202,500 270,000 337,500 405,000 472,500 540,000
1,200,000 270,000 360,000 450,000 540,000 630,000 720,000
1,500,000 337,500 450,000 562,500 675,000 787,500 900,000
</TABLE>
No deductions have been made in the above table for offsets tied to Social
Security benefits.
Remuneration earned by Messrs. Pichler, Dillon, Heschel, Bryant, and
McMullen in 1998, which was covered by the Plan, was $942,073, $664,073,
$540,000, $0, and $382,968, respectively. As of January 2, 1999, they had 11, 3,
7, 17, and 13 years of credited service, respectively.
DILLON PLANS
Dillon Companies, Inc. and its subsidiaries maintain pension, profit
sharing, stock ownership, and savings plans that provide benefits at levels
comparable to the plans described above. David B. Dillon has 20 years of
credited service and Joseph A. Pichler has 6 years of credited service under
certain of the pension and profit sharing plans, but no further credited service
will be accrued for either of them under those plans. Warren F. Bryant has 10
years of credited service under these plans and remuneration earned by him which
was covered by those plans during 1998 was $338,778.
18
<PAGE> 22
Under the Dillon Employees' Profit Sharing Plan, Dillon and each of its
participating subsidiaries contributes a certain percentage of net income,
determined annually, to be allocated among participating employees based on the
percent that the participating employee's total compensation bears to the total
compensation of all participating employees employed by the particular Dillon
division or subsidiary. On participating employees' termination upon attaining
the age 60, death or disability, they are entitled to their full contribution
account balance. In addition to this plan, Dillon and several of its
subsidiaries have adopted the Dillon Pension Plan, a defined benefit plan, for
their eligible employees. Under the pension plan, the normal retirement benefit
for eligible employees is a certain percentage of average compensation during a
certain period of employment multiplied by the years of credited service (in
some of these plans there is a maximum period of credited service), minus the
benefit provided by the Profit Sharing Plan (except as may be limited by
provisions of ERISA).
The following table shows the estimated annual pension payable upon
retirement to persons covered by Dillon's Plans. Benefits payable under the
Profit Sharing Plan may exceed the amount payable under the Pension Plan, and
participants are entitled to the greater of the two. The table does not reflect
benefits payable under Dillon's Profit Sharing Plan, since benefits under that
plan are not determined by years of service, and no deductions have been made in
the table for offsets tied to Social Security benefits. Dillon also maintains an
Excess Benefit Plan that pays benefits which exceed the maximum benefit payable
under ERISA by defined benefit and defined contribution plans.
<TABLE>
<CAPTION>
YEARS OF SERVICE
AVERAGE ---------------------------------------------------------------
COMPENSATION 15 20 25 30 35 40
------------ -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
$150,000 $ 33,750 $ 45,000 $ 56,250 $ 67,500 $ 78,750 $ 90,000
250,000 56,250 75,000 93,750 112,500 131,250 150,000
450,000 101,250 135,000 168,750 202,500 236,250 270,000
650,000 146,250 195,000 243,750 292,500 341,250 390,000
850,000 191,500 255,000 318,750 382,500 446,250 510,000
</TABLE>
The amounts contributed by Dillon and its subsidiaries pursuant to these
retirement plans are not readily ascertainable for any individual, and thus are
not set forth above.
EMPLOYMENT CONTRACTS
The Company entered into an amended and restated employment agreement with
Mr. Pichler dated as of July 22, 1993. During his employment, the Company agrees
to pay Mr. Pichler at least $420,000 a year, unless the amount is reduced due to
adverse business conditions. Mr. Pichler's employment may be terminated at the
discretion of the Board of Directors. The contract also provides that the
Company will continue to pay Mr. Pichler's salary to his beneficiary for a
period of five years after a termination of employment resulting from his death,
or will pay to Mr. Pichler his salary for a term equal to the lesser of five
years or until October 4, 2005, if Mr. Pichler's termination of employment
results from his involuntary separation. The Company also has agreed to
reimburse Mr. Pichler for premiums on a policy of life insurance plus the tax
effects of that reimbursement. After his termination of employment for any
reason after age 62, if he is not entitled to receive the salary continuation
described above, Mr. Pichler will, in exchange for his availability to provide
certain consulting services, then receive each year until his death an amount
equal to 25% of the highest salary paid him during the term of this agreement.
19
<PAGE> 23
BENEFICIAL OWNERSHIP OF COMMON STOCK
As of February 5, 1999, the directors of the Company, the named executive
officers and the directors and executive officers as a group, beneficially owned
shares of the Company's common stock as follows:
<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF BENEFICIAL
NAME OWNERSHIP
- ------------------------------------------------------------------------------------------------
<S> <C>
Reuben V. Anderson.......................................... 13,066(1)
Robert D. Beyer............................................. 0(2)
Warren F. Bryant............................................ 177,393(3)(4)(5)
Ronald W. Burkle............................................ 0(2)
John L. Clendenin........................................... 13,066(1)
David B. Dillon............................................. 476,192(4)(5)(6)
Michael S. Heschel.......................................... 52,601(4)(5)
Carlton J. Jenkins.......................................... 0(2)
Bruce Karatz................................................ 0(2)
John T. LaMacchia........................................... 13,066(1)
Edward M. Liddy............................................. 7,866(7)
W. Rodney McMullen.......................................... 239,532(4)(5)
Robert G. Miller............................................ 1,000(2)
Clyde R. Moore.............................................. 1,400(8)
T. Ballard Morton, Jr. ..................................... 31,066(1)
Thomas H. O'Leary........................................... 13,066(1)
Katherine D. Ortega......................................... 14,244(1)
Joseph A. Pichler........................................... 1,069,308(4)(5)(9)
Steven R. Rogel............................................. 0(2)
Martha Romayne Seger........................................ 13,466(1)
Bobby S. Shackouls.......................................... 0(10)
James D. Woods.............................................. 13,066(1)
Directors and Executive Officers as a group (including those
named above).............................................. 2,754,707(4)(5)(11)(12)
</TABLE>
- --------------------------------------------------------------------------------
(1) This amount includes 11,066 shares that represent options exercisable on or
before April 6, 1999.
(2) The named individual was not a director of the Company on February 5, 1999,
but will only become a director of the Company when the merger with Fred
Meyer is completed. That may occur before or after the date of the annual
meeting. On February 5, 1999, Messrs. Beyer, Burkle, Jenkins, Karatz,
Miller, and Rogel, beneficially owned 947, 14,463,978, 242, 2,651, 851,120,
and 7,073 shares of Fred Meyer common stock, respectively. Mr. Miller's
shares include 786,722 options exercisable on or before April 6, 1999. Mr.
Beyer disclaims ownership of 56,878 shares not included in his total. Mr.
Burkle disclaims beneficial ownership of his shares, except to the extent
of his pecuniary interest in them. Based on Amendment No. 4 to Schedule 13D
filed with the SEC, 3,573,000 of those shares have been pledged to secure,
and may be required to be forfeited upon settlement of, a derivative
security transaction in Fred Meyer common stock that some of Mr. Burkle's
affiliates have entered into. Mr. Burkle's total also includes a currently
exercisable warrant held by affiliates to purchase 3,869,366 shares, and
66,390 shares held by a charitable trust of which Mr. Burkle is trustee.
Upon completion of the merger with Fred Meyer the shares will be converted
into shares of Kroger common stock, the options will become options to
purchase Kroger common stock and the warrant will become a warrant to
purchase Kroger common stock.
(3) This amount does not include 4,856 shares owned by Mr. Bryant's wife. Mr.
Bryant disclaims beneficial ownership of these shares.
(4) This amount includes shares that represent options exercisable on or before
April 6, 1999, in the following amounts: Mr. Bryant, 149,500; Mr. Dillon,
268,000; Mr. Heschel, 18,500; Mr. McMullen, 181,000; Mr. Pichler, 451,000;
and all directors and executive officers as a group, 1,622,276.
(5) The fractional interest resulting from allocations under Kroger's 401(k)
plan and Dillon's ESOP and 401(k) plan has been rounded to the nearest
whole number.
20
<PAGE> 24
(6) This amount does not include 88,159 shares owned by Mr. Dillon's wife,
27,012 shares in his children's trust or 26,568 shares owned by his
children. Mr. Dillon disclaims beneficial ownership of these shares.
(7) This amount includes 3,066 shares that represent options exercisable on or
before April 6, 1999.
(8) This amount includes 400 shares that represent options exercisable on or
before April 6, 1999.
(9) This amount does not include 16,560 shares owned by Mr. Pichler's wife. Mr.
Pichler disclaims beneficial ownership of these shares.
(10) Mr. Shackouls became a member of the Board on February 26, 1999.
(11) The figure shown does not include an aggregate of 15,080 additional shares
held by, or for the benefit of, the immediate families or other relatives
of all directors and executive officers as a group not listed above. In
each case the director or executive officer disclaims beneficial ownership
of those shares.
(12) No director or executive officer owned as much as 1% of the common stock of
the Company. The directors and executive officers as a group beneficially
owned 1.1% of the common stock of the Company.
21
<PAGE> 25
As of February 6, 1999, the following persons reported beneficial
ownership of the Company's common stock based on reports on Schedule 13G filed
with the Securities and Exchange Commission or other reliable information as
follows:
<TABLE>
<CAPTION>
AMOUNT
AND
NATURE OF PERCENTAGE
NAME ADDRESS OF BENEFICIAL OWNER OWNERSHIP OF CLASS
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
The Kroger Co. Savings Plan 1014 Vine Street 26,846,519(1) 10.4%
Cincinnati, OH 45202
The Dillon Cos. Employee Master Trust 700 East 30th Street 17,009,686(1) 6.6%
Hutchinson, KS 67052
</TABLE>
- ------------
(1) Shares beneficially owned by plan trustees for the benefit of participants
in employee benefit plans.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the
Company's officers and directors, and persons who own more than ten percent of a
registered class of the Company's equity securities, to file reports of
ownership and changes in ownership with the Securities and Exchange Commission
and the New York Stock Exchange. Those officers, directors, and shareholders are
required by SEC regulation to furnish the Company with copies of all Section
16(a) forms they file.
Based solely on its review of the copies of forms received by the Company,
or written representations from certain reporting persons that no Forms 5 were
required for those persons, the Company believes that during fiscal year 1998
all filing requirements applicable to its officers, directors and ten percent
beneficial owners were timely satisfied except that Mr. Lawrence Turner filed an
amended Form 4 reporting the inadvertent understatement of 7,000 shares reported
in the exercise of a stock option and the sale of the underlying securities, and
Ms. Lynn Marmer filed a Form 5 reporting the sale of 200 shares of stock that
inadvertently was not reported on a Form 4 during 1998.
INCREASE AUTHORIZED SHARES OF COMMON STOCK
(ITEM NO. 2)
The Board of Directors believes it would be in the best interest of the
Company and its shareholders and therefore proposes that the shareholders
authorize the amendment of the Amended Articles of Incorporation to increase the
number of shares of common stock ("Common Stock") that the Company may issue
from the 1,000,000,000 shares presently authorized to 2,000,000,000 shares (the
"Proposal"). If the Proposal is approved by shareholders, the increase in
authorized shares of Common Stock will be implemented by filing Amended Articles
of Incorporation with the Ohio Secretary of State if and when determined by the
Board of Directors to be in the best interest of the Company. On March 23, 1999,
there were 257,856,756 shares of Common Stock issued and outstanding. An
additional approximately 36,000,000 shares of Common Stock have been reserved
for issuance pursuant to the Company's stock option and other employee benefit
plans. Upon completion of the merger with Fred Meyer, approximately 156,800,000
additional shares of Common Stock will be outstanding and approximately
15,500,000 additional shares will be reserved for issuance to holders of Fred
Meyer's outstanding stock options and warrants.
The purpose of the proposal is to provide additional shares that could be
used for proper corporate purposes, including, without limitation, stock splits,
acquisitions, other compensation plans, and raising additional capital. The
officers of the Company are from time-to-time engaged in general discussions
with principals of other organizations and other companies with a view toward
possible acquisitions by the Company. If the Proposal is
22
<PAGE> 26
adopted, the Board of Directors will have the authority to issue the additional
authorized shares or any part thereof to such persons and for such consideration
as it may determine without further action by the shareholders except as
shareholder action may be required by law or contractual arrangements. Any such
issuances (or an issuance of authorized but unissued preferred stock) could have
the effect of discouraging an attempt to acquire control of the Company. For
example, stock could be issued to persons, firms or entities known to be
friendly to management. With the exception of the warrant dividend plan
discussed in the accompanying annual report and redemption provisions contained
in debt instruments exercisable upon a change in control, there are no other
provisions of the Company's Amended Articles of Incorporation, Regulations, or
debt instruments that management believes could reasonably be deemed to have an
anti-takeover effect. Except with respect to shares to be issued in connection
with the Fred Meyer merger and $1,600,000 worth of shares to be issued in
connection with a pending acquisition in Indiana, and under stock option and
employee benefit plans, as set forth in the preceding paragraph, the Company
does not now have any commitments, arrangements or understandings that would
require the issuance of additional shares of Common Stock. Upon completion of
the merger with Fred Meyer, a warrant to purchase shares of Fred Meyer will
become a warrant to purchase Company Common Stock.
Under Ohio law, a plan of merger requires shareholder approval if the
non-surviving entity acquires one-sixth or more of the voting power of the
Company. In addition, the Company is required by the rules of the New York Stock
Exchange to submit certain transactions to a vote of its shareholders,
including, without limitation, mergers involving subsidiaries (which otherwise
are not subject to required approval of the Company's shareholders), where the
issuance of shares of Common Stock could result in an increase in the number of
outstanding shares by 20 percent or more. Approval of the proposal would not
alter in any way the Company's obligations under these authorities.
Each additional share of Common Stock authorized by the proposed amendment
will have the same rights and privileges as each share of outstanding Common
Stock. Shareholders of Common Stock have no preemptive rights to receive or
purchase any shares of the presently authorized but unissued Common Stock or to
the shares authorized by this proposed amendment.
In order for the Proposal to be adopted, it must be approved by the
holders of a majority in voting power of the outstanding shares of Common Stock.
THE BOARD OF DIRECTORS AND MANAGEMENT RECOMMEND A VOTE FOR THIS PROPOSAL.
APPROVAL OF THE 1999 LONG-TERM INCENTIVE PLAN
(ITEM NO. 3)
The Board of Directors has adopted, subject to shareholder approval, The
Kroger Co. 1999 Long-Term Incentive Plan ("Plan") for which a maximum of
10,000,000 shares of common stock will be reserved. The purpose of the Plan is
to assist in attracting and retaining employees and directors of outstanding
ability and to promote the identification of their interests with those of the
shareholders of the Company. If approved, the Plan will be effective as of May
20, 1999.
In 1988, the Company instituted a broad-based stock option program
designed to motivate employees at all levels of the organization. In 1998 the
stock option committee made grants of stock options to approximately 4,750
employees. This program was adopted in efforts to more closely align the
interests of employees and shareholders, as stock appreciation will benefit both
non-employee shareholders and employees. The 1999 Long-Term Incentive Plan
continues this policy.
The stock option committee intends to continue to impose performance
criteria on the vesting of a portion of the stock options granted to
approximately 100 of the most senior executives. Performance based
23
<PAGE> 27
options will comprise half of the grant made to these individuals. Previously,
these options vested during the first four years from the date of the grant only
if the Company's stock price achieved a 63% appreciation from the option price.
Thereafter, the options vested only if the Company's stock price achieved a
minimum of a 13% appreciation per annum from the date of grant or 200%
appreciation, whichever is less. We expect that for 1999 these options will vest
during the first four years from the date of the grant only if the Company's
stock price has achieved a 75% appreciation from the option price. Thereafter,
it is expected that the options vest only if the Company's stock price has
achieved a minimum of a 15% appreciation per annum from the date of grant or
252% appreciation, whichever is less. The other half of the options granted to
these individuals are expected to vest in equal installments over five years
from the date of grant. The stock option committee intends to consider these
same limitations and other alternatives for future grants.
