Kroger Company (KR)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 7, 2009
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from         to
Commission file number 1-303

 

 

THE KROGER CO.

(Exact name of registrant as specified in its charter)

 

 

 

1014 Vine Street, Cincinnati, OH 45202

(Address of principal executive offices)

(Zip Code)

 

(513) 762-4000

(Registrant’s telephone number, including area code)

 

Unchanged

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x.

 

There were 649,891,077 shares of Common Stock ($1 par value) outstanding as of December 11, 2009.

 

 

 

PART I — FINANCIAL INFORMATION

 

Item 1.           Financial Statements.

 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share amounts)

(unaudited)

 

		Third Quarter Ended						Three Quarters Ended
		November 7, 2009			November 8, 2008			November 7, 2009			November 8, 2008
Sales		$	17,669		$	17,615		$	58,203		$	58,853
Merchandise costs, including advertising, warehousing, and transportation, excluding items shown separately below		13,666			13,545			44,583			45,456
Operating, general and administrative		3,140			3,104			10,263			9,998
Rent		152			152			502			510
Depreciation and amortization		356			335			1,157			1,095
Goodwill impairment charge		1,113			—			1,113			—
Operating profit (loss)		(758		)	479			585			1,794
Interest expense		105			106			383			369
Earnings (loss) before income tax expense		(863		)	373			202			1,425
Income tax expense		13			136			396			522
Net earnings (loss) including noncontrolling interests		(876		)	237			(194		)	903
Net earnings (loss) attributable to noncontrolling interests		(1		)	—			(9		)	3
Net earnings (loss) attributable to The Kroger Co.		$	(875	)	$	237		$	(185	)	$	900
Net earnings (loss) attributable to The Kroger Co. per basic common share		$	(1.35	)	$	0.36		$	(0.29	)	$	1.37
Average number of common shares used in basic calculation		646			649			647			653
Net earnings (loss) attributable to The Kroger Co. per diluted common share		$	(1.35	)	$	0.36		$	(0.29	)	$	1.36
Average number of common shares used in diluted calculation		646			655			647			659
Dividends declared per common share		$	.095		$	.09		$	.275		$	.27

 

The accompanying notes are an integral part of the Consolidated Financial Statements.

 

2

 

THE KROGER CO.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

(unaudited)

 

		November 7,			January 31,
		2009			2009
ASSETS
Current assets
Cash and temporary cash investments		$	517		$	263
Deposits in-transit		669			631
Receivables		817			944
FIFO inventory		6,093			5,659
LIFO credit		(848		)	(800		)
Prefunded employee benefits		—			300
Prepaid and other current assets		282			209
Total current assets		7,530			7,206
Property, plant and equipment, net		13,818			13,161
Goodwill		1,158			2,271
Other assets		578			573
Total Assets		$	23,084		$	23,211
LIABILITIES
Current liabilities
Current portion of long-term debt including obligations under capital leases and financing obligations		$	578		$	558
Trade accounts payable		4,169			3,822
Accrued salaries and wages		783			828
Deferred income taxes		344			344
Other current liabilities		2,290			2,077
Total current liabilities		8,164			7,629
Long-term debt including obligations under capital leases and financing obligations
Face-value long-term debt including obligations under capital leases and financing obligations		7,421			7,460
Adjustment to reflect fair-value interest rate hedges		55			45
Long-term debt including obligations under capital leases and financing obligations		7,476			7,505
Deferred income taxes		436			384
Pension and postretirement benefit obligations		914			1,174
Other long-term liabilities		1,242			1,248
Total Liabilities		18,232			17,940
Commitments and contingencies (see Note 12)
SHAREOWNERS’ EQUITY
Preferred stock, $100 par per share, 5 shares authorized and unissued		—			—
Common stock, $1 par per share, 1,000 shares authorized; 957 shares issued in 2009 and 955 shares issued in 2008		957			955
Additional paid-in capital		3,339			3,266
Accumulated other comprehensive loss		(491		)	(495		)
Accumulated earnings		7,123			7,489
Common stock in treasury, at cost, 311 shares in 2009 and 306 shares in 2008		(6,145		)	(6,039		)
Total Shareowners’ Equity - The Kroger Co.		4,783			5,176
Noncontrolling interests		69			95
Total Equity		4,852			5,271
Total Liabilities and Equity		$	23,084		$	23,211

 

The accompanying notes are an integral part of the Consolidated Financial Statements.

 

3

 

THE KROGER CO.

