<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of Report: May 10, 1999
THE KROGER CO.
(Exact name of registrant as specified in its charter)
An Ohio Corporation No. 1-303 31-0345740
(State or other jurisdiction (Commission File (IRS Employer
of incorporation) Number) Number)
1014 Vine Street
Cincinnati, OH 45201
(Address of principal
executive offices)
Registrant's telephone number: (513) 762-4000
<PAGE> 2
Item 5. Other Events
- ------- ------------
Filed herewith as Exhibit 99.1 are The Kroger Co.'s audited
financial statements as of January 30, 1999, and for the
twenty-eight days then ended. The period presented is the
transition period resulting from the change in The Kroger
Co.'s fiscal year end to the Saturday closest to January 31 of
each year.
Item 7. Financial Statements, Pro Forma Financial Information and
- ------- ---------------------------------------------------------
Exhibits
--------
(c) Exhibits:
23.1 Consent of PricewaterhouseCoopers LLP.
99.1 Audited financial statements for transition
period.
<PAGE> 3
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereto duly authorized.
THE KROGER CO.
May 10, 1999 By: (Paul Heldman)
Paul Heldman
Senior Vice President, Secretary
and General Counsel
<PAGE> 4
EXHIBIT INDEX
Exhibit No. Exhibit
- ----------- -------
23.1 Consent of PricewaterhouseCoopers LLP.
99.1 Audited financial statements for transition period.
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
The Kroger Co. on Form S-8 (File No. 33-2056), Form S-8 (File No. 2-98858), Form
S-8 (File No. 33-20734), Form S-8 (File No. 33-25698), Form S-8 File No.
(33-38121), Form S-8 (File No. 33-38122), Form S-8 (File No. 33-53747), Form S-8
(File No. 33-55501), Form S-3 (File No. 33-61563), Form S-8 (File No.
333-11859), Form S-8 (File No.333-11909), Form S-8 (File No.333-27211), Form S-4
(File No. 333-66961), and Form S-3 (File No. 333-74389) of our report dated
April 30, 1999, on our audits of the consolidated financial statements of The
Kroger Co. as of January 30, 1999, and for the twenty-eight days then ended,
which report is included in this Current Report on Form 8-K.
(PricewaterhouseCoopers LLP)
PricewaterhouseCoopers LLP
Cincinnati, Ohio
May 10, 1999
<PAGE> 1
1
Exhibit 99.1
FINANCIAL STATEMENTS
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 30, 1999, and the consolidated results
of its operations and its cash flows for the twenty-eight days then ended, 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.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Cincinnati, Ohio
April 30, 1999
<PAGE> 2
2
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
JANUARY 30,
(IN THOUSANDS OF DOLLARS) 1999
- --------------------------------------------------------------------------
<S> <C>
ASSETS
Current assets
Cash...................................................... $ 85,338
Receivables............................................... 409,566
Inventories:
FIFO cost.............................................. 2,273,181
Less LIFO reserve...................................... (472,932)
-----------
1,800,249
Property held for sale.................................... 8,126
Prepaid and other current assets.......................... 425,791
-----------
Total current assets................................. 2,729,070
Property, plant and equipment, net.......................... 3,806,174
Investments and other assets................................ 243,378
-----------
TOTAL ASSETS......................................... $ 6,778,622
===========
LIABILITIES
Current liabilities
Current portion of long-term debt......................... $ 164,026
Current portion of obligations under capital leases....... 11,377
Accounts payable.......................................... 1,719,105
Other current liabilities................................. 1,261,862
-----------
Total current liabilities............................ 3,156,370
Long-term debt.............................................. 3,099,816
Obligations under capital leases............................ 201,831
Deferred income taxes....................................... 202,155
Other long-term liabilities................................. 467,839
-----------
TOTAL LIABILITIES.................................... 7,128,011
-----------
SHAREOWNERS' DEFICIT
Common capital stock, par $1
Authorized: 1,000,000,000 shares
Issued: 282,282,502 shares................................ 850,854
Accumulated deficit......................................... (748,792)
Common stock in treasury, at cost
24,838,335 shares.................................. (451,451)
-----------
TOTAL SHAREOWNERS' DEFICIT........................... (349,389)
-----------
TOTAL LIABILITIES AND SHAREOWNERS' DEFICIT........... $ 6,778,622
===========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 3