DESCRIPTION OF THE PLAN
General. The Plan consists of three separate programs; the Insider
Program, the Non-Insider Program and the Outside Director Program. Officers of
the Company, including inside directors, subject to Section 16(a) of the
Securities Exchange Act of 1934 (the "Exchange Act") are eligible for grants or
awards under the Insider Program while all other employees of the Company are
eligible for grants or awards under the Non-Insider Program. Non-employee
directors will receive grants under the Outside Director Program as more
particularly described below. Currently, 12 employees are eligible to
participate in the Insider Program and the remaining approximately 213,000
employees of the Company are eligible to participate in the Non-Insider Program.
Grants will be made under the Outside Director Program to all non-employee
directors who own a minimum of 1,000 shares of common stock of the Company on
the date of the grant. As of February 5, 1999, ten of the non-employee directors
are eligible for grants under the Outside Director Program. Mr. Shackouls became
a member of the Board on February 26, 1999. We anticipate that he will be
eligible for a grant on the date of the annual meeting. If the merger with Fred
Meyer occurs prior to the annual meeting, Messrs. Beyer, Burkle, Jenkins,
Karatz, and Rogel will become directors, and they will be eligible for grants on
the date of the annual meeting if they meet the share ownership criteria on the
date of the annual meeting.
Administration. The Insider Program and the Outside Director Program will
be administered by a committee of the Board of Directors that meets the
standards of Rule 16b-3(d)(1) under the Exchange Act and initially will be those
members of the Compensation Committee of the Board of Directors who qualify as
"outside directors" under Section 162(m) of the Internal Revenue Code of 1986,
as amended (the "Code"). The Non-Insider Program will be administered by a
committee appointed by the Chief Executive Officer, the members of which are
ineligible to receive grants or awards under the Non-Insider Program. The
administering committee in each case is referred to as the "Committee."
The Committee is authorized to grant nonstatutory stock options and to
award restricted stock to participants under the Insider Program and the
Non-Insider Program. Annually, the Committee will grant to eligible participants
under the Outside Director Program a nonstatutory stock option to purchase 2,000
shares of common stock of the Company. The Committee will determine the types
and amounts of awards or grants, the recipients of awards or grants, vesting
schedules, restrictions, performance criteria, and other provisions of the
grants or awards. All of these provisions will be set forth in a written
agreement with the participant.
In addition to other rights of indemnification they may have as directors
or employees of the Company, members of the Committee will be indemnified by the
Company for reasonable expenses incurred in connection with defense of any
action brought against them by reason of action taken or failure to act under or
in connection with the Plan or any grant or award thereunder, if the members
acted in good faith and in a manner which they believed to be in the best
interests of the Company.
24
<PAGE> 28
The Board of Directors may terminate or amend the Plan at any time without
shareholder approval, except that it may not amend the Plan without shareholder
approval if required by applicable law, regulations, or rules of the principal
exchange or interdealer quotation system on which the common stock is listed or
quoted. Unless earlier terminated by the Board of Directors, the Plan will
terminate on February 26, 2009. Termination of the Plan will have no effect on
the validity of any options or restricted stock outstanding on the date of
termination. Unless otherwise provided in the agreement, awards and grants will
not be transferable other than by will or the laws of descent and distribution.
Shares Subject to Grant. Under the Plan up to 10,000,000 authorized but
unissued or reacquired shares of common stock may be issued upon the exercise of
nonstatutory stock options and as restricted stock. In no event may any
participant receive awards and grants totaling more than 500,000 shares of
common stock in the aggregate under the Plan.
If an option expires, or if restricted stock is not issued or is forfeited
prior to the payment of a dividend on those shares to a participant, the shares
not exercised, unissued or forfeited, as the case may be, will generally become
available for other grants or awards under the Plan.
Outside Director Program. The Outside Director Program is a formula plan
in which non-employee directors who own at least 1,000 shares of common stock of
the Company at the time of the grant will receive annually during each of 1999
through 2001, a nonstatutory stock option to purchase 2,000 shares of common
stock at an option price equal to the fair market value of the common stock on
the date of the grant. The option generally will have a 10-year term (subject to
earlier termination in the event of termination of Board membership other than
by reason of retirement) and will vest in equal share amounts, respectively, on
the five annual anniversary dates from the date of grant. The Plan provides for
the first grant to eligible directors of nonstatutory options covering 2,000
shares of common stock to be made on May 20, 1999, subject to approval by the
Company's stockholders of the Plan.
Stock Options. Nonstatutory stock options granted under the Plan will have
exercise prices not less than the greater of the fair market value per share of
the optioned stock or the par value of a share of common stock, a term of not
more than ten years after the date of grant, and generally may not be exercised
before six months from the date of grant. Subject to the terms of the Plan, the
Committee determines the vesting schedule and other terms and conditions
applicable to stock options granted to employees. In recent years, option grants
have not become exercisable earlier than one year from the date of grant. An
eligible participant may receive more than one option.
The Committee may in its discretion provide for the payment of the option
exercise price otherwise than in cash, including by delivery of common stock,
valued at its fair market value on the date of exercise, or by a combination of
both cash and common stock.
Restricted Stock. The Committee may award restricted stock to
participants. The stock will be subject to forfeiture, restrictions on
transferability, and other restrictions as specified in the agreement. The
Committee has authority to impose other terms and conditions as it may determine
in its discretion including making the vesting of awards contingent on the
achievement of performance goals. Performance goals may be established by the
Committee and may be based on earnings or earnings growth; sales; return on
assets, equity or investment; total shareholder return; regulatory compliance;
satisfactory internal or external audits; improvement of financial ratings;
achievement of balance sheet or income statement objectives or any other
objective goals established by the Committee and may be absolute in terms or
measured against or in relation to other companies comparably, or otherwise
situated to the Company. During the period that a restricted stock award is
subject to restrictions, an
25
<PAGE> 29
employee has the right to vote the shares and to receive dividends. The maximum
number of shares of restricted stock that can be issued under the Plan is
500,000.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
Nonstatutory Stock Options. A grantee will not recognize income on the
grant of a nonstatutory stock option but generally will recognize ordinary
income upon the exercise thereof. The amount of income recognized upon the
exercise of a nonstatutory stock option generally will be measured by the
excess, if any, of the fair market value of the shares at the time of exercise
over the exercise price, provided the shares issued are either transferable or
not subject to a substantial risk of forfeiture.
In the case of ordinary income recognized by a grantee as described above
in connection with the exercise of a nonstatutory stock option, the Company will
be entitled to a deduction in the amount of ordinary income so recognized by the
grantee, provided the Company satisfies certain federal income tax reporting
requirements.
Restricted Stock. The recipient of restricted stock is not required to
include the value of these shares in ordinary income until the first time the
grantee's rights in the shares are transferable or are not subject to a
substantial risk of forfeiture, whichever occurs earlier, unless the grantee
elects to be taxed on receipt of the shares. In either case, the amount of
income will be equal to the excess of the fair market value of the stock at the
time the income is recognized over the amount paid for the stock. The Company
will be entitled to a deduction in the amount of the ordinary income recognized
by the grantee for the Company's taxable year which includes the last day of the
grantee's taxable year in which the grantee recognizes the income, provided the
Company satisfies certain federal income tax reporting requirements.
General. The rules governing the tax treatment of options and restricted
stock and stock acquired upon the exercise of options are quite technical, so
that the above description of tax consequences is necessarily general in nature
and does not purport to be complete. Moreover, statutory provisions are, of
course, subject to change, as are their interpretations, and their application
may vary in individual circumstances. Finally, the tax consequences under
applicable state law may not be the same as under the federal income tax laws.
Tax Deductibility Cap. Section 162(m) of the Code provides that certain
compensation received in any year by a "covered employee" in excess of
$1,000,000 is non-deductible by the Company for federal income tax purposes.
Section 162(m) provides an exception, however, for "performance-based
compensation." The Committee currently intends to structure grants and awards
made under the Plan to "covered employees" as performance-based compensation
that is exempt from Section 162(m).
NEW PLAN BENEFITS
<TABLE>
<CAPTION>
1999 LONG-TERM INCENTIVE PLAN
-----------------------------
DOLLAR NUMBER OF
NAME AND POSITION(1) VALUE UNITS
-------------------- ------------- ----------------
<S> <C> <C>
Non-Executive Director Group............................... $0(2) 20,000(3)
</TABLE>
- ---------------
(1) Awards, values and benefits are not determinable for other than the
Non-Executive Director Group.
(2) Options to be granted to Non-Executive Directors upon approval of
shareholders at fair market value of stock.
(3) Based on number of eligible Non-Executive Directors as of February 5, 1999.
Mr. Shackouls became a Board member on February 26, 1999. Messrs. Beyer,
Burkle, Jenkins, Karatz, and Rogel will become members of the Board upon
completion of the merger with Fred Meyer.
THE BOARD OF DIRECTORS AND MANAGEMENT RECOMMEND A VOTE FOR THIS PROPOSAL.
26
<PAGE> 30
SELECTION OF AUDITORS
(ITEM NO. 4)
The Board of Directors, on February 26, 1999, appointed the firm of
PricewaterhouseCoopers LLP as Company auditors for 1999, subject to ratification
by shareholders. This appointment was recommended by the Company's Audit
Committee, comprised of directors who are not employees of the Company. If the
firm is unable for any reason to perform these services, or if selection of the
auditors is not ratified, other independent auditors will be selected to serve.
Ratification of this appointment requires the adoption of the following
resolution by the affirmative vote of the holders of a majority of the shares
represented at the meeting:
"RESOLVED, That the appointment by the Board of Directors of
PricewaterhouseCoopers LLP as Company auditors for 1999 be, and it hereby
is, ratified."
A representative of PricewaterhouseCoopers LLP is expected to be present
at the meeting to respond to appropriate questions and to make a statement if he
or she desires to do so.
THE BOARD OF DIRECTORS AND MANAGEMENT RECOMMEND A VOTE FOR THIS PROPOSAL.
SHAREHOLDER PROPOSAL
(ITEM NO. 5)
The Company has been notified by the Plumbers & Pipefitters National
Pension Fund, 103 Oronoco Street, Alexandria, Virginia 22314-2015, the
beneficial owner of 46,300 shares of Kroger common stock, that it intends to
propose the following resolution at the annual meeting:
Resolved, that the shareholders of the Kroger Company, request that the
Board of Directors take those steps necessary to provide that all directors be
elected annually and not by classes as is now provided.
The following is the statement submitted in support of this proposal:
Classified Boards remove the threat of annual elections from directors. As
a result, directors may lose their sense of accountability to shareholders and
make decisions more in the interests of management than in the interests of
shareholders. A classified Board of Directors also maintains the current board
and, therefore, current management. This limits the accountability of both the
Board and management to stockholders.
A classified Board of Directors also imposes a barrier to control of the
company that may make it less attractive as a potential acquisition. In addition
to discouraging some potential acquirers and making change more difficult, it
could also result in a period of division and controversy on the Board of
Directors if some but not all Directors are replaced in connection with a
takeover attempt. These consequences do not benefit shareholders.
According to the Investor Responsibility Research Center (IRRC)
shareholder proposals to repeal classified boards win high levels of voting
support from shareholders while company proposals to classify boards have run
into increasing difficulty obtaining support from shareholders. IRRC also
reports that "shareholder support for proposals to repeal classified boards rose
to a record level in 1997, averaging 43.8 percent of the votes cast...." Twelve
shareholder resolutions to repeal classified boards won majority votes in 1997.
As of the deadline for submitting this resolution, 13 shareholder resolutions to
repeal classified boards have won majority votes in 1998.
A number of large companies have moved away from staggered boards in
recent years. Time Warner put the repeal of its classified board to a
shareholder vote in 1997. The resolution passes with 80.9 percent of the vote.
Other companies which have moved away from classified boards include Ameritech,
Westinghouse, Lockheed-Martin, Campbell Soups, Atlantic Richfield, Pacific
Enterprises and the Travelers Group.
27
<PAGE> 31
In contrast, fewer companies propose to adopt classified Boards. Five
management proposals to adopt classified boards failed in 1997.
The annual election of Directors at the Kroger Company will allow
shareholders the opportunity to register annually their views of the performance
of the Board of Directors collectively and of each Director individually. This
will enhance the accountability of the Board and management to shareholders.
Please vote for this proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE AGAINST THE RESOLUTION FOR THE
FOLLOWING REASONS:
The shareholders of Kroger decided, by action at the annual meeting of
shareholders in 1973 with 95% of the votes cast in favor of the proposal, that
its Board of Directors should be divided into three classes with directors
elected to staggered three-year terms. This was to insure continuity of
experienced Board members. Prior to this time, all directors were elected
annually.
The Board of Directors believes that the classification gives the Board a
greater continuity of experience since a majority of directors at any given time
will have experience with the business affairs and operations of the Company.
This permits more effective long-term strategic planning in use of Company
resources. The Board believes that continuity and quality of leadership that
result from the classified Board creates long-term value for the shareholders.
A classified Board reduces the possibility of a sudden and surprise change
in majority control of the Board. It also has the effect, in tandem with the
warrant dividend plan adopted in 1986, of impeding disruptive and inequitable
tactics that have become relatively common corporate take-over practices. PRIOR
TO RECOMMENDING AN EXTENSION OF THE TERM OF THE WARRANT DIVIDEND PLAN FOR TEN
YEARS IN 1996, MANAGEMENT CONSULTED WITH ITS OUTSIDE ADVISORS AND DETERMINED
THAT RETENTION OF THE WARRANT DIVIDEND PLAN AND A CLASSIFIED BOARD WAS IN THE
BEST INTERESTS OF SHAREHOLDERS.
In the event of a hostile take-over attempt, the fact that approximately
two-thirds of the Board members have tenure for more than a year would encourage
initiation of arms-length discussions with the Board. The Board is in the best
position to evaluate and negotiate a transaction that is in the best interest of
shareholders and other affected constituencies.
Directors elected for staggered terms are not any less accountable or
responsive to shareholders than they would be if elected annually. The same
standards of performance apply to all directors regardless of the term of
service. The shareholders always retain the ability to replace directors or
propose and elect alternate nominees for the class of directors to be elected
each year. Therefore, you continue to enjoy a significant opportunity to express
your views regarding the Board's performance and to influence the Board's
composition.
EFFECT OF ADOPTION
If approved, this proposal will serve as a recommendation to the Board of
Directors to take the necessary steps to eliminate the classified Board, but it
will not declassify the board. If the proposal is adopted, and if the Board
subsequently agrees with the recommendation, implementation of the proposal
would require the modification of Kroger's regulations regarding the terms of
directors. In accordance with amendments to the regulations approved by Kroger
shareholders in 1986, the necessary modification of the regulations to implement
annual election of all Board members requires the favorable vote at a subsequent
shareholders' meeting of the holders of at least 75% of the then outstanding
shares of voting stock of Kroger.
---------------------------
SHAREHOLDER PROPOSALS--2000 ANNUAL MEETING. Shareholder proposals intended
for inclusion in the Company's proxy material relating to the Company's annual
meeting in June 2000 should be addressed to the
28
<PAGE> 32
Secretary of the Company and must be received at the Company's executive offices
not later than December 15, 1999. These proposals must comply with the proxy
rules established by the Securities and Exchange Commission. In addition, the
proxy solicited by the Board of Directors for the 2000 annual meeting of
shareholders will confer discretionary authority to vote on any shareholder
proposal presented at the meeting unless the Company is provided with notice of
the proposal before February 27, 2000.
---------------------------
Attached to this Proxy Statement is the Company's 1998 Annual Report which
includes a brief description of the Company's business indicating its general
scope and nature during 1998, together with the audited financial information
contained in the Company's 1998 report to the Securities and Exchange Commission
on Form 10-K. A COPY OF THAT REPORT IS AVAILABLE TO SHAREHOLDERS ON REQUEST BY
WRITING: LAWRENCE M. TURNER, VICE PRESIDENT AND TREASURER, THE KROGER CO., 1014
VINE STREET, CINCINNATI, OHIO 45202-1100 OR BY CALLING 1-513-762-1220. The
Company's SEC filings are available to the public from the SEC's web site at
http://www.sec.gov.