 CONSOLIDATED STATEMENTS OF CASH FLOWS

 (in millions and unaudited)

 

		Three Quarters Ended
		November 7, 2009			November 8, 2008
Cash Flows from Operating Activities:
Net earnings (loss) including noncontrolling interests		$	(194	)	$	903
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization		1,157			1,095
Goodwill impairment charge		1,113			—
Asset impairment charge		44			21
LIFO charge		48			155
Stock-based employee compensation		64			69
Expense for Company-sponsored pension plans		24			35
Deferred income taxes		51			147
Other		15			7
Changes in operating assets and liabilities net of effects from acquisitions of businesses:
Deposits in-transit		(38		)	66
Receivables		(4		)	(20		)
Inventories		(434		)	(669		)
Prepaid expenses		228			302
Trade accounts payable		351			293
Accrued expenses		(1		)	16
Income taxes receivable and payable		229			(25		)
Contribution to Company-sponsored pension plans		(265		)	(20		)
Other		(13		)	(18		)
Net cash provided by operating activities		2,375			2,357
Cash Flows from Investing Activities:
Payments for capital expenditures		(1,766		)	(1,613		)
Proceeds from sale of assets		7			51
Payments for acquisitions		(23		)	(80		)
Other		(13		)	(10		)
Net cash used by investing activities		(1,795		)	(1,652		)
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt		505			778
Dividends paid		(176		)	(168		)
Payments on long-term debt		(426		)	(1,017		)
Borrowings (payments) on credit facility		(129		)	133
Excess tax benefits on stock-based awards		2			13
Proceeds from issuance of capital stock		30			164
Treasury stock purchases		(130		)	(626		)
Decrease in book overdrafts		(4		)	(19		)
Other		2			10
Net cash used by financing activities		(326		)	(732		)
Net increase (decrease) in cash and temporary cash investments		254			(27		)
Cash from Consolidated Variable Interest Entity		—			65
Cash and temporary cash investments:
Beginning of year		263			242
End of quarter		$	517		$	280
Reconciliation of capital expenditures:
Payments for capital expenditures		$	(1,766	)	$	(1,613	)
Changes in construction-in-progress payables		(65		)	(106		)
Total capital expenditures		$	(1,831	)	$	(1,719	)
Disclosure of cash flow information:
Cash paid during the year for interest		$	434		$	404
Cash paid during the year for income taxes		$	119		$	444

 

The accompanying notes are an integral part of the Consolidated Financial Statements.

 

4

 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY

(in millions, except per share amounts)

(unaudited)

 

															Accumulated
							Additional								Other
		Common Stock					Paid-In			Treasury Stock					Comprehensive			Accumulated			Noncontrolling
		Shares		Amount			Capital			Shares		Amount			Gain (Loss)			Earnings			Interest			Total
Balances at February 2, 2008		947		$	947		$	3,031		284		$	(5,422	)	$	(122	)	$	6,480		$	7		$	4,921
Issuance of common stock:
Stock options exercised		7		7			155			—		2			—			—			—			164
Restricted stock issued		—		—			(43		)	(1	)	27			—			—			—			(16		)
Treasury stock activity:
Treasury stock purchases, at cost		—		—			—			17		(448		)	—			—			—			(448		)
Stock options exchanged		—		—			—			6		(177		)	—			—			—			(177		)
Tax benefits from exercise of stock options		—		—			33			—		—			—			—			—			33
Share-based employee compensation		—		—			69			—		—			—			—			—			69
Other comprehensive gain net of income tax of $5		—		—			—			—		—			7			—			—			7
Purchase of non-wholly owned entity		—		—			—			—		—			—			—			97			97
Other		—		—			12			—		(12		)	—			—			(11		)	(11		)
Cash dividends declared ($0.27 per common share)		—		—			—			—		—			—			(177		)	—			(177		)
Net earnings including noncontrolling interests		—		—			—			—		—			—			900			3			903
Balances at November 8, 2008		954		$	954		$	3,257		306		$	(6,030	)	$	(115	)	$	7,203		$	96		$	5,365
Balances at January 31, 2009		955		$	955		$	3,266		306		$	(6,039	)	$	(495	)	$	7,489		$	95		$	5,271
Issuance of common stock:
Stock options exercised		2		2			27			—		1			—			—			—			30
Restricted stock issued		—		—			(56		)	(1	)	40			—			—			—			(16		)
Treasury stock activity:
Treasury stock purchases, at cost		—		—			—			5		(106		)	—			—			—			(106		)
Stock options exchanged		—		—			—			1		(24		)	—			—			—			(24		)
Tax benefits from exercise of stock options		—		—			20			—		—			—			—			—			20
Share-based employee compensation		—		—			64			—		—			—			—			—			64
Other comprehensive gain net of income tax of $2		—		—			—			—		—			4			—			—			4
Other		—		—			18			—		(17		)	—			—			(17		)	(16		)
Cash dividends declared ($0.275 per common share)		—		—			—			—		—			—			(181		)	—			(181		)
Net earnings (loss) including noncontrolling interests		—		—			—			—		—			—			(185		)	(9		)	(194		)
Balances at November 7, 2009		957		$	957		$	3,339		311		$	(6,145	)	$	(491	)	$	7,123		$	69		$	4,852