3
CONSOLIDATED STATEMENT OF OPERATIONS AND
ACCUMULATED DEFICIT
Period Ended January 30, 1999
<TABLE>
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
- ----------------------------------------------------------------------
<S> <C>
Sales................................................... $ 2,160,377
------------
Costs and expenses
Merchandise costs, including warehousing and
transportation..................................... 1,651,409
Operating, general and administrative................. 387,983
Rent.................................................. 27,388
Depreciation and amortization......................... 33,374
Net interest expense.................................. 20,522
------------
Total......................................... 2,120,676
------------
Earnings before tax expense............................. 39,701
Tax expense............................................. 14,888
------------
Net earnings.................................. $ 24,813
============
Accumulated Deficit
Beginning of period................................... $ (773,605)
Net earnings.......................................... 24,813
------------
End of period......................................... $ (748,792)
============
Basic earnings per Common Share......................... $ 0.10
=======
Average number of common shares used in basic
calculation........................................... 256,818
Diluted earnings per Common Share....................... $ 0.09
=======
Average number of common shares used in diluted
calculation........................................... 266,506
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 4
4
CONSOLIDATED STATEMENT OF CASH FLOWS
Period Ended January 30, 1999
<TABLE>
<CAPTION>
(IN THOUSANDS OF DOLLARS)
- -------------------------------------------------------------------------
<S> <C>
Cash Flows From Operating Activities:
Net earnings.............................................. $ 24,813
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation and amortization.......................... 33,374
Amortization of deferred financing costs............... 344
Other changes, net..................................... 703
Net decrease in cash from changes in
operating assets and liabilities..................... (104,689)
-----------
Net cash used by operating activities................ (45,455)
-----------
Cash Flows From Investing Activities:
Capital expenditures...................................... (52,491)
Proceeds from sale of assets.............................. 412
Decrease in property held for sale........................ 442
Increase in other investments............................. (719)
-----------
Net cash used by investing activities................ (52,356)
-----------
Cash Flows From Financing Activities:
Principal payments under capital lease obligations........ (775)
Proceeds from issuance of long-term debt.................. 75,754
Reductions in long-term debt.............................. (1,797)
Outstanding checks........................................ (16,922)
Proceeds from issuance of capital stock................... 5,880
Capital stock reacquired.................................. (422)
-----------
Net cash provided by financing activities............ 61,718
-----------
Net decrease in cash and temporary cash investments......... (36,093)
Cash and Temporary Cash Investments:
Beginning of period....................................... 121,431
-----------
End of period............................................. $ 85,338
===========
Increase (Decrease) In Cash From Changes In Operating Assets
And Liabilities:
Inventories (FIFO)........................................ $ (71,093)
Receivables............................................... 47,351
Prepaid and other current assets.......................... (60,024)
Accounts payable.......................................... (49,603)
Other current liabilities................................. 12,681
Deferred income taxes..................................... 14,216
Other liabilities......................................... 1,783
-----------
$ (104,689)
===========
</TABLE>
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
<PAGE> 5
5
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.
On January 6, 1999, the Company decided to change its year-end to the
Saturday nearest January 31. The twenty-eight days beginning January 3, 1999 and
ending January 30, 1999 represent the transition period from the end of the
Company's previous fiscal year to the beginning of the Company's new fiscal
year, and are referred to throughout these statements as the period ended
January 30, 1999.
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 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 $27,531 for the period ended January 30, 1999.