The management knows of no other matters that are to be presented at the
meeting but, if any should be presented, the Proxy Committee expects to vote
thereon according to its best judgment.
By order of the Board of Directors,
Paul W. Heldman, Secretary
29
<PAGE> 33
1998 ANNUAL REPORT
<PAGE> 34
FINANCIAL REPORT 1998
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The management of The Kroger Co. has the responsibility for preparing the
accompanying financial statements and for their integrity and objectivity. The
statements were prepared in accordance with generally accepted accounting
principles applied on a consistent basis and are not misstated due to material
error or fraud. The financial statements include amounts that are based on
management's best estimates and judgments. Management also prepared the other
information in the report and is responsible for its accuracy and consistency
with the financial statements.
The Company's financial statements have been audited by
PricewaterhouseCoopers LLP, independent certified public accountants, approved
by the shareholders. Management has made available to PricewaterhouseCoopers LLP
all of the Company's financial records and related data, as well as the minutes
of stockholders' and directors' meetings. Furthermore, management believes that
all representations made to PricewaterhouseCoopers LLP during its audit were
valid and appropriate.
Management of the Company has established and maintains a system of
internal control that provides reasonable assurance as to the integrity of the
financial statements, the protection of assets from unauthorized use or
disposition, and the prevention and detection of fraudulent financial reporting.
The system of internal control provides for appropriate division of
responsibility and is documented by written policies and procedures that are
communicated to employees with significant roles in the financial reporting
process. The policies and procedures are updated as necessary. Management
continually monitors the system of internal control for compliance. The Company
maintains a strong internal auditing program that independently assesses the
effectiveness of the internal controls and recommends possible improvements
thereto. In addition, as part of its audit of the Company's financial
statements, PricewaterhouseCoopers LLP completed a review of selected internal
accounting controls to establish a basis for reliance thereon in determining the
nature, timing and extent of audit tests to be applied. Management has
considered the internal auditor's and PricewaterhouseCoopers LLP's
recommendations concerning the Company's system of internal control and has
taken actions that we believe are cost-effective in the circumstances to respond
appropriately to these recommendations. Management believes that, as of January
2, 1999, the Company's system of internal control is adequate to accomplish the
objectives discussed herein.
Management also recognizes its responsibility for fostering a strong
ethical climate so that the Company's affairs are conducted according to the
highest standards of personal and corporate conduct. This responsibility is
characterized and reflected in the Company's code of corporate conduct, which is
publicized throughout the Company. The code of conduct addresses, among other
things, the necessity of ensuring open communication within the Company;
potential conflicts of interests; compliance with all domestic and foreign laws,
including those relating to financial disclosure; and the confidentiality of
proprietary information. The Company maintains a systematic program to assess
compliance with these policies.
JOSEPH A. PICHLER W. RODNEY MCMULLEN
Chairman of the Board and Senior Vice President and
Chief Executive Officer Chief Financial Officer
AUDIT COMMITTEE CHAIR'S LETTER
The Audit Committee of the Board of Directors is composed of five
independent directors. The committee held three meetings during fiscal year
1998. In addition, members of the committee received and reviewed various
reports from the Company's internal auditor and from PricewaterhouseCoopers LLP
throughout the year.
The Audit Committee oversees the Company's financial reporting process on
behalf of the Board of Directors. In fulfilling its responsibility, the
Committee recommended to the Board of Directors, subject to shareowner approval,
the selection of the Company's independent public accountant,
PricewaterhouseCoopers LLP. The Audit Committee discussed with the Company's
internal auditor and PricewaterhouseCoopers LLP the overall scope and specific
plans for their respective audits. The committee also discussed the Company's
consolidated financial statements and the adequacy of the Company's internal
controls. At each meeting, the Committee met with the Company's internal auditor
and PricewaterhouseCoopers LLP, in each case without management present, to
discuss the results of their audits, their evaluations of the Company's internal
controls, and the overall quality of the Company's financial reporting. Those
meetings also were designed to facilitate any private communications with the
Committee desired by the Company's internal auditor or PricewaterhouseCoopers
LLP.
KATHERINE D. ORTEGA
Audit Committee Chair
A-1
<PAGE> 35
THE COMPANY
The Kroger Co. (the "Company") was founded in 1883 and incorporated in
1902. As of January 2, 1999, the Company was the largest grocery retailer in the
United States based on annual sales. The Company also manufactures and processes
food for sale by its supermarkets. The Company's principal executive offices are
located at 1014 Vine Street, Cincinnati, Ohio 45202 and its telephone number is
(513) 762-4000.
As of January 2, 1999, the Company operated 1,410 supermarkets, most of
which are leased. Of this number, 1,145 supermarkets were operated, directly or
through a partnership composed of the Company and wholly-owned subsidiaries of
the Company, principally under the Kroger name in the Midwest and South. Dillon
Companies, Inc. ("Dillon"), a wholly-owned subsidiary of the Company, operated
265 supermarkets directly or through wholly-owned subsidiaries (the "Dillon
Supermarkets"). The Dillon Supermarkets, principally located in Colorado,
Kansas, Arizona and Missouri, operate under the names "King Soopers", "Dillon
Food Stores", "Fry's Food Stores", "City Market", "Gerbes Supermarkets", and
"Sav-Mor".
As of January 2, 1999, the Company, through its Dillon subsidiary,
operated 797 convenience stores under the trade names of "Kwik Shop", "Quik Stop
Markets", "Tom Thumb Food Stores", "Turkey Hill Minit Markets", "Loaf 'N Jug",
and "Mini-Mart". The Company owned and operated 684 of these stores while 113
were operated through franchise agreements. The convenience stores offer a
limited assortment of staple food items and general merchandise and, in most
cases, sell gasoline.
The Company intends to develop new food and convenience store locations
and will continue to assess existing stores as to possible replacement,
remodeling, enlarging, or closing.
A-2
<PAGE> 36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
SALES
Our total sales in the fourth quarter 1998 increased 12.9% from $6.5
billion to $7.3 billion, compared to the fourth quarter 1997. The fourth quarter
of 1998 had an extra week compared to the same quarter of 1997 because fiscal
1998 contained 53 weeks compared to a 52 week year in 1997. For the full year,
total sales increased 6.2% and food store sales increased 6.5%. In the fourth
quarter 1998, food store sales increased 13.2%. Sales by operating segments for
the three years ended January 2, 1999, were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
% OF 1998 ----------------- ----------------- -----------------
SALES AMOUNT CHANGE AMOUNT CHANGE AMOUNT CHANGE
--------- ------- ------ ------- ------ ------- ------
(MILLIONS OF DOLLARS)
<S> <C> <C> <C> <C> <C> <C> <C>
Food Stores.............. 93.7% $26,423 +6.5% $24,801 +5.5% $23,508 +4.5%
Convenience Stores....... 3.6% 1,003 -0.2% 1,006 +6.0% 948 +11.6%
Other sales.............. 2.7% 777 +2.2% 760 +6.5% 714 +19.0%
----- ------- ------- -------
Total sales.............. 100.0% $28,203 +6.2% $26,567 +5.5% $25,170 +5.1%
</TABLE>
After adjusting for the 53rd week in 1998, fourth quarter total sales
increased 3.9%, from $6.5 billion to $6.8 billion, and food store sales rose
4.3%, from $6.1 billion to $6.3 billion. These are in comparison to fourth
quarter 1997. After adjusting for the extra week in 1998, the percentage of
change in sales by operating segments for the three years ended January 2, 1999,
were:
<TABLE>
<CAPTION>
% OF 1998 1998 1997 1996
SALES CHANGE CHANGE CHANGE
--------- ------ ------ ------
<S> <C> <C> <C> <C>
Food Stores............................................... 93.7% +4.3% +5.5% +4.5%
Convenience Stores........................................ 3.6% -2.1% +6.0% +11.6%
Other sales............................................... 2.7% +0.6% +6.5% +19.0%
-----
Total sales............................................... 100.0% +4.0% +5.5% +5.1%
</TABLE>
Sales in identical food stores, which include stores in operation and not
expanded or relocated for five quarters, increased 0.4% in the fourth quarter
and increased 1.0% for the full year. Comparable store sales, which include
identical stores plus expanded and relocated stores, increased 2.4% in the
fourth quarter.
The increase in food store sales is related to the 4.3% square footage
growth generated by Kroger's capital expenditure program. This program enabled
us to open, relocate or expand 96 food stores during 1998. Most of the new and
expanded stores feature our combination store format. This "one-stop shopping"
format saves time and travel for customers and is adaptable to the demographics
of individual markets.
Total sales in our convenience stores decreased 0.2% for the year and
increased 5.8% during the fourth quarter of 1998. Adjusting for the extra week,
convenience stores total sales decreased 2.1% for the year and 2.2% in the
fourth quarter of 1998. The sales decrease during the fourth quarter can be
attributed to a 15.5% decrease in the retail price of gasoline. Total gasoline
sales dollars decreased 8.4% for the year. Total gasoline gallons sold increased
6.8% for the year. The percentage of change in convenience store identical
gasoline sales dollars, gasoline gallons sold and non-gasoline sales dollars for
the 4th quarter and year ended January 2, 1999 were:
<TABLE>
<CAPTION>
4TH QUARTER 1998 1998
IDENTICAL CONVENIENCE STORES CHANGE CHANGE
---------------------------- ---------------- ------
<S> <C> <C>
Gasoline Sales Dollars...................................... -13.0% -10.9%
Gasoline Gallons Sold....................................... +2.3% +3.6%
Non-Gasoline Sales Dollars.................................. +7.4% +5.8%
</TABLE>
A-3
<PAGE> 37
Other sales represent sales by our manufacturing plants to entities other
than Kroger. Compared to 1997, other sales increased 14.2% for the fourth
quarter and 2.2% for the year. Adjusting for the extra week in 1998, other sales
increased 7.1% for the fourth quarter and 0.6% for the year.
Total food store square footage increased 4.3%, 5.7% and 6.7% in 1998,
1997, and 1996, respectively. Convenience store square footage decreased 1.2% in
1998 due to operational closings of 16 stores and disposition of 14 stores.
Convenience store square footage decreased 1.3% in 1997, and increased 1.5% in
1996.
Sales per average square foot for the last three years were:
<TABLE>
<CAPTION>
TOTAL SALES PER
AVERAGE SQUARE FOOT
--------------------
1998 1996 1995
---- ---- ----
<S> <C> <C> <C>
Food Stores................................................. $405 $398 $401
Convenience Stores.......................................... $554 $548 $519
</TABLE>
Sales per average square foot for 1998 include an extra week compared to
1997 and 1996. Excluding the extra week, sales per average square foot for 1998
would have been $396 for food stores and $543 for convenience stores. Sales per
average square foot exclude stores operated by franchisees. Our storing program
in 1998 and 1997 has led to the decrease in sales per average square foot in our
food stores. The new stores, which are generally larger and built in developing
areas, take longer to contribute to higher sales per square foot. They also
reduce the sales per square foot at nearby stores.
ONE-TIME EXPENSES
In the second quarter of 1998, we incurred a $40.8 million pre-tax, $25.3
million after-tax or $.09 per diluted share, 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 include non-cash asset writedowns
of $15.5 million and were included in merchandise costs, including warehouse and
transportation. The remaining $25.3 million of expenses are summarized as
follows:
<TABLE>
<CAPTION>
CASH AMOUNT ACCRUED
EXPENSE PAYMENTS AT JANUARY 2, 1999
------- -------- ------------------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Employee Severance.......................................... $11,000 $ 6,600 $ 4,400
Carrying Costs of Idled Facilities.......................... 9,500 3,200 6,300
Ending the Joint Venture.................................... 4,800 4,800
------- ------- -------
$25,300 $14,600 $10,700
</TABLE>
The employee severance costs will be paid through the second quarter of
1999 and the carrying costs of the idled warehouse facilities are projected to
be paid through 2001.
Additionally, in the second quarter of 1998, we incurred one-time expenses
of $11.6 million pre-tax, $7.2 million after-tax or $.03 per diluted share,
associated with accounting, data and operations consolidations in Texas. These
included the costs of closing eight stores and relocating the remaining Dallas
office employees to a smaller facility. These expenses, which include non-cash
asset writedowns of $2.2 million, were included in operating, general and
administrative expenses. Cash expenses paid to date are $0.9 million and the
remaining accrual of $8.5 million at January 2, 1999 represents estimated rent
or lease termination costs that will be paid on closed stores through 2013.
A-4
<PAGE> 38
ACCOUNTING CHANGE
In the second quarter of 1998, we changed our 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 $89.7 million and reduced
earnings before extraordinary loss and net earnings by $55.6 million, or $0.21
per diluted share. We have not calculated the pro forma effect on prior periods
because cost information for these periods is not determinable. The item cost
method did not have a material impact on earnings subsequent to its initial
adoption.
MERCHANDISE COSTS
Merchandise costs include advertising, warehousing and transportation
expenses and charges related to valuing inventory on the LIFO method. The
following table shows the relative effect of LIFO charges, One-Time Expenses and
the Accounting Change on merchandising costs as a percent of sales.
<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Merchandise costs as reported............................... 76.31% 76.23% 76.63%
One-Time Expenses........................................... .14%
Accounting Change........................................... .32%
----- ----- -----
Merchandise costs net of One-Time Expenses and Accounting
Change.................................................... 75.85% 76.23% 76.63%
LIFO charge................................................. .01% .02% .05%
----- ----- -----
Merchandise costs as adjusted............................... 75.84% 76.21% 76.58%
</TABLE>
Our merchandise costs, adjusted for One-Time Expenses and the Accounting
Change, as a percent of sales declined during 1998 from the 1997 and 1996
levels. Merchandise costs were reduced by:
- coordinated purchasing,
- category management,
- technology related efficiencies, and
- increases in private label sales.
OPERATING, GENERAL AND ADMINISTRATIVE EXPENSES
Operating, general and administrative expenses as a percent of sales were
17.42%, 17.33% and 17.36%, in 1998, 1997 and 1996 respectively. Operating,
general and administrative expenses as a percent of sales, excluding One-Time
Expenses of $11.6 million, were 17.38% for 1998. The increase is due to higher
incentive payouts based on our 1998 performance.
INCOME TAXES
We have closed all tax years through 1984 with the Internal Revenue
Service. The Internal Revenue Service has completed its examination of our tax
returns for tax years 1985-1992. On September 15, 1998, the IRS voluntarily
dismissed its appeal against Kroger. This action settled a previously unresolved
issue for tax years 1984-1992. One issue remains in dispute with the IRS for tax
years 1991 and 1992. We have provided for this and other tax contingencies.
A-5
<PAGE> 39
NET EARNINGS
Net earnings and the effects of extraordinary losses, One-Time Expenses
and the Accounting Change for the three years ended January 2, 1999 were:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Earnings before extraordinary loss excluding One-Time
Expenses and the Accounting Change........................ $538,012 $444,032 $352,735
One-Time Expense, net of income tax benefit................. 32,500
Accounting Change, net of income tax benefit................ 55,600
-------- -------- --------
Earnings before extraordinary loss.......................... 449,912 444,032 352,735
Extraordinary loss, net of income tax benefit............... (39,123) (32,376) (2,862)
-------- -------- --------
Net earnings................................................ $410,789 $411,656 $349,873
</TABLE>
Extraordinary losses are from the early retirement of debt. Net earnings
in 1998 compared to 1997 and 1996 were affected by:
- net interest expense in 1998 of $266.9 million compared to $285.9
million in 1997 and $300.0 million in 1996, and
- depreciation expense in 1998 of $430.0 million, compared to $380.2
million in 1997 and $343.8 million in 1996.