 

The accompanying notes are an integral part of the Consolidated Financial Statements.

 

5

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

All amounts in the notes to Consolidated Financial Statements are in millions except per share amounts.

 

Certain prior-year amounts have been reclassified to conform to current-year presentation.

 

1.              ACCOUNTING POLICIES

 

Basis of Presentation and Principles of Consolidation

 

The accompanying financial statements include the consolidated accounts of The Kroger Co., its wholly-owned subsidiaries, and the Variable Interest Entities (“VIE”) in which the Company is the primary beneficiary.  The January 31, 2009 balance sheet was derived from audited financial statements, adjusted for the adoption of the new standards for the Company’s noncontrolling interest in a subsidiary and, due to its summary nature, does not include all disclosures required by generally accepted accounting principles (“GAAP”). Significant intercompany transactions and balances have been eliminated.  References to the “Company” in these Consolidated Financial Statements mean the consolidated company.

 

In the opinion of management, the accompanying unaudited Consolidated Financial Statements include all normal, recurring adjustments that are necessary for a fair presentation of results of operations for such periods but should not be considered as indicative of results for a full year. The financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted, pursuant to SEC regulations. Accordingly, the accompanying Consolidated Financial Statements should be read in conjunction with the Annual Report on Form 10-K of The Kroger Co. for the fiscal year ended January 31, 2009.

 

The unaudited information in the Consolidated Financial Statements for the third quarter and three quarters ended November 7, 2009 and November 8, 2008 includes the results of operations of the Company for the 40-week periods then ended.

 

In the first quarter of 2009, the Company adopted the new standards for a parent’s noncontrolling interests in a subsidiary and applied it retrospectively.  As a result, the Company reclassified noncontrolling interests in amounts of $95 from the mezzanine section to equity in the January 31, 2009 Consolidated Balance Sheet.  Certain reclassifications to the Consolidated Statements of Operations have been made to prior period amounts to conform to the presentation of the current period under the new standards.  Recorded amounts for prior periods previously presented as Net Earnings, which are now presented as Net Earnings Attributable to The Kroger Co., have not changed as a result of the adoption of the new standards.

 

Impairment of Long-Lived Assets

 

In accordance with GAAP, the Company monitors the carrying value of long-lived assets for potential impairment each quarter based on whether certain trigger events have occurred.  These events include current period losses combined with a history of losses or a projection of continuing losses or a significant decrease in the market value of an asset.  When a trigger event occurs, an impairment calculation is performed, comparing projected undiscounted future cash flows, utilizing current cash flow information and expected growth rates related to specific stores, to the carrying value for those stores.  If the Company identifies impairment for long-lived assets to be held and used, the Company compares the assets’ current carrying value to the assets’ fair value.  Fair value is based on current market values or discounted future cash flows.  The Company records impairment when the carrying value exceeds fair market value.  With respect to owned property and equipment held for sale, the value of the property and equipment is adjusted to reflect recoverable values based on previous efforts to dispose of similar assets and current economic conditions.  Impairment is recognized for the excess of the carrying value over the estimated fair market value, reduced by estimated direct costs of disposal.  The Company recorded asset impairments in the normal course of business totaling $29 in the third quarter of 2009 and $5 in the third quarter of 2008.  During the first three quarters of 2009 and 2008, the Company recorded asset impairments in the normal course of business totaling $44 and $21, respectively.  Included in these amounts are asset impairments recorded totaling $24 in both the third quarter and first three quarters of 2009 for a southern California reporting unit.  Costs to reduce the carrying value of long-lived assets for each of the years presented have been included in the Consolidated Statements of Operations as operating, general and administrative expense.