<PAGE> 6
6
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 period for interest and income taxes was as follows:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Interest.................................................... $ 24,168
Income taxes................................................ 412
</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 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 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 as
of January 30, 1999:
<TABLE>
<CAPTION>
CASH AMOUNT ACCRUED
EXPENSE PAYMENTS AT JANUARY 30, 1999
------- -------- -------------------
<S> <C> <C> <C>
Employee Severance.......................................... $11,000 $ 6,600 $ 4,400
Carrying Costs of Idled Facilities.......................... 9,500 3,400 6,100
Ending the Joint Venture.................................... 4,800 4,800
------- ------- -------
$25,300 $14,800 $10,500
======= ======= =======
</TABLE>
<PAGE> 7
7
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 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 $1,000 and
the remaining accrual of $8,400 at January 30, 1999 represents estimated rent or
lease termination costs that will be paid on closed stores through 2013.
PREPAID AND OTHER CURRENT ASSETS
Prepaid and other current assets consists of:
<TABLE>
<CAPTION>
1999
-----------
<S> <C>
Health and welfare benefit costs............................ $ 200,000
Other....................................................... 212,850
-----------
$ 412,850
===========
</TABLE>
PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment, net consists of:
<TABLE>
<CAPTION>
1999
-----------
<S> <C>
Land........................................................ $ 397,027
Buildings and land improvements............................. 1,515,117
Equipment................................................... 3,329,815
Leasehold improvements...................................... 1,031,461
Construction-in-progress.................................... 341,831
Leased property under capital leases........................ 297,400
-----------
6,912,651
Accumulated depreciation and amortization................... (3,106,477)
-----------
$ 3,806,174
===========
</TABLE>
<PAGE> 8
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Approximately $271,284, original cost, of Property, Plant and Equipment
collateralizes certain mortgage obligations at January 30, 1999.
INVESTMENTS AND OTHER ASSETS
Investments and other assets consists of:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Deferred financing costs.................................... $ 53,531
Goodwill.................................................... 48,579
Investments in Debt Securities.............................. 67,314
Other....................................................... 73,954
--------
$243,378
========
</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>
1999
----------
<S> <C>
Salaries and wages.......................................... $ 322,350
Taxes, other than income taxes.............................. 208,346
Interest.................................................... 39,161
Other....................................................... 696,106
----------
$1,265,963
==========
</TABLE>
TAXES BASED ON INCOME
The provision for taxes based on income consists of:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Federal
Current................................................... $ 25,101
Deferred.................................................. (11,740)
--------
13,361
State and local............................................. 1,527
--------
$ 14,888
========
</TABLE>
A reconciliation of the statutory federal rate and the effective rate is
as follows:
<TABLE>
<CAPTION>
1999
----
<S> <C>
Statutory rate.............................................. 35.0%
State income taxes, net of federal tax benefit.............. 2.5
Tax credits................................................. (.3)
Other, net.................................................. .3
----
37.5%
====
</TABLE>
<PAGE> 9
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The tax effects of significant temporary differences that comprise
deferred tax balances were as follows:
<TABLE>
<CAPTION>
1999
- -----------------------------------------------------------------------
<S> <C>
Current deferred tax assets:
Compensation related costs................................ $ 57,601
Insurance related costs................................... 38,558
Inventory related costs................................... 52,769
Other..................................................... 39,768
---------
188,696
---------
Current deferred tax liabilities:
Compensation related costs................................ (104,146)
Lease accounting.......................................... (4,218)
Inventory related costs................................... (67,520)
Other..................................................... (4,556)
---------
(180,440)
---------
Current deferred taxes, net................................. $ 8,256
=========
Long-term deferred tax assets:
Compensation related costs................................ $ 130,122
Insurance related costs................................... 31,938
Lease accounting.......................................... 26,176