LIQUIDITY AND CAPITAL RESOURCES
Debt Management and Interest Expense
The table below provides information about debt repurchases and
redemptions for the three years ended January 2, 1999.
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
(THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Senior debt repurchases and redemptions..................... $315,993 $ 9,155 $ 23,363
Senior subordinated debt repurchases........................ $ 31,106 $318,590 $161,256
Mortgage loan prepayments................................... $218,551 $177,978
</TABLE>
We used the proceeds from the issuance of new senior debt, additional bank
borrowings and cash generated from operations to make these purchases and
redemptions.
We have a 364-Day Credit Agreement and Five Year Credit Agreement
(together, the "Credit Agreement") with a consortium of bank lenders. The
364-Day Credit Agreement is a revolving credit facility in the amount of $500
million, that terminates on May 29, 1999, unless extended. The Five Year Credit
Agreement is a revolving credit facility in the amount of $1.5 billion, that
terminates on May 28, 2002, unless extended or terminated earlier by us. The
average interest rate on our bank debt was 6.14% in 1998 compared to 6.06% in
1997 and 6.16% in 1996. Our borrowings at year-end 1998 under the Credit
Agreement totaled $844 million compared to $1.262 billion at year-end 1997 and
$1.001 billion at year-end 1996. In December 1998 we amended our Credit
Agreement to permit our merger with Fred Meyer. The amendments, which become
effective when the merger is completed, increase our rates to market rates. Our
rates under the Credit Agreement are variable. As of January 2, 1999, we had
$1.147 billion available under our Credit Agreement to meet short term liquidity
needs.
Long-term debt, including capital leases and current portion thereof,
decreased $113.5 million to $3.404 billion at year-end 1998 from $3.517 billion
at year-end 1997 and $3.681 billion at year-end 1996. We purchased a portion of
the debt issued by the lenders of some structured financings in an effort to
further reduce
A-6
<PAGE> 40
our effective interest expense. We also prefunded $200 million of employee
benefit costs at year-end 1998 compared to $160 million at year-end 1997. If we
exclude the debt incurred to make these purchases, which we classify as
investments, and the prefunding of employee benefits, our year-end 1998
long-term debt would have been $267.3 million less, or $3.1 billion, compared to
$3.2 billion at year-end 1997 and $3.4 billion at year-end 1996.
Interest Rate Protection Program
We use derivatives to limit our exposure to rising interest rates. During
1998 we followed these guidelines in using derivatives:
- use average daily bank balance to determine annual debt amounts subject
to interest rate exposure,
- limit the annual amount of debt subject to interest rate reset and the
amount of floating rate debt to a combined total of $1.0 billion or
less,
- include no leveraged derivative products, and
- hedge without regard to profit motive or sensitivity to current
mark-to-market status.
We review compliance with these guidelines annually with the Financial
Policy Committee of our Board of Directors. In addition, our internal auditors
review compliance with these guidelines on an annual basis. These guidelines may
change as our business needs dictate.
The table below provides information about our interest rate derivative
and underlying debt portfolio. The amounts each year represent the contractual
maturities of long-term debt, excluding capital leases, and the outstanding
notional amount of interest rate derivatives. Interest rates reflect the
weighted average for the maturing instruments. The variable component of each
interest rate derivative and variable rate debt is based on 6 month LIBOR using
the forward yield curve as of January 2, 1999. The Fair-Value column includes
only those debt instruments for which it is reasonably possible to calculate a
fair value and interest rate derivatives as of January 2, 1999. (See Fair Value
of Financial Instruments footnote.)
<TABLE>
<CAPTION>
EXPECTED YEAR OF MATURITY
(THOUSANDS OF DOLLARS)
-------------------------------------------------------------------------------------------
1999 2000 2001 2002 2003 THEREAFTER TOTAL FAIR-VALUE
--------- --------- ------- ------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LONG-TERM DEBT
- ------------------------
Fixed rate.............. 163,904 209,913 13,356 162,976 76,928 1,719,079 2,346,156 1,985,813
Average interest rate... 7.76% 7.94% 7.94% 7.74% 7.75% 7.75%
Variable rate........... 843,728 843,728 843,728
Average interest rate... 5.22% 5.28% 5.44% 5.55%
INTEREST RATE
DERIVATIVES AVERAGE NOTIONAL AMOUNTS OUTSTANDING
- ------------------------ -------------------------------------------------------------------------------------------
(THOUSANDS OF DOLLARS)
Variable to fixed....... 962,500 752,500 392,000 88,000 65,000 58,500 1,000,000 (43,218)
Average pay rate........ 7.08% 7.05% 7.24% 6.71% 6.80% 6.80% 7.07%
Average receive rate.... 5.10% 5.16% 5.32% 5.43% 5.43% 5.45% 5.19%
Fixed to variable....... 695,000 493,000 250,000 150,000 785,000 21,833
Average pay rate........ 5.10% 5.16% 5.32% 5.43% 5.19%
Average receive rate.... 6.39% 6.27% 6.86% 6.86% 6.47%
</TABLE>
It was not practicable to determine a fair value for $472.2 million of
fixed rate debt.
A-7
<PAGE> 41
Common Stock Repurchase Program
On January 29, 1997, we began repurchasing common stock in order to reduce
dilution caused by our stock option plans. These repurchases were made using the
proceeds, including the tax benefit, from options exercised. Further repurchases
of up to $100 million of common stock were authorized by the Board of Directors
during October 1997. On October 19, 1998, we suspended the repurchase program as
result of the merger agreement between Kroger and Fred Meyer, Inc. During 1998,
we made open market purchases of 2,625,299 shares of Kroger stock for $120.8
million compared to purchases in 1997 of 3,015,887 shares for $84.9 million.
CAPITAL EXPENDITURES
Capital expenditures for 1998 totaled $923.5 million, compared to $612.2
million in 1997, and $733.8 million in 1996. The 1998 capital expenditures
include the acquisition of seven Owens stores in the third quarter and five
Hilander stores in the fourth quarter. The Owens stores are located in Indiana
and the Hilander stores are located in Illinois. During 1998 we opened, acquired
or expanded 96 food stores and 11 convenience stores. The table below shows our
storing activity.
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Food Stores
New Stores................................................ 26 37 38
Relocated Stores.......................................... 31 25 35
Acquisitions (New)........................................ 10 10 4
Acquisitions (Relocations)................................ 8 5 3
Expansions................................................ 21 19 36
-- -- ---
Total Opened, Acquired or Expanded.......................... 96 96 116
Operational Closings...................................... 18 11 13
Convenience Stores
New Stores................................................ 10 15 16
Relocated Stores.......................................... 1 0 0
Acquisitions (New)........................................ 0 0 15
Expansions................................................ 0 0 4
-- -- ---
Total Opened, Acquired or Expanded.......................... 11 15 35
Operational Closings...................................... 16 12 19
</TABLE>
In addition to the above activity, we also completed 74 food store and 13
convenience store remodels during 1998.
CONSOLIDATED STATEMENT OF CASH FLOWS
During 1998, we generated $1,142.2 million in cash from operating
activities compared to $853.6 million in 1997 and $499.4 million in 1996. The
increase over 1997 is primarily due to a net decrease in operating assets and
liabilities that provided $239.2 million of cash in 1998 compared to $12.9
million in 1997. The largest components of the change in operating assets and
liabilities was a decrease in net owned inventories of $132.9 million compared
to a decrease of $16.6 million in 1997 and an increase in other liabilities of
$132.3 million compared to $51.5 million in 1997. The increase over 1997 also
includes an increase of non-cash charges for depreciation and amortization of
$49.7 million.
A-8
<PAGE> 42
Investing activities used $759.6 million of cash in 1998 compared to
$579.4 million in 1997 and $856.9 million in 1996. The increase in the use of
cash resulted from increased capital expenditures of $311.3 million, offset by
decreased purchases of investments of $101.5 million.
Cash used by financing activities in 1998 totaled $326.7 million compared
to $275.7 million in 1997 and $345.5 million of cash provided in 1996. Compared
to 1997, our financing activities in 1998 used an additional $23.7 million of
cash for debt prepayments and finance charges, and an additional $36.7 million
to repurchase capital stock.
EBITDA
Our Credit Agreement and the indentures underlying approximately $377
million of publicly issued debt, contain various restrictive covenants. Many of
these covenants are based on earnings before interest, taxes, depreciation,
amortization and LIFO charge, 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, management believes the presentation of EBITDA is important
for understanding Kroger's 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 Credit Agreement and indenture covenants on January 2,
1999.
EBITDA for 1998, excluding one-time expenses, as described in "One-Time
Expenses" above, of $52.4 million and the $89.7 million accounting change, as
described in "Accounting Change" above, increased 12.4% to $1.556 billion
compared to $1.385 billion in 1997. EBITDA in 1996 was $1.224 billion. Excluding
the effect of strikes in the King Soopers and City Market divisions, EBITDA
would have been approximately $1.256 billion in 1996. EBITDA including One-Time
Expenses and the Accounting Change increased 2.1% in 1998 to $1.414 billion
compared to $1.385 billion in 1997.
OTHER ISSUES
On October 19, 1998 we announced our intended merger with Fred Meyer, Inc.
Under the terms of the merger agreement, Fred Meyer, Inc. shareholders will
receive one newly issued share of Kroger common stock for each Fred Meyer, Inc.
common share. The transaction will be accounted for as a pooling of interests.
We expect to close the transaction in spring 1999 subject to approval of Kroger
and Fred Meyer shareholders, antitrust clearance and customary closing
conditions. Additional information regarding the merger can be found in our
Current Report on Form 8-K dated October 20, 1998.
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 6, 1999. Our first new fiscal year will end January 29, 2000.
It will include 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 intend to file separate audited statements of
operations and cash flows covering the transition period from January 3, 1999 to
January 30, 1999 on a Current Report on Form 8-K on or before May 15, 1999.
We are party to more than 160 collective bargaining agreements with local
unions representing approximately 158,000 employees. During 1998 we negotiated
11 labor contracts without any material work stoppages. Typical agreements are 3
to 5 years in duration and, as agreements expire, we expect to enter into new
collective bargaining agreements. In 1999, 35 collective bargaining agreements
will expire. 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 adverse effect on the results of our operations.
A-9
<PAGE> 43
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. Since the
intended merger described in the "Other Issues" section above is not expected to
close until spring 1999, the effects of the merger are not considered in making
these statements unless referred to specifically. 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 4.5% to 5.0%. We expect to continue to realize
savings from economies of scale in technology and logistics, some of
which may be reinvested in retail price reductions to increase sales
volume and enhance market share.
- We expect combination stores to 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, procurement, category management,
merchandising and distribution practices, which should continue to
reduce merchandising costs as a percent of sales.
- We expect to reduce working capital over the next 2 years.
- In the second quarter of 1998 we raised our earnings per share target to
a 15%-17% average annual increase over fiscal years 1999-2001 from the
previously stated target of a 13%-15% average annual increase. Assuming
consummation of the merger referenced in the "Other Issues" section
above, we are raising our earnings per share target to 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 $850-$950 million
compared to $923.5 million during all of 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.
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 these
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.
A-10
<PAGE> 44
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 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 the end of 1998.
<TABLE>
<CAPTION>
PHASE 1 2 3
----- ---- ---- ----
(PERCENT COMPLETE)
<S> <C> <C> <C>
IT Systems.................................................. 95% 85% 74%
Non-IT Systems.............................................. 95% 61% 40%
</TABLE>
This summary includes all IT and Non-IT Systems without regard to their
effect on the operation of the Company. We estimate that business
critical IT Systems are 83% complete through Phase 3. We expect to
complete assessment and remediation of these by the end of the first
quarter of 1999. We will continue to test our systems, including a
simulation of the year 2000, and expect to complete all work by the end
of the third quarter of 1999.
In addition to the remediation of the IT Systems and Non-IT Systems, we
are contacting all critical product suppliers, service providers, and
those with which we exchange information, to ensure they will be able to
continue normal business operations uninterrupted. This effort also
consists of three phases:
1) identify the entities and verify address and contact information
2) mail the initial request
3) receive and accept response
This third step includes the verification of year 2000 readiness, if
appropriate. During the fourth quarter of 1998, we have identified
additional external entities to contact for year 2000 compliance. To
date, we have identified and mailed year 2000 verification requests to
approximately 58% of the critical external entities. Approximately 20%
of these entities have responded, and less than 10% of their year 2000
readiness plans have been verified. We expect that substantially all
critical external entities will have been contacted and year 2000
readiness verified by the end of the first quarter 1999.
We have not developed contingency plans related to all uncertainties in
our year 2000 plan. Based on the results of our testing, implementation
and verification efforts noted above, we will establish contingency
plans in mission critical processes to address potential additional year
2000 issues. Contingency plans are being developed and accessed by teams
of programmers and users. We expect that these contingency plans will be
in place by the end of the third quarter of 1999.
The total estimated cost for the project, over a four year period, is
$30.9 million, most of which is being expensed as incurred. This cost is
being funded through operating cash flow. This represents an
A-11
<PAGE> 45
immaterial part of our information technology budget over the period.
The breakdown of the costs are as follows.
<TABLE>
<CAPTION>
TOTAL PROJECTED COST INCURRED
COST TO DATE
(IN MILLIONS) (IN MILLIONS)
--------------- -------------
<S> <C> <C>
Labor-Internal.............................................. $ 8.8 $ 3.9
Labor-External.............................................. 8.5 6.5
Hardware Upgrades........................................... 7.5 3.0
Software Upgrades........................................... 2.6 1.2
Non-IT Upgrades............................................. 1.8 0.2
Other....................................................... 1.7 0.3
----- -----
Total.................................................. $30.9 $15.1
</TABLE>
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.
Inflationary factors, increased competition, construction delays, and
labor disputes could affect our ability to obtain expected increases in sales
and earnings. Delays in store maturity, increased competition and increased
capital spending could adversely affect the anticipated increase in sales per
square foot. Increases in gross profit rate may not be achieved if start-up
costs are higher than expected or if problems associated with integrating new
systems occur. Increased operating costs and changes in inflationary trends
could prevent us from reducing operating, general and administrative expenses.
New technologies could fail to achieve the desired savings and efficiencies. Net
interest expenses could exceed expectations due to acquisitions, higher working
capital usage, inflation, or increased competition. Our ability to achieve our
storing goals could be hampered by construction delays, labor disputes,
increased competition or delays in technology projects. The effects of the
intended merger and the inherent complexity of computer software and reliance on
third party software vendors to interface with our systems could affect the
completion of necessary "Year 2000" modifications.
A-12
<PAGE> 46
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareowners and Board of Directors
The Kroger Co.