 

6

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Store Closing and Other Expense Allowances

 

The Company provides for closed store liabilities relating to the present value of the estimated remaining noncancelable lease payments after the closing date, net of estimated subtenant income.  The Company estimates the net lease liabilities using a discount rate to calculate the present value of the remaining net rent payments on closed stores.  The closed store lease liabilities usually are paid over the lease terms associated with the closed stores, which generally have remaining terms ranging from one to 20 years.  Adjustments to closed store liabilities primarily relate to changes in subtenant income and actual exit costs differing from original estimates.  Adjustments are made for changes in estimates in the period in which the change becomes known.  Store closing liabilities are reviewed quarterly to ensure that any accrued amount that is not a sufficient estimate of future costs, or that no longer is needed for its originally intended purpose, is adjusted to income in the proper period.

 

Owned stores held for disposal are reduced to their estimated net realizable value.  Costs to reduce the carrying values of property, equipment and leasehold improvements are accounted for in accordance with the Company’s policy on impairment of long-lived assets.  Inventory write-downs, if any, in connection with store closings, are classified in “Merchandise costs.”  Costs to transfer inventory and equipment from closed stores are expensed as incurred.

 

The following table summarizes accrual activity for future lease obligations of stores that were closed in the normal course of business and locations closed in California prior to the Fred Meyer merger in 1999.

 

		Future Lease Obligations
		November 7, 2009			November 8, 2008
Balance at beginning of year		$	65		$	74
Additions		3			2
Payments		(9		)	(10		)
Adjustments		(1		)	6
Balance at end of third quarter		$	58		$	72

 

2.              GOODWILL

 

The following table summarizes the changes in the Company’s goodwill balance through November 7, 2009.

 

		Goodwill
Balance at January 31, 2009
Goodwill		$	3,672
Accumulated impairment losses		(1,401		)
		2,271
Goodwill impairment charge		(1,113		)
Balance at November 7, 2009		$	1,158
Balance at November 7, 2009
Goodwill		$	3,672
Accumulated impairment losses		(2,514		)
Balance at November 7, 2009		$	1,158

 

Testing for impairment must be performed annually, or on an interim basis upon the occurrence of a triggering event or a change in circumstances that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  The Company last performed its annual test for impairment during the fourth quarter of 2008 and was scheduled to do so again in the fourth quarter of 2009.  In the third quarter of 2009, the Company's operating performance suffered due to deflation and intense competition.  Based on the revised forecast for the current year and the initial results of the Company's annual budget process of the supermarket reporting units, management believed that there were circumstances evident to warrant impairment testing at these reporting units as of November 7, 2009.  The Company did not test for impairment the variable interest entities with recorded goodwill as no triggering event occurred.  All reporting units will be tested in the fourth quarter during our annual review of goodwill.

 

7

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Based on the results of the Company's step 1 analysis, the Ralphs reporting unit in Southern California was the only reporting unit for which there was a potential impairment.  The operating performance of the Ralphs reporting unit was significantly affected by the current economic conditions and responses to competitive actions in Southern California.  As a result of this decline in current and future expected cash flows, along with comparable fair value information, management concluded that the carrying value of goodwill for the Ralphs reporting unit exceeded its implied fair value, resulting in a pre-tax impairment charge of $1.11 billion ($1.04 billion after tax).  Subsequent to the impairment, no goodwill remains at the Ralphs reporting unit.

 

The Company believes additional goodwill impairments will not be reasonably possible in the fourth quarter of 2009 upon completion of the Company’s annual review of goodwill impairment.  A 10% reduction in fair value of the other supermarket reporting units would not indicate a potential for impairment of the Company’s remaining goodwill balance for these reporting units, except for one supermarket reporting unit with less than $20 of recorded goodwill.

 

3.              STOCK OPTION PLANS

 

The Company recognized total stock-based compensation of $19 and $21 in the third quarter ended November 7, 2009 and November 8, 2009, respectively.  The Company recorded $64 and $69 of stock-based compensation for the first three quarters ended November 7, 2009 and November 8, 2008, respectively.  These costs were recognized as operating, general and administrative costs in the Company’s Consolidated Statements of Operations.

 

The Company grants options for common stock (“stock options”) to employees, as well as to its non-employee directors, under various plans at an option price equal to the fair market value of the stock at the date of grant. In addition to stock options, the Company awards restricted stock to employees and its non-employee directors under various plans.  Equity awards may be made once each quarter on a predetermined date.  It has been the Company’s practice to make a general annual grant to employees, which occurred in the second quarter of 2009.  Special grants may be made in the other three quarters.  It has been the Company’s practice to make a grant to non-employee directors in December of each year.