Other..................................................... 24,333
---------
212,569
---------
Long-term deferred tax liabilities:
Depreciation.............................................. (377,331)
Compensation related costs................................ (9,831)
Lease accounting.......................................... (539)
Deferred charges.......................................... (2,226)
Other..................................................... (24,797)
---------
(414,724)
---------
Long-term deferred taxes, net............................... $(202,155)
=========
</TABLE>
<PAGE> 10
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DEBT OBLIGATIONS
Long-term debt consists of:
<TABLE>
<CAPTION>
1999
----------
<S> <C>
Five-Year Credit Agreement.................................. $ 919,482
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
8.15% Senior Notes due 2006................................. 222,500
7.65% Senior Notes due 2007................................. 200,000
9 7/8% Senior Subordinated Debentures, due 2002............. 77,245
6 3/4% to 9 5/8% Senior Subordinated Notes, due 1999 to
2009...................................................... 145,377
10% Senior Subordinated Notes, due 1999..................... 123,572
10% Mortgage loans, with semi-annual payments due through
2004...................................................... 205,301
3 3/4% to 8 5/8% Industrial Revenue Bonds, due in varying
amounts through 2021...................................... 177,580
7 7/8% to 10 1/4% mortgages, due in varying amounts through
2017...................................................... 281,815
3 1/2% to 10 1/4% notes, due in varying amounts through
2017...................................................... 10,970
----------
Total debt.................................................. 3,263,842
Less current portion........................................ 164,026
----------
Total long-term debt........................................ $3,099,816
==========
</TABLE>
The aggregate annual maturities and scheduled payments of long-term debt
for the five years subsequent to January 30, 1999 are:
<TABLE>
<S> <C>
1999.................................................... $ 164,026
2000.................................................... $ 209,525
2001.................................................... $ 13,210
2002.................................................... $1,111,302
2003.................................................... $ 47,407
</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
<PAGE> 11
11
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 30, 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); (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); (iii) the $250,000 10%
Senior Subordinated Notes were redeemed at maturity effective May 1, 1999.
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.
<PAGE> 12
12
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. 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, $280,000 at January 30, 1999, and competitive bid
borrowings, $165,000 at January 30, 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 the period ended January 30, 1999 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.
<PAGE> 13
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The table below indicates the types of swaps used, their duration, and
their respective interest rates.
<TABLE>
<CAPTION>
1999
----------
<S> <C>
Receive fixed swaps
Notional amount........................................... $ 785,000
Duration in years......................................... 1.9
Average receive rate...................................... 6.50%
Average pay rate.......................................... 5.30%
Receive variable swaps
Notional amount........................................... $ 925,000
Duration in years......................................... 2.3
Average receive rate...................................... 5.57%
Average pay rate.......................................... 7.09%
</TABLE>
In addition, as of January 30, 1999, the Company had entered into a 2 year
$75,000 receive variable swap that becomes effective July 1, 1999.
<PAGE> 14
14
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 $919,482 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
January 30, 1999. If the swaps and caps were canceled as of the year-end the
result would have been a net cash outflow. 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>
JANUARY 30, 1999
------------------------
ESTIMATED
CARRYING FAIR
VALUE VALUE
---------- ----------
<S> <C> <C>
Long-term investments for which it is
Practicable................................. $ 71,105 $ 73,585
Not Practicable............................. $ 9,070 --
Long-term debt for which it is
Practicable................................. $2,793,477 $2,905,295
Not Practicable............................. $ 470,365 --
Interest Rate Protection Agreements
Receive fixed swaps......................... $ -- $ 21,800
Receive variable swaps...................... $ -- $ (43,200)
Interest rate caps.......................... $ -- $ --
---------- ----------
$ 0 $ (21,400)
========== ==========
</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 $177,580, various mortgages of $281,815, and other notes of $10,970 for
which there is no market.