In our opinion, the accompanying consolidated balance sheet of The Kroger
Co. and the related consolidated statements of operations and accumulated
deficit, and cash flows present fairly, in all material respects, the financial
position of The Kroger Co. as of January 2, 1999 and December 27, 1997, and the
consolidated results of its operations and its cash flows for the years ended
January 2, 1999, December 27, 1997, and December 28, 1996, in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in the notes to the consolidated financial statements, the
Company changed its application of the LIFO method of accounting for store
inventories as of December 28, 1997.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Cincinnati, Ohio
January 28, 1999
A-13
<PAGE> 47
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
January 2, December 27,
(IN THOUSANDS OF DOLLARS) 1999 1997
- -----------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets
Cash...................................................... $ 121,431 $ 65,484
Receivables............................................... 456,917 400,529
Inventories:
FIFO cost.............................................. 2,202,088 2,273,896
Less LIFO reserve...................................... (471,932) (467,931)
----------- ----------
1,730,156 1,805,965
Property held for sale.................................... 10,291 39,672
Prepaid and other current assets.......................... 354,385 328,901
----------- ----------
Total current assets................................. 2,673,180 2,640,551
Property, plant and equipment, net.......................... 3,785,122 3,296,599
Investments and other assets................................ 241,769 364,191
----------- ----------
TOTAL ASSETS......................................... $ 6,700,071 $6,301,341
=========== ==========
LIABILITIES
Current liabilities
Current portion of long-term debt......................... $ 163,904 $ 14,304
Current portion of obligations under capital leases....... 11,300 10,031
Accounts payable.......................................... 1,785,630 1,781,527
Other current liabilities................................. 1,231,234 1,137,654
----------- ----------
Total current liabilities............................ 3,192,068 2,943,516
Long-term debt.............................................. 3,025,980 3,306,451
Obligations under capital leases............................ 202,683 186,624
Deferred income taxes....................................... 200,952 166,013
Other long-term liabilities................................. 466,220 483,585
----------- ----------
TOTAL LIABILITIES.................................... 7,087,903 7,086,189
----------- ----------
SHAREOWNERS' DEFICIT
Common capital stock, par $1
Authorized: 1,000,000,000 shares
Issued: 1998 -- 281,788,752 shares
1997 -- 277,153,260 shares........................ 836,802 728,644
Accumulated deficit......................................... (773,605) (1,184,394)
Common stock in treasury, at cost
1998 -- 24,831,009 shares
1997 -- 22,182,650 shares.......................... (451,029) (329,098)
----------- ----------
TOTAL SHAREOWNERS' DEFICIT........................... (387,832) (784,848)
----------- ----------
TOTAL LIABILITIES AND SHAREOWNERS' DEFICIT........... $ 6,700,071 $6,301,341
=========== ==========
- -----------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
A-14
<PAGE> 48
CONSOLIDATED STATEMENT OF OPERATIONS AND
ACCUMULATED DEFICIT
Years Ended January 2, 1999, December 27, 1997, and December 28, 1996
<TABLE>
<CAPTION>
1998 1997 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (53 Weeks) (52 Weeks) (52 Weeks)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Sales................................................... $ 28,203,304 $26,567,348 $25,170,909
------------ ----------- -----------
Costs and expenses
Merchandise costs, including warehousing and
transportation..................................... 21,523,021 20,253,354 19,287,890
Operating, general and administrative................. 4,912,215 4,604,453 4,370,324
Rent.................................................. 358,254 331,012 301,629
Depreciation and amortization......................... 429,954 380,221 343,769
Net interest expense.................................. 266,896 285,945 299,984
------------ ----------- -----------
Total......................................... 27,490,340 25,854,985 24,603,596
------------ ----------- -----------
Earnings before tax expense and extraordinary loss...... 712,964 712,363 567,313
Tax expense............................................. 263,052 268,331 214,578
------------ ----------- -----------
Earnings before extraordinary loss...................... 449,912 444,032 352,735
Extraordinary loss, net of income tax benefit........... (39,123) (32,376) (2,862)
------------ ----------- -----------
Net earnings.................................. $ 410,789 $ 411,656 $ 349,873
============ =========== ===========
Accumulated Deficit
Beginning of year..................................... $ (1,184,394) $(1,596,050) $(1,945,923)
Net earnings.......................................... 410,789 411,656 349,873
------------ ----------- -----------
End of year........................................... $ (773,605) $(1,184,394) $(1,596,050)
============ =========== ===========
Basic earnings per Common Share
Earnings before extraordinary loss.................... $ 1.76 $ 1.75 $ 1.41
Extraordinary loss.................................... (.15) (.13) (.01)
------- ------- -------
Net earnings.......................................... $ 1.61 $ 1.62 $ 1.40
------- ------- -------
------- ------- -------
Average number of common shares used in basic
calculation........................................... 255,814 254,284 250,979
Diluted earnings per Common Share
Earnings before extraordinary loss.................... $ 1.70 $ 1.69 $ 1.36
Extraordinary loss.................................... (.15) (.12) (.01)
------- ------- -------
Net earnings.......................................... $ 1.55 $ 1.57 $ 1.35
------- ------- -------
------- ------- -------
Average number of common shares used in diluted
calculation........................................... 265,382 262,860 258,837
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
A-15
<PAGE> 49
CONSOLIDATED STATEMENT OF CASH FLOWS
Years Ended January 2, 1999, December 27, 1997, and December 28, 1996
<TABLE>
<CAPTION>
1998 1997 1996
(IN THOUSANDS OF DOLLARS) (53 Weeks) (52 Weeks) (52 Weeks)
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net earnings.............................................. $ 410,789 $ 411,656 $ 349,873
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Extraordinary loss..................................... 39,123 32,376 2,862
Depreciation and amortization.......................... 429,954 380,221 343,769
Amortization of deferred financing costs............... 17,130 13,907 13,004
LIFO charge............................................ 4,001 6,242 12,526
Other changes, net..................................... 1,967 (3,669) 4,296
Net increase (decrease) in cash from changes in
operating assets and liabilities..................... 239,230 12,857 (226,931)
----------- --------- ---------
Net cash provided by operating activities............ 1,142,194 853,590 499,399
----------- --------- ---------
Cash Flows From Investing Activities:
Capital expenditures...................................... (923,461) (612,198) (733,883)
Proceeds from sale of assets.............................. 30,345 24,657 9,242
(Increase) decrease in property held for sale............. 19,768 (4,165) 580
(Increase) decrease in other investments.................. 113,797 12,269 (132,796)
----------- --------- ---------
Net cash used by investing activities................ (759,551) (579,437) (856,857)
----------- --------- ---------
Cash Flows From Financing Activities:
Debt prepayment costs..................................... (11,115) (8,012) (4,196)
Financing charges incurred................................ (47,773) (27,210) (17,927)
Principal payments under capital lease obligations........ (10,563) (9,662) (9,229)
Proceeds from issuance of long-term debt.................. 892,698 662,322 382,161
Reductions in long-term debt.............................. (1,023,569) (831,952) (235,214)
Outstanding checks........................................ (57,036) (17,493) 181,993
Proceeds from issuance of capital stock................... 52,593 41,498 48,120
Capital stock reacquired.................................. (121,931) (85,212) (254)
----------- --------- ---------
Net cash provided (used) by financing activities..... (326,696) (275,721) 345,454
----------- --------- ---------
Net increase (decrease) in cash and temporary cash
investments............................................... 55,947 (1,568) (12,004)
Cash and Temporary Cash Investments:
Beginning of year......................................... 65,484 67,052 79,506
----------- --------- ---------
End of year............................................... $ 121,431 $ 65,484 $ 67,052
=========== ========= =========
Increase (Decrease) In Cash From Changes In Operating Assets
And Liabilities:
Inventories (FIFO)........................................ $ 71,809 $ (98,266) $(140,750)
Receivables............................................... (56,388) (76,478) (35,983)
Prepaid and other current assets.......................... (25,786) (53,476) (120,641)
Accounts payable.......................................... 61,139 81,712 (83,808)
Other current liabilities................................. 132,320 51,534 76,423
Deferred income taxes..................................... (19,905) 65,354 45,665
Other liabilities......................................... 76,041 42,477 32,163
----------- --------- ---------
$ 239,230 $ 12,857 $(226,931)
=========== ========= =========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
A-16
<PAGE> 50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All dollar amounts are in thousands except per share amounts.
ACCOUNTING POLICIES
The following is a summary of the significant accounting policies followed
in preparing these financial statements:
Principles of Consolidation
The consolidated financial statements include the Company and all of its
subsidiaries. Certain prior year amounts have been restated to conform to
current year presentation.
Pervasiveness of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities.
Disclosure of contingent assets and liabilities as of the date of the
consolidated financial statements and the reported amounts of consolidated
revenues and expenses during the reporting period also is required. Actual
results could differ from those estimates.
Inventories
Inventories are stated at the lower of cost or market. Approximately 95%
of inventories for 1998 and 90% of inventories for 1997 were valued using the
LIFO method. Cost for the balance of the inventories is determined using the
FIFO method.
Property Held for Sale
Property held for sale includes the net book value of property, plant and
equipment that the Company plans to sell. The property is valued at the lower of
cost or market on an individual property basis.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation and
amortization, which includes the amortization of assets recorded under capital
leases, are computed principally using the straight-line method over the
estimated useful lives of individual assets, composite group lives or the
initial or remaining terms of leases. Buildings and land improvements are
depreciated based on lives varying from ten to 40 years. Equipment depreciation
is based on lives varying from three to 15 years. Leasehold improvements are
amortized over their useful lives, which vary from four to 25 years.
Interest Rate Protection Agreements
The Company uses interest rate swaps to hedge a portion of its borrowings
against changes in interest rates. The interest differential to be paid or
received is accrued as interest rates change and is recognized over the life of
the agreements currently as a component of interest expense. Gains and losses
from the disposition of hedge agreements are deferred and amortized over the
shorter of the term of the related agreements or borrowings.
Advertising Costs
The Company's advertising costs are expensed as incurred and included in
"merchandise costs, including warehousing and transportation." Advertising
expenses amounted to $341,000, $312,000, and $302,000 for 1998, 1997, and 1996,
respectively.
A-17
<PAGE> 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Deferred Income Taxes
Deferred income taxes are recorded to reflect the tax consequences of
differences between the tax bases of assets and liabilities and their financial
reporting bases. The types of differences that give rise to significant portions
of deferred income tax liabilities or assets relate to: property, plant and
equipment; inventories; accruals for compensation-related costs; and other
changes. Deferred income taxes are classified as a net current and noncurrent
asset or liability based on the classification of the related asset or liability
for financial reporting. A deferred tax asset or liability that is not related
to an asset or liability for financial reporting is classified according to the
expected reversal date. (See Taxes Based on Income footnote.)
Consolidated Statement of Cash Flows
For purposes of the Consolidated Statement of Cash Flows, the Company
considers all highly liquid debt instruments purchased with a maturity of three
months or less to be temporary cash investments. Outstanding checks, which are
included in accounts payable, represent disbursements that are funded as the
item is presented for payment.
Cash paid during the year for interest and income taxes was as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------
<S> <C> <C> <C>
Interest.................................................... $265,540 $304,176 $304,240
Income taxes................................................ 192,529 154,025 166,732
</TABLE>
MERGER
On October 19, 1998 we announced our intended merger with Fred Meyer, Inc.
Under the terms of the merger agreement, Fred Meyer, Inc. shareholders will
receive one newly issued share of Kroger common stock for each Fred Meyer, Inc.
common share. The transaction will be accounted for as a pooling of interests.
We expect to close the transaction in spring, 1999 subject to approval of Kroger
and Fred Meyer shareholders, antitrust clearance and customary closing
conditions. Additional information regarding the merger can be found in our
current report on Form 8-K dated October 20, 1998.
ONE-TIME EXPENSES
In the second quarter of 1998, we incurred a $40,800 pre-tax, $25,300
after-tax or $.09 per diluted share, 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 $15,500 and were included
in merchandise costs, including warehouse and transportation. The remaining
$25,300 of expenses are summarized as follows:
<TABLE>
<CAPTION>
CASH AMOUNT ACCRUED
EXPENSE PAYMENTS AT JANUARY 2, 1999
------- -------- ------------------
<S> <C> <C> <C>
Employee Severance.......................................... $11,000 $ 6,600 $ 4,400
Carrying Costs of Idled Facilities.......................... 9,500 3,200 6,300
Ending the Joint Venture.................................... 4,800 4,800
------- ------- -------
$25,300 $14,600 $10,700
======= ======= =======
</TABLE>
A-18
<PAGE> 52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The employee severance costs will be paid through the second quarter of
1999 and the carrying costs of the idled warehouse facilities are projected to
be paid through 2001.
Additionally, in the second quarter of 1998, we incurred one-time expenses
of $11,600 pre-tax, $7,200 after-tax or $.03 per diluted share, 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
$2,200, were included in operating, general and administrative expenses. Cash
expenses paid to date are $900 and the remaining accrual of $8,500 at January 2,
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, we changed our 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 $89,700 and reduced
earnings before extraordinary loss and net earnings by $55,600, or $0.21 per
diluted share. We have not calculated the pro forma effect on prior periods
because cost information for these periods is not determinable. The item cost
method did not have a material impact on earnings subsequent to its initial
adoption.
PREPAID AND OTHER CURRENT ASSETS
Prepaid and other current assets consists of:
<TABLE>
<CAPTION>
1998 1997
--------------------------
<S> <C> <C>
Health and welfare benefit costs............................ $ 200,000 $ 160,000
Other....................................................... 154,385 168,901
----------- -----------
$ 354,385 $ 328,901
=========== ===========
</TABLE>
PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net consists of:
<TABLE>
<CAPTION>
1998 1997
--------------------------
<S> <C> <C>
Land........................................................ $ 389,953 $ 352,319
Buildings and land improvements............................. 1,493,674 1,263,700
Equipment................................................... 3,317,134 3,106,548
Leasehold improvements...................................... 1,027,984 908,948
Construction-in-progress.................................... 335,583 278,821
Leased property under capital leases........................ 297,600 272,911
----------- -----------
6,861,928 6,183,247
Accumulated depreciation and amortization................... (3,076,806) (2,886,648)
----------- -----------
$ 3,785,122 $ 3,296,599
=========== ===========
</TABLE>
A-19
<PAGE> 53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Approximately $271,284 and $369,295, original cost, of Property, Plant and
Equipment collateralizes certain mortgage obligations at 1998 and 1997,
respectively.
INVESTMENTS AND OTHER ASSETS
Investments and other assets consists of:
<TABLE>
<CAPTION>
1998 1997
--------------------
<S> <C> <C>
Deferred financing costs.................................... $ 52,316 $ 59,939
Goodwill.................................................... 48,937 39,119
Investments in Debt Securities.............................. 67,314 155,141
Other....................................................... 73,202 109,992
-------- --------
$241,769 $364,191
======== ========
</TABLE>
The Company is amortizing deferred financing costs using the interest
method. Substantially all goodwill is amortized on the straight-line method over
40 years.