<PAGE> 15
15
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>
1999
--------
<S> <C>
Minimum rentals............................................. $ 26,367
Contingent payments......................................... 1,021
--------
$ 27,388
========
</TABLE>
Assets recorded under capital leases consists of:
<TABLE>
<CAPTION>
1999
---------
<S> <C>
Distribution and manufacturing facilities................... $ 30,382
Store facilities............................................ 267,018
Less accumulated amortization............................... (133,785)
---------
$ 163,615
=========
</TABLE>
Minimum annual rentals for the five years subsequent to January 30, 1999
and in the aggregate are:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
---------- ----------
<S> <C> <C>
1999........................................................ $ 36,734 $ 345,913
2000........................................................ 35,782 323,576
2001........................................................ 34,723 303,771
2002........................................................ 33,582 286,039
2003........................................................ 31,553 275,392
Thereafter.................................................. 285,630 2,311,868
---------- ----------
458,004 $3,846,559
==========
Less estimated executory costs included in capital leases... 16,257
----------
Net minimum lease payments under capital leases............. 441,747
Less amount representing interest........................... 228,546
----------
Present value of net minimum lease payments under capital
leases.................................................... $ 213,201
==========
</TABLE>
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.
<PAGE> 16
16
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 PERIOD ENDED
JANUARY 30, 1999
----------------------------
INCOME SHARES PER-
(NUMER- (DENOMI- SHARE
ATOR) NATOR) AMOUNT
-------- -------- ------
<S> <C> <C> <C>
Basic EPS................... $ 24,813 256,818 $0.10
Dilutive effect of stock
option awards............. 9,688
-------- -------
Diluted EPS................. $ 24,813 266,506 $0.09
======== =======
</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 30, 1999. Fifty thousand
shares have been designated "Series A Preferred Shares" and are reserved for
issuance under the Company's warrant dividend 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 a 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 period ended January 30, 1999, changes in
common stock were:
<TABLE>
<CAPTION>
ISSUED IN TREASURY
---------------------- ---------------------
SHARES AMOUNT SHARES AMOUNT
----------------------------------------------
<S> <C> <C> <C> <C>
January 2, 1999....................................... 281,788,752 $836,802 24,831,009 $451,029
Exercise of stock options including restricted stock
grants.............................................. 493,750 6,045 7,326 422
Tax benefit from exercise of non-qualified stock
options............................................. 8,007
----------- -------- ---------- --------
January 30, 1999...................................... 282,282,502 $850,854 24,838,335 $451,451
=========== ======== ========== ========
</TABLE>
<PAGE> 17
17
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 30, 1999, 5,028,107 shares of 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, January 2, 1999................................ 22,654,791 $19.52
Exercised................................................... (477,750) $12.31
Canceled or expired........................................ (1,167) $26.80
----------
Outstanding, January 30, 1999............................... 22,175,874 $19.69
==========
</TABLE>
<PAGE> 18
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
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 $1,254, or less than $.01 per share for the
period ended January 30, 1999. There were no stock options granted during the
period ended January 30, 1999. A summary of options outstanding and exercisable
at January 30, 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 1/30/99 LIFE PRICE AS OF 1/30/99 PRICE
- ------------------------------------------------------------ ----------------------------
<S> <C> <C> <C> <C> <C>
$ 4.85 - $ 6.22 873,506 1.30 $ 6.21 873,506 $ 6.21
6.47 - 7.85 1,706,452 3.69 7.75 1,706,452 7.75
8.10 - 10.29 2,206,808 3.43 9.35 2,206,808 9.35
10.57 - 11.69 2,454,402 5.37 11.68 2,454,402 11.68
11.72 - 12.66 1,578,792 2.49 11.75 1,578,792 11.75
12.75 - 12.97 2,941,629 6.30 12.75 2,941,629 12.75
13.04 - 20.75 4,206,520 7.26 20.34 3,445,112 20.25
21.19 - 41.63 2,847,824 8.37 26.99 1,276,253 26.79
42.13 - 54.47 3,359,941 9.30 44.69 14,475 44.48
---------- ----------
$ 4.85 - $54.47 22,175,874 6.11 $19.69 16,497,429 $13.86
========== ==========
</TABLE>
<PAGE> 19
19
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 30, 1999 awards related to
366,898 shares 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 30, 1999.
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
<PAGE> 20
20
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.
<PAGE> 21
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Information with respect to change in benefit obligation, change in plan
assets, net amounts recognized at end of period, weighted average assumptions
and components of net periodic benefit cost follow:
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
---------------- --------------
1999 1999
---------- ---------
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of period............ $1,039,080 $ 255,951
Service Cost......................................... 2,368 761
Interest Cost........................................ 5,236 1,291
Plan participants' contributions..................... - 263
Benefits paid........................................ (4,050) (1,237)
---------- ---------
Benefit obligation at end of period.................. $1,042,634 $ 257,029
========== =========
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of period..... $1,239,441 $ --
Actual return on plan assets......................... 18,719 --
Employer contribution................................ 230 974
Plan participants' contributions..................... -- 263
Benefits paid........................................ (4,050) (1,237)
---------- ---------
Fair value of plan assets at end of period........... $1,254,340 $ --
========== =========
<CAPTION>
Pension plan assets include $174,989 of common stock of The Kroger Co. at January 30, 1999.
<S> <C> <C>
NET AMOUNT RECOGNIZED AT END OF PERIOD:
Funded status at end of period....................... $ 211,706 $(257,030)
Unrecognized actuarial gain.......................... (218,974) (38,240)
Unrecognized prior service cost...................... 18,675 (20,820)
Unrecognized net transition asset.................... (5,244) --
---------- ---------
Net amount recognized at end of period............... $ 6,163 $(316,090)
========== =========
Prepaid benefit cost................................. $ 32,519 $ --
Accrued benefit liability............................ (26,356) (316,090)
---------- ---------
Net amount recognized at end of period............... $ 6,163 $(316,090)
========== =========
</TABLE>
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
---------------- --------------
1999 1999
---------- ----------
<S> <C> <C>
WEIGHTED AVERAGE ASSUMPTIONS:
Discount rate.......................................... 6.75% 6.75%
Expected return on plan assets......................... 9.50% n/a
Rate of compensation increase.......................... 3.25% 3.25%
</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.
<PAGE> 22
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
<TABLE>
<CAPTION>
PENSION BENEFITS OTHER BENEFITS
---------------- --------------
1999 1999
-------- --------
<S> <C> <C>
COMPONENTS OF NET PERIODIC BENEFIT COST:
Service cost............................ $ 2,368 $ 761
Interest cost........................... 5,236 1,291
Expected return on plan assets.......... (7,339) --
Amortization of:
Transition asset................... (48) --
Prior service cost................. 165 (164)
Actuarial (gain) loss.............. (4) (50)
-------- -------
Net periodic benefit cost............... $ 378 $ 1,838
======== =======
</TABLE>
The accumulated benefit obligation for pension plans with no plan assets was
$26,352 as of January 30, 1999.
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..... $ 223 $ (187)
Effect on postretirement benefit obligation................. $24,719 $(21,889)
</TABLE>
The Company also administers certain defined contribution plans for eligible
union and non-union employees. The cost of these plans for the period ended
January 30, 1999 was $2,136.
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 the period ended January 30, 1999 was
$6,404.
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.
<PAGE> 23
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Information about the Company's operations by operating segment is as
follows:
<TABLE>
<CAPTION>
CORPORATE AND AMOUNTS NOT
RETAIL ALL OTHER ALLOCATED(A) CONSOLIDATED
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Period ended January 30, 1999
Sales............................... $ 2,099,949 $ 60,428 $ 2,160,377
Depreciation and amortization....... 27,698 5,676 33,374
Operating income.................... 51,536 8,687 $(20,522) 39,701
Total assets........................ 5,604,165 1,174,457 6,778,622
Capital expenditures................ 47,549 4,942 52,491
- -----------------------------------------------------------------------------------------------
</TABLE>
Intercompany eliminations are not material.
(A) Amounts not allocated to segments include LIFO charges, interest income, and
interest expense.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued Statement of Financial
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities". The Company has not yet determined what effect, if any, this
statement will have.
COMPREHENSIVE INCOME
The Company has no items of other comprehensive income in the period
presented. Therefore net earnings as presented in the Consolidated Statement of
Operations equals comprehensive income.