OTHER CURRENT LIABILITIES
Other current liabilities consists of:
<TABLE>
<CAPTION>
1998 1997
------------------------
<S> <C> <C>
Salaries and wages.......................................... $ 322,025 $ 300,202
Taxes, other than income taxes.............................. 172,886 147,905
Interest.................................................... 42,023 36,699
Other....................................................... 694,300 652,848
---------- ----------
$1,231,234 $1,137,654
========== ==========
</TABLE>
TAXES BASED ON INCOME
The provision for taxes based on income consists of:
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------------
<S> <C> <C> <C>
Federal
Current................................................... $262,164 $173,715 $146,296
Deferred.................................................. (19,904) 65,354 43,638
-------- -------- --------
242,260 239,069 189,934
State and local............................................. 20,792 29,262 24,644
-------- -------- --------
263,052 268,331 214,578
Tax credit from extraordinary loss.......................... (21,736) (19,427) (1,792)
-------- -------- --------
$241,316 $248,904 $212,786
======== ======== ========
</TABLE>
A reconciliation of the statutory federal rate and the effective rate is
as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------------------------
<S> <C> <C> <C>
Statutory rate.............................................. 35.0% 35.0% 35.0%
State income taxes, net of federal tax benefit.............. 2.0 2.7 2.8
Tax credits................................................. (.3) (.2) (.2)
Other, net.................................................. .2 .2 .2
---- ---- ----
36.9% 37.7% 37.8%
==== ==== ====
</TABLE>
A-20
<PAGE> 54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The tax effects of significant temporary differences that comprise
deferred tax balances were as follows:
<TABLE>
<CAPTION>
1998 1997
- ------------------------------------------------------------------------------------
<S> <C> <C>
Current deferred tax assets:
Compensation related costs................................ $ 43,347 $ 32,772
Insurance related costs................................... 38,210 35,971
Inventory related costs................................... 53,339 16,257
Other..................................................... 39,901 18,001
--------- ---------
174,797 103,001
--------- ---------
Current deferred tax liabilities:
Compensation related costs................................ (103,613) (85,913)
Lease accounting.......................................... (4,216) (4,128)
Inventory related costs................................... (67,245) (62,830)
Other..................................................... (4,408) (9,658)
--------- ---------
(179,482) (162,529)
--------- ---------
Current deferred taxes, net................................. $ (4,685) $ (59,528)
========= =========
Long-term deferred tax assets:
Compensation related costs................................ $ 128,275 $ 130,825
Insurance related costs................................... 31,967 37,788
Lease accounting.......................................... 25,981 25,110
Other..................................................... 24,214 20,692
--------- ---------
210,437 214,415
--------- ---------
Long-term deferred tax liabilities:
Depreciation.............................................. (374,273) (339,951)
Compensation related costs................................ (9,791) (10,328)
Lease accounting.......................................... (538) (740)
Deferred charges.......................................... (2,239) (6,653)
Other..................................................... (24,548) (22,756)
--------- ---------
(411,389) (380,428)
--------- ---------
Long-term deferred taxes, net............................... $(200,952) $(166,013)
========= =========
</TABLE>
A-21
<PAGE> 55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DEBT OBLIGATIONS
Long-term debt consists of:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Five-Year Credit Agreement.................................. $ 843,728 $1,262,058
6 3/8% Senior Notes due 2008................................ 200,000
7% Senior Notes due 2018.................................... 200,000
6% Senior Notes due 2010.................................... 200,000
6.8% Senior Notes due 2018.................................. 300,000
9 1/4% Senior Secured Debentures, due 2005.................. 100,648
8 1/2% Senior Secured Debentures, due 2003.................. 197,845
8.15% Senior Notes due 2006................................. 222,500 240,000
7.65% Senior Notes due 2007................................. 200,000 200,000
9 7/8% Senior Subordinated Debentures, due 2002............. 77,245 81,530
6 3/4% to 9 5/8% Senior Subordinated Notes, due 1999 to
2009...................................................... 145,377 171,909
10% Senior Subordinated Notes, due 1999..................... 123,572 123,861
10% Mortgage loans, with semi-annual payments due through
2004...................................................... 205,301 426,219
3 3/4% to 8 5/8% Industrial Revenue Bonds, due in varying
amounts through 2021...................................... 201,330 201,030
7 7/8% to 10 1/4% mortgages, due in varying amounts through
2017...................................................... 259,827 267,368
3 1/2% to 10 1/4% notes, due in varying amounts through
2017...................................................... 11,004 48,287
---------- ----------
Total debt.................................................. 3,189,884 3,320,755
Less current portion........................................ 163,904 14,304
---------- ----------
Total long-term debt........................................ $3,025,980 $3,306,451
========== ==========
</TABLE>
The aggregate annual maturities and scheduled payments of long-term debt
for the five years subsequent to 1998 are:
<TABLE>
<S> <C>
1999.................................................... $ 163,904
2000.................................................... $ 209,913
2001.................................................... $ 13,356
2002.................................................... $1,006,704
2003.................................................... $ 76,928
</TABLE>
364-Day Credit Agreement and Five-Year Credit Agreement
The Company has a 364-Day Credit Agreement and a Five-Year Credit
Agreement dated as of May 28, 1997 (collectively the "Credit Agreement"). The
following constitutes only a summary of the principal terms and conditions of
the Credit Agreement. Reference is directed to the Credit Agreement attached as
an exhibit to the Company's Current Reports on Form 8-K dated June 2, 1997 and
January 8, 1999.
The 364-Day facility is a revolving credit facility in the amount of
$500,000, that terminates on May 29, 1999, unless extended in accordance with
its terms. It may be converted into a term loan maturing two years after the
conversion unless earlier terminated by the Company as provided in the Credit
Agreement. The Five-Year facility is a revolving credit facility in the amount
of $1,500,000. It terminates on May 28, 2002, unless extended or earlier
terminated by the Company as provided in the Credit Agreement.
Interest Rates
Borrowings under the Credit Agreement bear interest at the option of the
Company at a rate equal to either (i) the highest, from time to time, of (A) the
base rate of Citibank, N.A., (B) 1/2% over a moving average of secondary
A-22
<PAGE> 56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
market morning offering rates for three month certificates of deposit adjusted
for reserve requirements, and (C) 1/2% over the federal funds rate or (ii) an
adjusted Eurodollar rate based upon the London Interbank Offered Rate
("Eurodollar Rate") plus an Applicable Margin.
The Applicable Margin for the 364-Day facility varies from .125% to .200%
prior to conversion to a term loan facility and thereafter, if exercised by the
Company, from .175% to .300%. The Applicable Margin for the Five-Year facility
varies from .105% to .175%. In addition, the Company pays a Facility Fee ranging
from .050% to .100% on the entire amount of the 364-Day facility and a Facility
Fee ranging from .070% to .125% on the entire amount of the Five-Year facility.
Both the Applicable Margin and the Facility Fee vary based on the Company's
achievement of a financial ratio. As of January 2, 1999, the Applicable Margin
for the 364-Day facility was .140% and for the Five-Year facility was .120%. The
Facility Fee for the 364-Day facility was .060% and for the Five-Year facility
was .080%.
In December 1998 we amended our Credit Agreement to permit our merger with
Fred Meyer (See Merger footnote). The amendments, which become effective when
the merger is completed, increase our rates to market rates.
Prepayment
The Company may prepay the Credit Agreement, in whole or in part, at any
time, without a prepayment penalty. Certain Senior Notes totaling $900,000 are
eligible for early redemption at varying times and premiums.
Certain Covenants
The Credit Agreement contains covenants which, among other things,
restrict dividends and require the maintenance of certain financial ratios and
levels, including fixed charge coverage ratios and leverage ratios.
Senior Subordinated Indebtedness
Senior Subordinated Indebtedness consists of the following: (i) $250,000
9 7/8% Senior Subordinated Debentures due August 1, 2002, redeemable at any time
on or after August 1, 1999, in whole or in part at the option of the Company at
par (the Company has repurchased $172,755 of the 9 7/8% Senior Subordinated
Debentures in total, $4,285 in 1998); (ii) $355,774 6 3/4% to 9 5/8% Senior
Subordinated Notes due March 15, 1999 to October 15, 2009, with portions of
these issues subject to early redemption by the Company at varying times and
premiums (the Company has repurchased or redeemed $210,397 of the notes in
total, $26,532 in 1998); (iii) $250,000 10% Senior Subordinated Notes due May 1,
1999. This issue is not subject to early redemption by the Company (the Company
has repurchased $126,428 of the 10% Senior Subordinated Notes in total, $289 in
1998).
Redemption Event
Subject to certain conditions (including repayment in full of all
obligations under the Credit Agreement or obtaining the requisite consents under
the Credit Agreement), the Company's publicly issued debt will be subject to
redemption, in whole or in part, at the option of the holder upon the occurrence
of a redemption event, upon not less than five days' notice prior to the date of
redemption, at a redemption price equal to the default amount, plus a specified
premium. "Redemption Event" is defined in the indentures as the occurrence of
(i) any person or group, together with any affiliate thereof, beneficially
owning 50% or more of the voting power of the Company or (ii) any one person or
group, or affiliate thereof, succeeding in having a majority of its nominees
elected to the Company's Board of Directors, in each case, without the consent
of a majority of the continuing directors of the Company.
A-23
<PAGE> 57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Mortgage Financing
During 1989 the Company completed a $612,475, 10% mortgage financing of
127 of its retail properties, distribution warehouse facilities, food processing
facilities and other properties (the "Properties"), with a net book value of
$325,327 held by 13 newly formed wholly-owned subsidiaries. The wholly-owned
subsidiaries mortgaged the Properties, which are leased to the Company or
affiliates of the Company, to a newly formed special purpose corporation,
Secured Finance Inc.
The mortgage loans had an original maturity of 15 years. The Properties
are subject to the liens of Secured Finance Inc. The mortgage loans are subject
to semi-annual payments of interest and principal on $150,000 of the borrowing
based on a 30-year payment schedule and interest only on the remaining $462,475
principal amount. The unpaid principal amount will be due on December 15, 2004.
In total, the Company has prepaid 89 mortgages with an original balance of
$348,349. During 1998 the Company prepaid 54 mortgages with an original balance
of $198,002. The mortgage balances at the time of the prepayment totaled
$182,126. Pursuant to the terms of the mortgages a 20% premium payment was
required. The premium totaled $36,425 and was applied, on a pro-rata basis, to
the 38 remaining mortgage loans.
Subsequent to the prepayment the remaining mortgage loans totaled
$205,301. The remaining mortgage loans are subject to semi-annual payments of
interest and principal on $45,777 based on the original 30-year payment
schedule, adjusted for the pre-payment, and interest only on the remaining
$159,524 principal amount.
Commercial Paper
Under the Credit Agreement the Company is permitted to issue up to
$2,000,000 of unrated commercial paper and borrow up to $2,000,000 from the
lenders under the Credit Agreement on a competitive bid basis. The total of
unrated commercial paper, $141,257 at January 2, 1999, however, may not exceed
$2,000,000. All commercial paper must be supported by availability under the
Credit Agreement. These borrowings have been classified as long-term because the
Company expects that during 1999 these borrowings will be refinanced using the
same type of securities. Additionally, the Company has the ability to refinance
the short-term borrowings under the Five-Year facility of the Credit Agreement
which matures May 28, 2002.
Interest Rate Protection Program
The Company uses derivatives to limit its exposure to rising interest
rates. During 1998 we followed these guidelines in using derivatives: (i) use
average daily bank balance to determine annual debt amounts subject to interest
rate exposure, (ii) limit the annual amount of debt subject to interest rate
reset and the amount of floating rate debt to a combined total of $1,000,000 or
less, (iii) include no leveraged derivative products, and (iv) hedge without
regard to profit motive or sensitivity to current mark-to-market status. We
review compliance with these guidelines annually with the Financial Policy
Committee of the Company's Board of Directors. In addition, our internal
auditors review compliance with these guidelines on an annual basis. These
guidelines may be changed at any time as our business needs dictate.
A-24
<PAGE> 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The table below indicates the types of swaps used, their duration, and
their respective interest rates. The variable component of each interest rate
derivative is based on the 6 month LIBOR using the forward yield curve as of
January 2, 1999.
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Receive fixed swaps
Notional amount........................................... $ 785,000 $1,085,000
Duration in years......................................... 2.0 3.0
Average receive rate...................................... 6.50% 6.33%
Average pay rate.......................................... 5.30% 5.79%
Receive variable swaps
Notional amount........................................... $ 925,000 $1,250,000
Duration in years......................................... 2.4 2.7
Average receive rate...................................... 5.57% 5.83%
Average pay rate.......................................... 7.09% 6.92%
Interest rate caps
Notional amount........................................... $ -- $ 200,000
Duration in years......................................... -- .9
Average receive rate...................................... -- 5.81%
</TABLE>
In addition, as of January 2, 1999, the Company had entered into a 2 year
$75,000 receive variable swap that becomes effective July 1, 1999.
A-25
<PAGE> 59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
that value:
Long-term Investments
The fair values of these investments are estimated based on quoted market
prices for those or similar investments.
Long-term Debt
The fair value of the Company's long-term debt, including the current
portion thereof, is estimated based on the quoted market price for the same or
similar issues. The fair value of $843,728 of long-term debt outstanding under
the Company's Credit Agreement approximates carrying value.
Interest Rate Protection Agreements
The fair value of these agreements is based on the net present value of
the future cash flows using the forward interest rate yield curve in effect at
the respective years-end. If the swaps and caps were cancelled as of the
respective years-end the result would have been a net cash outflow for 1998 and
1997. The swaps are linked to the Company's debt portfolio. (See Accounting
Policies and Debt Obligations footnotes.)
The estimated fair values of the Company's financial instruments are as
follows:
<TABLE>
<CAPTION>
1998 1997
------------------------ ------------------------
ESTIMATED ESTIMATED
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Long-term investments for which it is
Practicable................................. $ 71,102 $ 71,582 $ 167,609 $ 168,512
Not Practicable............................. $ 8,800 -- $ 33,605 $ --
Long-term debt for which it is
Practicable................................. $2,717,723 $2,829,541 $2,804,070 $2,937,041
Not Practicable............................. $ 472,161 -- $ 516,685 $ --
Interest Rate Protection Agreements
Receive fixed swaps......................... $ -- $ 21,833 $ -- $ 11,307
Receive variable swaps...................... $ -- $ (43,218) $ -- $ (42,016)
Interest rate caps.......................... $ -- $ -- $ 1,130 $ 434
---------- ---------- ---------- ----------
$ 0 $ (21,385) $ 1,130 $ (30,275)
========== ========== ========== ==========
</TABLE>
The use of different assumptions and/or estimation methodologies may have
a material effect on the estimated fair value amounts. Accordingly, the
estimates presented herein are not necessarily indicative of the amounts that
the Company could actually realize. In addition, the Company is not subjected to
a concentration of credit risk related to these instruments.
The investments for which it was not practicable to estimate fair value
relate to equity investments accounted for under the equity method and
investments in real estate development partnerships for which there is no
market.
It was not practicable to estimate the fair value of Industrial Revenue
Bonds of $201,330, various mortgages of $259,827, and other notes of $11,004 for
which there is no market.
A-26
<PAGE> 60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
LEASES
The Company operates primarily in leased facilities. Lease terms generally
range from 10 to 25 years with options to renew at varying terms. Certain of the
leases provide for contingent payments based on a percent of sales.
Rent expense (under operating leases) consists of:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Minimum rentals............................................. $347,977 $321,782 $291,256
Contingent payments......................................... 10,277 9,230 10,373
-------- -------- --------
$358,254 $331,012 $301,629
======== ======== ========
</TABLE>
Assets recorded under capital leases consists of:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Distribution and manufacturing facilities................... $ 30,382 $ 30,382
Store facilities............................................ 267,218 242,529
Less accumulated amortization............................... (132,952) (123,891)
--------- ---------
$ 164,648 $ 149,020
========= =========
</TABLE>
Minimum annual rentals for the five years subsequent to 1998 and in the
aggregate are:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
1999........................................................ $ 36,806 $ 347,646
2000........................................................ 35,863 325,112
2001........................................................ 34,805 305,141
2002........................................................ 33,743 287,334
2003........................................................ 31,641 270,513
Thereafter.................................................. 287,977 2,337,555
---------- ----------
460,835 $3,873,301
==========
Less estimated executory costs included in capital leases... 16,414
----------
Net minimum lease payments under capital leases............. 444,421
Less amount representing interest........................... 230,438
----------
Present value of net minimum lease payments under capital
leases.................................................... $ 213,983
==========
</TABLE>
EXTRAORDINARY LOSS
The extraordinary loss in 1998, 1997, and 1996 relates to premiums paid to
retire certain indebtedness early and the write-off of related deferred
financing costs.
EARNINGS PER COMMON SHARE
Basic earnings per common share equals net earnings divided by the
weighted average number of common shares outstanding. Diluted earnings per
common share equals net earnings divided by the weighted average number of
common shares outstanding after giving effect to dilutive stock options.
A-27
<PAGE> 61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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.
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
JANUARY 2, 1999 DECEMBER 27, 1997 DECEMBER 28, 1996
---------------------------- ---------------------------- ----------------------------
INCOME SHARES PER- INCOME SHARES PER- INCOME SHARES PER-
(NUMER- (DENOMI- SHARE (NUMER- (DENOMI- SHARE (NUMER- (DENOMI- SHARE
ATOR) NATOR) AMOUNT ATOR) NATOR) AMOUNT ATOR) NATOR) AMOUNT
-------- -------- ------ -------- -------- ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic EPS................... $449,912 255,814 $1.76 $444,032 254,284 $1.75 $352,735 250,979 $1.41
Dilutive effect of stock
option awards............. 9,568 8,576 7,858
-------- ------- -------- ------- -------- -------
Diluted EPS................. $449,912 265,382 $1.70 $444,032 262,860 $1.69 $352,735 258,837 $1.36
======== ======= ======== ======= ======== =======
</TABLE>
PREFERRED STOCK
The Company has authorized 5,000,000 shares of voting cumulative preferred
stock; 2,000,000 were available for issuance at January 2, 1999. Fifty thousand
shares have been designated "Series A Preferred Shares" and are reserved for
issuance under the Company's Shareholders' rights plan. The stock has a par
value of $100 and is issuable in series.
COMMON STOCK
The Company has authorized 1,000,000,000 shares of common stock, $1 par
value per share. On January 29, 1997, the Company began repurchasing its common
stock in order to reduce dilution caused by the Company's stock option plans.
These repurchases were made using the proceeds, including the tax benefit, from
options exercised. Further repurchases of up to $100,000 of the Company's common
stock were authorized by the Board of Directors during October of 1997. On
October 18, 1998, the Company suspended its repurchase program as result of the
merger agreement between the Company and Fred Meyer, Inc. The main trading
market for the Company's common stock is the New York Stock Exchange, where it
is listed under the symbol KR. For the three years ended January 2, 1999,
changes in common stock were:
<TABLE>
<CAPTION>
ISSUED IN TREASURY
---------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT
----------------------------------------------
<S> <C> <C> <C> <C>
December 30, 1995..................................... 267,555,842 $586,541 19,151,900 $243,631
Exercise of stock options including restricted stock
grants.............................................. 5,367,200 50,091 11,812 255
Tax benefit from exercise of non-qualified stock
options............................................. 21,598
----------- -------- ---------- --------
December 28, 1996..................................... 272,923,042 658,230 19,163,712 243,886
Exercise of stock options including restricted stock
grants.............................................. 4,230,218 43,693 3,051 280
Open market purchases................................. 3,015,887 84,932
Tax benefit from exercise of non-qualified stock
options............................................. 26,721
----------- -------- ---------- --------
December 27, 1997..................................... 277,153,260 728,644 22,182,650 329,098
Exercise of stock options including restricted stock
grants.............................................. 4,635,492 53,553 23,060 1,101
Open market purchases................................. 2,625,299 120,830
Tax benefit from exercise of non-qualified stock
options............................................. 54,605
----------- -------- ---------- --------
January 2, 1999....................................... 281,788,752 $836,802 24,831,009 $451,029
=========== ======== ========== ========
</TABLE>
STOCK OPTION PLANS
The Company grants options for common stock to employees under various
plans, as well as to its non-employee directors owning a minimum of 1,000 shares
of common stock of the Company, at an option price equal to the fair market
value of the stock at the date of grant. In addition to cash payments, the plans
provide for the exercise of options by exchanging issued shares of stock of the
Company. At January 2, 1999, 4,992,558 shares of
A-28
<PAGE> 62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
common stock were available for future options. Options generally will expire 10
years from the date of grant. Options vest in one year to five years or, for
certain options, upon the Company's stock reaching certain pre-determined market
prices within ten years from the date of grant. All grants outstanding become
immediately exercisable upon certain changes of control of the Company.
Changes in options outstanding under the stock option plans, excluding
restricted stock grants, were:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES SUBJECT OF EXERCISE
TO OPTION PRICE OF OPTIONS
----------------------------------
<S> <C> <C>
Outstanding, December 30, 1995.............................. 25,327,054 $ 9.68
Granted..................................................... 5,687,020 $20.71
Exercised................................................... (5,339,416) $ 9.04
Cancelled or expired........................................ (183,518) $16.12
----------
Outstanding, December 28, 1996.............................. 25,491,140 $12.23
Granted..................................................... 3,110,560 $26.67
Exercised................................................... (4,229,352) $ 9.89
Cancelled or expired........................................ (210,670) $12.53
----------
Outstanding, December 27, 1997.............................. 24,161,678 $14.50
Granted..................................................... 3,210,415 $43.13
Exercised................................................... (4,541,437) $11.59
Cancelled or expired........................................ (175,865) $28.72
----------
Outstanding, January 2, 1999................................ 22,654,791 $19.52
==========
</TABLE>
The Company applies Accounting Principles Board Opinion No. 25 "Accounting
for Stock Issued to Employees," and related interpretations in accounting for
its plans. Accordingly, no compensation expense has been recognized for its
stock-based compensation plans other than for restricted stock awards and
certain options where vesting is contingent upon the Company's stock reaching
certain pre-determined market prices. Had compensation cost for the Company's
stock option plans been determined based upon the fair value at the grant date
for awards under these plans consistent with the methodology prescribed under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," the Company's net income and diluted net earnings per share would
have been reduced by approximately $16,306, or $.06 per share, $13,616, or $.05
per share, and $12,800, or $.05 per share, for 1998, 1997 and 1996,
respectively. The weighted average fair value of the options granted during
1998, 1997, and 1996 was estimated as $18.72, $10.82 and $5.89, respectively, on
the date of grant using the Black-Scholes option-pricing model with the
following weighted average assumptions: volatility of 26.6%, 24.0% and 22.7% for
1998, 1997 and 1996, respectively; risk-free interest rate of 4.6%, 5.7% and
6.3% for 1998, 1997 and 1996, respectively; and an expected term of
approximately 7.8 years for 1998, 5.4 years for 1997, and 3.3 years for 1996. A
summary of options outstanding and exercisable at January 2, 1999 follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------- ------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
NUMBER REMAINING AVERAGE OPTIONS AVERAGE
RANGE OF OUTSTANDING CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICE AS OF 1/2/99 LIFE PRICE AS OF 1/2/99 PRICE
- ------------------------------------------------------- ------------------------
<S> <C> <C> <C> <C> <C>
$ 4.85 - $ 6.22 936,026 1.30 $ 6.21 936,026 $ 6.21
6.47 - 7.85 1,778,989 3.69 7.75 1,778,989 7.75
8.10 - 10.29 2,278,179 3.43 9.35 2,278,179 9.35
10.57 - 11.69 2,500,857 5.37 11.68 2,500,857 11.68
11.72 - 12.66 1,650,667 2.49 11.75 1,650,667 11.75
12.75 - 12.97 3,016,299 6.30 12.75 3,016,299 12.75
13.04 - 20.75 4,269,784 7.26 20.34 3,508,376 20.25
21.19 - 41.63 2,864,049 8.37 26.99 1,292,478 26.79
42.13 - 54.47 3,359,941 9.30 44.69 14,475 44.48
---------- ----------
$ 4.85 - $54.47 22,654,791 6.11 $19.52 16,976,346 $13.80
========== ==========
</TABLE>
At December 27, 1997 and December 28, 1996, options for 18,127,665 and
16,906,890 shares were exercisable at a weighted average exercise price of
$11.72 and $9.44, respectively.
A-29
<PAGE> 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Also, the Company may grant restricted stock awards to eligible employee
participants. In general, a restricted stock award entitles an employee to
receive a stated number of shares of common stock of the Company subject to
forfeiture if the employee fails to remain in the continuous employ of the
Company for a stipulated period. The holder of an award is entitled to the
rights of a shareowner except that the restricted shares and the related rights
to vote or receive dividends may not be transferred. The award is charged to
earnings over the period in which the employee performs services and is based
upon the market value of common stock at the date of grant for those grants
without performance contingencies. As of January 2, 1999 and December 27, 1997,
awards related to 382,898 and 354,850 shares, respectively, were outstanding.
The charge to earnings for grants with performance-contingent vesting includes
share appreciation between the grant date and the vesting date.
Incentive shares may be granted under the 1994 plan, which consist of
shares of common stock issued subject to achievement of performance goals. No
incentive shares were outstanding as of January 2, 1999 and December 27, 1997.
CONTINGENCIES
The Company continuously evaluates contingencies based upon the best
available evidence.
Management believes that allowances for loss have been provided to the
extent necessary and that its assessment of contingencies is reasonable. To the
extent that resolution of contingencies results in amounts that vary from
management's estimates, future earnings will be charged or credited.
The principal contingencies are described below:
Income Taxes -- We have closed all tax years through 1984 with the
Internal Revenue Service. The Internal Revenue Service has completed its
examination of our tax returns for tax years through 1992. On September 15,
1998, the IRS voluntarily dismissed its appeal against Kroger. This action
settled a previously unresolved issue for tax years 1984-1992. One issue remains
in dispute with the IRS for tax years 1991 and 1992. We have provided for this
and other tax contingencies.
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. Management is of the opinion that their outcome
will not have a material adverse effect on the Company's financial position or
results of operations.
WARRANT DIVIDEND PLAN
On February 28, 1986, the Company adopted a warrant dividend plan
providing for stock purchase rights to owners of the Company's common stock. The
Plan was amended and restated as of April 4, 1997 and further amended on October
18, 1998. Each right, when exercisable, entitles the holder to purchase from the
Company one ten-thousandth of a share of Series A Preferred Shares, par value
$100 per share, at $87.50 per one ten-thousandth of a share. The rights will
become exercisable, and separately tradeable, ten days after a person or group
acquires 10% or more of the Company's common stock or ten business days
following a tender offer or exchange offer resulting in a person or group having
beneficial ownership of 10% or more of the Company's common stock. In the event
the rights become exercisable, each right will entitle the holder the right, if
that holder pays the exercise price, to purchase the Company's common stock,
having a market value of twice the exercise
A-30
<PAGE> 64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
price of the right. Under certain other circumstances, including certain
acquisitions of the Company in a merger or other business combination
transaction, or if 50% or more of the Company's assets or earning power are sold
under certain circumstances, each right will entitle the holder to receive upon
payment of the exercise price, shares of common stock of the acquiring company
with a market value of two times the exercise price. At the Company's option,
the rights, prior to becoming exercisable, are redeemable in their entirety at a
price of $.01 per right. The rights are subject to adjustment and expire March
19, 2006. This summary description of the Plan is qualified in its entirety by
the terms of the plan more particularly set forth in the Company's Forms 8-A/A
dated April 4, 1997 and October 18, 1998.
OTHER POST EMPLOYMENT BENEFITS
The Company administers non-contributory defined benefit retirement plans
for substantially all non-union employees. Funding for the pension plans is
based on a review of the specific requirements and on evaluation of the assets
and liabilities of each plan. Employees are eligible to participate upon the
attainment of age 21 (25 for participants prior to January 1, 1986) and the
completion of one year of service, and benefits are based upon final average
salary and years of service. Vesting is based upon years of service.
In addition to providing pension benefits, the Company provides certain
health care and life insurance benefits for retired employees. The majority of
the Company's employees may become eligible for these benefits if they reach
normal retirement age while employed by the Company. Funding of retiree health
care and life insurance benefits occurs as claims or premiums are paid.
A-31
<PAGE> 65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Information with respect to change in benefit obligation, change in plan
assets, net amounts recognized at end of year, weighted average assumptions and
components of net periodic benefit cost follow:
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
----------------------- ---------------------
1998 1997 1998 1997
---------- ---------- --------- ---------
<S> <C> <C> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year.............. $ 943,456 $ 874,097 $ 247,712 $ 253,172
Service Cost......................................... 27,959 26,682 8,596 9,463
Interest Cost........................................ 68,456 67,701 16,841 19,609
Plan participants' contributions..................... -- -- 3,420 3,655
Amendments........................................... -- -- -- (4,741)
Actuarial loss (gain)................................ 48,486 22,088 12,428 (13,587)
Curtailment credit................................... -- -- (16,970) --
Benefits paid........................................ (49,277) (47,112) (16,076) (19,859)
---------- ---------- --------- ---------
Benefit obligation at end of year.................... $1,039,080 $ 943,456 $ 255,951 $ 247,712
========== ========== ========= =========
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year....... $1,095,118 $ 947,726 $ -- $ --
Actual return on plan assets......................... 190,613 191,755 -- --
Employer contribution................................ 2,987 2,750 12,656 16,203
Plan participants' contributions..................... -- -- 3,420 3,656
Benefits paid........................................ (49,277) (47,112) (16,076) (19,859)
---------- ---------- --------- ---------
Fair value of plan assets at end of year............. $1,239,441 $1,095,118 $ -- $ --
========== ========== ========= =========
Pension plan assets include $166,548 and $148,942 of common stock of The Kroger Co. at the end of 1998
and 1997, respectively.
NET AMOUNT RECOGNIZED AT END OF YEAR:
Funded status at end of year......................... $ 200,361 $ 151,662 $(255,951) $(247,712)
Unrecognized actuarial gain.......................... (207,597) (153,582) (38,290) (52,274)
Unrecognized prior service cost...................... 18,840 21,213 (20,985) (23,231)
Unrecognized net transition asset.................... (5,292) (5,914) -- --
---------- ---------- --------- ---------
Net amount recognized at end of year................. $ 6,312 $ 13,379 $(315,226) $(323,217)
========== ========== ========= =========
Prepaid benefit cost................................. $ 32,476 $ 36,979 $ -- $ --
Accrued benefit liability............................ (26,164) (23,600) (315,226) (323,217)
---------- ---------- --------- ---------
Net amount recognized at end of year................. $ 6,312 $ 13,379 $(315,226) $(323,217)
========== ========== ========= =========
</TABLE>
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
--------------------- ---------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
WEIGHTED AVERAGE ASSUMPTIONS:
Discount rate.......................................... 6.75% 7.25% 6.75% 7.25%
Expected return on plan assets......................... 9.50% 9.50%
Rate of compensation increase.......................... 3.25% 3.75% 3.25% 3.75%
</TABLE>
For measurement purposes, a 5 percent annual rate of increase in the per capita
cost of covered health care benefits was assumed for 1999 and thereafter.
A-32
<PAGE> 66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
------------------------------ ----------------------------
1998 1997 1996 1998 1997 1996
-------- -------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
COMPONENTS OF NET PERIODIC BENEFIT COST:
Service cost............................ $ 27,959 $ 26,682 $ 25,977 $ 8,596 $ 9,463 $ 9,558
Interest cost........................... 68,456 67,701 61,091 16,841 19,608 18,006
Expected return on plan assets.......... (88,049) (81,102) (76,353) -- -- --
Amortization of:
Transition asset................... (622) (8,541) (8,541) -- -- --
Prior service cost................. 2,373 2,373 2,373 (2,131) (1,775) (829)
Actuarial (gain) loss.............. (63) 570 487 (1,555) (811) (162)
Curtailment credit...................... -- -- -- (17,086) -- --
-------- -------- -------- -------- ------- -------
Net periodic benefit cost............... $ 10,054 $ 7,683 $ 5,034 $ 4,665 $26,485 $26,573
======== ======== ======== ======== ======= =======
</TABLE>
The accumulated benefit obligation for pension plans with no plan assets was
$26,164 as of January 2, 1999, and $23,600 as of December 27, 1997.
Assumed health care cost trend rates have a significant effect on the amounts
reported for the health care plans. A one-percentage-point change in the assumed
health care cost trend rates would have the following effects:
<TABLE>
<CAPTION>
1%
POINT 1% POINT
INCREASE DECREASE
-------- --------
<S> <C> <C>
Effect on total of service and interest cost components..... $ 2,734 $ (2,300)
Effect on postretirement benefit obligation................. $24,026 $(21,271)
</TABLE>
The Company also administers certain defined contribution plans for eligible
union and non-union employees. The cost of these plans for 1998, 1997, and 1996
was $27,595, $22,445, and $21,278, respectively.
The Company participates in various multi-employer plans for substantially all
union employees. Benefits are generally based on a fixed amount for each year of
service. Contributions and expense for 1998, 1997, and 1996 were $86,185,
$83,506, and $88,758, respectively.
SEGMENTS
The Company operates retail food and drug stores in the Midwest, South and
Southwest. The Company also manufactures and processes food for sale by its
supermarkets and others, and also operates convenience stores.
Based on the information monitored by the Company's operating decision makers to
manage the business, the Company has identified one reportable segment. Retail
operation information consists of results from the Company's retail food and
drug store divisions and convenience store divisions. Corporate and all other
operation information relates primarily to results from the Company's Corporate
office and manufacturing operations, none of which individually meet the
quantitative thresholds of a reportable segment. All of the Company's operations
are domestic. The Company manages income taxes, LIFO charges, interest income
and interest expense on a consolidated basis at the Corporate level.
A-33
<PAGE> 67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Information about the Company's operations by operating segment is as
follows:
<TABLE>
<CAPTION>
CORPORATE AND AMOUNTS NOT UNUSUAL
RETAIL ALL OTHER ALLOCATED(A) ITEMS(B) CONSOLIDATED
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998
Sales............................... $27,426,412 $ 776,892 $28,203,304
Depreciation and amortization....... 365,239 64,715 429,954
Operating income.................... 951,730 174,231 $(270,897) $(142,100) 712,964
Total assets........................ 5,603,662 1,096,409 6,700,071
Capital expenditures................ 786,398 137,063 923,461
- -----------------------------------------------------------------------------------------------------------
1997
Sales............................... $25,806,915 $ 760,433 $26,567,348
Depreciation and amortization....... 301,237 78,984 380,221
Operating income.................... 910,726 93,824 $(292,187) 712,363
Total assets........................ 5,062,003 1,239,338 6,301,341
Capital expenditures................ 508,438 103,760 612,198
- -----------------------------------------------------------------------------------------------------------
1996
Sales............................... $24,456,730 $ 714,179 $25,170,909
Depreciation and amortization....... 270,551 73,218 343,769
Operating income.................... 811,369 68,454 $(312,510) 567,313
Total assets........................ 4,705,459 1,187,006 5,892,465
Capital expenditures................ 449,134 284,749 733,883
- -----------------------------------------------------------------------------------------------------------
</TABLE>
Intercompany eliminations are not material.
(A) Amounts not allocated to segments include LIFO charges, interest income, and
interest expense.
(B) See One-Time Expenses ($52,400) and Accounting Change ($89,700) footnotes.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued Statement of Financial
Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities"
and No. 134 "Accounting for Mortgage Backed Securities Retained after the
Securitization of Mortgage Loans Held for Sale by a Mortgage Banking
Enterprise". The Company has not yet determined what effect, if any, these
statements will have.
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.
SUBSEQUENT EVENTS
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 6, 1999. Our first new fiscal year will end January 29, 2000.
It will include 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 intend to file separate audited statements of
operations and cash flows covering the transition period from January 3, 1999 to
January 30, 1999 on a Current Report on Form 8-K on or before May 15, 1999.
A-34
<PAGE> 68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONCLUDED
QUARTERLY DATA (UNAUDITED)
<TABLE>
<CAPTION>
QUARTER
-------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL YEAR
1998 (12 WEEKS) (12 WEEKS) (16 WEEKS) (13 WEEKS) (53 WEEKS)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------
Sales................................... $6,388,759 $6,441,616 $8,023,906 $7,349,023 $28,203,304
Merchandise costs....................... 4,956,007 4,911,644 6,091,003 5,564,367 21,523,021
Extraordinary loss...................... (4,293) (6,490) (28,340) (39,123)
Net earnings............................ 47,428 94,329 117,895 151,137 410,789
Basic earnings per common share:
Earnings before extraordinary
loss............................. .20 .37 49 .70 1.76
Extraordinary loss................. (.02) (.03) (.10) (.15)
---------- ---------- ---------- ---------- -----------
Basic net earnings per common share..... .18 .37 .46 .60 1.61
Diluted earnings per common share:
Earnings before extraordinary
loss............................. .20 .36 .47 67 1.70
Extraordinary loss................. (.02) (.02) (11) (.15)
---------- ---------- ---------- ---------- -----------
Diluted net earnings per common share... .18 .36 .45 .56 1.55
</TABLE>
<TABLE>
<CAPTION>
QUARTER
-------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL YEAR
1997 (12 WEEKS) (12 WEEKS) (16 WEEKS) (12 WEEKS) (52 WEEKS)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------
Sales................................... $6,139,413 $6,231,794 $7,686,639 $6,509,502 $26,567,348
Merchandise costs....................... 4,686,363 4,741,737 5,863,919 4,961,335 20,253,354
Extraordinary loss...................... (5,210) (3,033) (803) (23,330) (32,376)
Net earnings............................ 87,050 105,104 95,727 123,775 411,656
Basic earnings per common share:
Earnings before extraordinary
loss............................. .36 .43 .38 .58 1.75
Extraordinary loss................. (.02) (.01) (.09) (.13)
---- ---- ---- ---- ----
Basic net earnings per common share..... .34 .42 .38 .49 1.62
Diluted earnings per common share:
Earnings before extraordinary
loss............................. .35 .41 .37 .56 1.69
Extraordinary loss................. (.02) (.01) (.09) (.12)
---- ---- ---- ---- ----
Diluted net earnings per common share... .33 .40 .37 .47 1.57
</TABLE>
Common Stock Price Range
<TABLE>
<CAPTION>
1998 1997
------------------ ------------------
QUARTER HIGH LOW HIGH LOW
- ----------------------------------------------------------------
<S> <C> <C> <C> <C>
1st................... 47 5/16 33 1/16 28 1/8 22 11/16
2nd................... 47 1/2 40 3/16 29 1/8 23 13/16
3rd................... 54 1/8 42 31 1/16 27 1/8
4th................... 60 13/16 44 37 5/16 28 1/2
</TABLE>
The number of shareowners of record of common stock as of March 23, 1999,
was 46,870.
Under the Company's Credit Agreement dated May 28, 1997, the Company is
prohibited from paying cash dividends during the term of the Credit Agreement.
The Company is permitted to pay dividends in the form of stock of the Company.
A-35
<PAGE> 69
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FISCAL YEARS ENDED
------------------------------------------------------------------------
JANUARY 2, DECEMBER 27, DECEMBER 28, DECEMBER 30, DECEMBER 31,
1998 1997 1996 1995 1994
(53 WEEKS) (52 WEEKS) (52 WEEKS) (52 WEEKS) (52 WEEKS)
------------------------------------------------------------------------
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Sales............................... $28,203,304 $26,567,348 $25,170,909 $23,937,795 $22,959,122
Earnings before extraordinary
loss.............................. 449,912 444,032 352,735 318,866 268,903
Extraordinary loss (net of income
tax benefit) (A).................. (39,123) (32,376) (2,862) (16,053) (26,707)
Net earnings........................ 410,789 411,656 349,873 302,813 242,196
Diluted earnings per share
Earnings before extraordinary
loss........................... 1.70 1.69 1.36 1.28 1.10
Extraordinary loss (A)............ (.15) (.12) (.01) (.06) (.10)
Net earnings...................... 1.55 1.57 1.35 1.22 1.00
Total assets........................ 6,700,071 6,301,341 5,892,465 5,044,717 4,707,674
Long-term obligations, including
obligations under capital
leases............................ 3,228,663 3,493,075 3,659,491 3,489,728 3,889,194
Shareowners' deficit................ (387,832) (784,848) (1,181,706) (1,603,013) (2,153,684)
Cash dividends per common share..... (B) (B) (B) (B) (B)
</TABLE>
- --------------------------------------------------------------------------------
(A) See Extraordinary Loss in the Notes to Consolidated Financial Statements.
(B) The Company is prohibited from paying cash dividends under the terms of its
Credit Agreement.
A-36
<PAGE> 70
EXECUTIVE OFFICERS
WARREN F. BRYANT
President and Chief Executive Officer--
Dillon Companies, Inc.
GEOFFREY J. COVERT
President--Manufacturing
Group Vice President
DAVID B. DILLON
President and Chief
Operating Officer
PAUL W. HELDMAN
Senior Vice President, Secretary and
General Counsel
MICHAEL S. HESCHEL
Executive Vice President and
Chief Information Officer
LYNN MARMER
Group Vice President
DON W. MCGEORGE
Senior Vice President
W. RODNEY MCMULLEN
Senior Vice President and
Chief Financial Officer
JOSEPH A. PICHLER
Chairman of the Board and
Chief Executive Officer
JAMES R. THORNE
Senior Vice President
LAWRENCE M. TURNER
Vice President and Treasurer
- --------------------------------------------------------------------------------
The Company has a variety of plans designed to allow employees to acquire stock
in Kroger. Employees of Kroger and its subsidiaries own shares through a profit
sharing plan, as well as 401(k) plans and a payroll deduction plan called the
Kroger Stock Exchange. If employees have questions concerning their shares in
the Kroger Stock Exchange, or if they wish to sell shares they have purchased
through this plan, they should contact:
Firstar, N.A. Cincinnati
P.O. Box 5277
Cincinnati, Ohio 45201
Toll Free 1-800-872-3307
Questions regarding the Company's 401(k) plan should be directed to the
employee's Human Resources Manager or 1-800-2KROGER.
Questions concerning any of the other plans should be directed to the employee's
local Human Resources Manager.
SHAREOWNERS: The Bank of New York is Registrar and Transfer Agent for the
Company's Common Stock. For questions concerning changes of address, etc.,
individual shareowners should contact:
<TABLE>
<S> <C>
Written inquiries: Certificate transfer and address changes:
The Bank of New York The Bank of New York
Shareholder Relations Department-11E Receive and Deliver Department-11W
P.O. Box 11258 P.O. Box 11002
Church Street Station Church Street Station
New York, New York 10286 New York, New York 10286
</TABLE>
The Bank's toll-free number is: 1-800-524-4458. E-mail:
[email protected]
Shareholder questions and requests for forms available on the Internet at:
http://stock.bankofny.com
SHAREOWNER UPDATES: The Kroger Co. provides a pre-recorded overview of the
Company's most recent quarter. Call 1-800-4STOCKX or, in Cincinnati, 762-4723.
Other information is available on our Internet site at http://www.kroger.com.
FINANCIAL INFORMATION: Call (513) 762-1220 to request printed financial
information, including the Company's most recent report on Form 10-Q or 10-K, or
press release. Written inquiries should be addressed to Shareholder Relations,
The Kroger Co., 1014 Vine Street, Cincinnati, Ohio 45202-1100. Financial
information also is available on the Internet at http://www.cfonews.com/kr.
- --------------------------------------------------------------------------------
<PAGE> 71
THE KROGER CO. - 1014 VINE STREET - CINCINNATI, OHIO 45202 - (513) 762-4000
<PAGE> 72
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
Cincinnati, Ohio, April 13, 1999
To All Shareholders
of The Kroger Co.:
The annual meeting of shareholders of The Kroger Co. will be held at the
REGAL HOTEL, 150 W. 5TH Street, Cincinnati, Ohio, on May 20, 1999, at 11 A.M.,
for the following purposes:
1. To elect five directors or, in the event the merger with Fred Meyer,
Inc. has been completed prior to the date of the annual meeting, seven
directors, to serve until the annual meeting of shareholders in 2002
or until their successors have been elected and qualified;
2. To consider and act upon a proposal to authorize an amendment to the
Amended Articles of Incorporation to increase the authorized shares of
Common Stock from 1,000,000,000 to 2,000,000,000;
3. To consider and act upon a proposal to approve the 1999 Long-Term
Incentive Plan;
4. To consider and act upon a proposal to ratify the selection of
auditors for the Company for the year 1999;
5. To act upon a shareholder proposal, if properly presented at the
annual meeting, to recommend that the Board take the necessary steps
to cause all directors to be elected annually as opposed to in classes;
and
6. To transact such other business as may properly be brought before the
meeting;
all as set forth in the Proxy Statement accompanying this Notice.
Holders of common stock of record at the close of business on March 23,
1999, will be entitled to vote at the meeting.
YOUR MANAGEMENT DESIRES TO HAVE A LARGE NUMBER OF SHAREHOLDERS REPRESENTED
AT THE MEETING, IN PERSON OR BY PROXY. PLEASE SIGN AND DATE THE ENCLOSED PROXY
AND MAIL IT AT ONCE IN THE ENCLOSED SELF-ADDRESSED ENVELOPE. NO POSTAGE IS
REQUIRED IF MAILED WITHIN THE UNITED STATES.
By order of the Board of Directors,
Paul W. Heldman, Secretary
FOLD AND DETACH HERE
THE KROGER CO.
PROXY
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE ANNUAL MEETING TO BE HELD MAY 20, 1999
The undersigned hereby appoints each of JOSEPH A. PICHLER, JOHN T.
LA MACCHIA and T. BALLARD MORTON, JR., or if more than one is present and acting
then a majority thereof, proxies, with full power of substitution and
revocation, to vote the common shares of The Kroger Co. which the undersigned is
entitled to vote at the annual meeting of shareholders, and at any adjournment
thereof, with all the powers the undersigned would possess if personally
present, including authority to vote on the matters shown on the reverse in the
manner directed, and upon any other matter which properly may come before the
meeting. The undersigned hereby revokes any proxy previously given to vote those
shares at the meeting or at any adjournment.
THE PROXIES ARE DIRECTED TO VOTE AS SPECIFIED ON THE REVERSE HEREOF AND IN
THEIR DISCRETION ON ALL OTHER MATTERS COMING BEFORE THE MEETING. EXCEPT AS
SPECIFIED TO THE CONTRARY ON THE REVERSE, THE SHARES REPRESENTED BY THIS PROXY
WILL BE VOTED FOR ALL NOMINEES LISTED, INCLUDING THE DISCRETION TO CUMULATE
VOTES, FOR PROPOSALS 2, 3, AND 4, AND AGAINST PROPOSAL 5.
(continued, and to be signed, on other side)
THE KROGER CO.
P.O. BOX 11127
NEW YORK, N.Y. 10203-0127
<PAGE> 73
DID YOU KNOW???
YOUR COMPANY IS THE WORLD'S LARGEST FLORIST. SEND FLOWERS ANYWHERE IN THE
WORLD BY CALLING
1-800-KROGERS
8AM-5PM EST
[LOGO]
FLOWERS
FROM AROUND THE WORLD
FOLD AND DETACH HERE
[ ]
<TABLE>
<CAPTION>
<S> <C> <C> <C>
The Board of Directors recommends a vote FOR the nominees, FOR Proposals 2, 3, and 4, and AGAINST Proposal 5.
1. ELECTION OF DIRECTORS FOR all nominees WITHHOLD AUTHORITY to vote *EXCEPTIONS
listed below [ ] for all nominees listed below [ ] [ ]
Nominees: John T. La Macchia, Edward M. Liddy, T. Ballard Morton, Jr., Katherine D. Ortega, and Bobby S. Shackouls.
In addition, if the merger with Fred Meyer is completed before the annual meeting, Robert D. Beyer and Carlton J. Jenkins
will be nominees.
(INSTRUCTION: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE MARK THE "EXCEPTIONS" BOX AND WRITE THAT NOMINEE'S
NAME ON THE SPACE PROVIDED BELOW.)
*EXCEPTIONS_______________________________________________________________________________________________________________
2. Approve increase in authorized Common Stock. 3. Approval of 1999 Long-Term Incentive Plan.
FOR [ ] AGAINST [ ] ABSTAIN [ ] FOR [ ] AGAINST [ ] ABSTAIN [ ]
4. Approval of PricewaterhouseCoopers LLP, as auditors. 5. Approve shareholder proposal, if properly presented, to
recommend implementation of annual election of all
directors.
FOR [ ] AGAINST [ ] ABSTAIN [ ] FOR [ ] AGAINST [ ] ABSTAIN [ ]
If you wish to vote in accordance with the recommendations of management, all you need do is sign and return this card.
The Proxy Committee cannot vote your shares unless you sign and return the card.
Change of Address or
Comments Mark Here [ ]
Please sign exactly as name appears herein. Joint owners
should each sign. Where applicable, indicate position or
representative capacity.
Dated: ____________________________________________, 1999
_________________________________________________________
_________________________________________________________
SIGNATURE
_________________________________________________________
SIGNATURE
Votes MUST be indicated [X] in Black or Blue ink. [ ]
PLEASE MARK, SIGN, DATE AND RETURN THE PROXY CARD PROMPTLY, USING THE ENCLOSED ENVELOPE.
</TABLE>
PLEASE DETACH HERE
YOU MUST DETACH THIS PORTION OF THE PROXY CARD
BEFORE RETURNING IT IN THE ENCLOSED ENVELOPE