 

Stock options granted in the first three quarters of 2009 expire 10 years from the date of grant and vest from one year to five years from the date of grant. Restricted stock awards granted in the first three quarters of 2009 have restrictions that lapse in one year to five years from the date of the awards. All grants and awards become immediately exercisable, in the case of options, and restrictions lapse, in the case of restricted stock, upon certain changes of control of the Company.

 

Changes in equity awards outstanding under the plans are summarized below.

 

Stock Options

 

		Shares subject to option		Weighted-average exercise price
Outstanding, January 31, 2009		39.7		$	21.58
Granted		3.5		$	22.33
Exercised		(1.8	)	$	16.55
Canceled or Expired		(5.2	)	$	27.13
Outstanding, November 7, 2009		36.2		$	21.10

 

Restricted Stock

 

		Restricted shares outstanding		Weighted-average grant-date fair value
Outstanding, January 31, 2009		4.1		$	27.22
Granted		2.5		$	22.32
Lapsed		(2.1	)	$	27.40
Canceled or Expired		(0.1	)	$	25.69
Outstanding, November 7, 2009		4.4		$	24.39

 

8

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

The weighted-average fair value of stock options granted during the first three quarters ended November 7, 2009 and November 8, 2008, was $6.30 and $8.67, respectively. The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option-pricing model, based on the assumptions shown in the table below. The Black-Scholes model utilizes extensive accounting judgment and financial estimates, including the term employees are expected to retain their stock options before exercising them, the volatility of the Company’s stock price over that expected term, the dividend yield over the term, and the number of awards expected to be forfeited before they vest. Using alternative assumptions in the calculation of fair value would produce fair values for stock option grants that could be different than those used to record stock-based compensation expense in the Consolidated Statements of Operations.

 

The following table reflects the weighted average assumptions used for grants awarded to option holders:

 

		2009		2008
Risk-free interest rate		3.17%		3.64%
Expected dividend yield		1.80%		1.50%
Expected volatility		28.05%		27.89%
Expected term		6.8 Years		6.8 Years

 

4.              DEBT OBLIGATIONS

 

Long-term debt consists of:

 

		November 7,			January 31,
		2009			2009
Commercial Paper and Money Market Borrowings		$	—		$	129
3.90% to 8.05% Senior Notes and Debentures due through 2038		7,308			7,186
5.00% to 9.88% Mortgages due in varying amounts through 2034		108			119
Other		153			163
Total debt, excluding capital leases and financing obligations		7,569			7,597
Less current portion		(547		)	(528		)
Total long-term debt, excluding capital leases and financing obligations		$	7,022		$	7,069

 

On June 1, 2009, the Company repaid $350 of senior notes bearing an interest rate of 7.25%.  During the third quarter of 2009, the Company issued $500 of senior notes bearing an interest rate of 3.90% due in 2015, the proceeds of which will be used to repay, $500 of senior notes bearing an interest rate of 8.05% maturing in the first quarter of 2010.

 

9

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

5.              COMPREHENSIVE INCOME

 

Comprehensive income is as follows:

 

		Third Quarter Ended						Year-To-Date
		November 7, 2009			November 8, 2008			November 7, 2009			November 8, 2008
Net earnings (loss) including noncontrolling interests		$	(876	)	$	237		$	(194	)	$	903
Unrealized gain on hedging activities, net of tax(1)		—			—			—			3
Amortization of unrealized gains and losses on hedging activities, net of tax(2)		1			—			2			1
Amortization of amounts included in net periodic pension expense(3)		4			1			2			3
Other		—						—			—
Comprehensive income		(871		)	238			(190		)	910
Comprehensive income (loss) attributable to noncontrolling interests		(1		)	—			(9		)	3
Comprehensive income (loss) attributable to The Kroger Co.		$	(870	)	$	238		$	(181	)	$	907

 

(1)	Amount is net of tax of $2 for the first three quarters of 2008.
(2)	Amount is net of tax of $1 for the first three quarters of 2008.
(3)	Amount is net of tax of $2 for the third quarter of 2009. Amount is net of tax of $2 for both the first three quarters of 2009 and 2008.

 

During 2009 and 2008, unrealized gains and losses on hedging activities included in comprehensive income consisted of reclassifications of unrealized gains and losses on cash flow hedges into net earnings.

 

6.              BENEFIT PLANS

 

The following table provides the components of net periodic benefit costs for the Company-sponsored pension plans and other post-retirement benefit plans for the third quarter of 2009 and 2008.

 

		Third Quarter
		Pension Benefits						Other Benefits
		2009			2008			2009			2008
Components of net periodic benefit cost:
Service cost		$	12		$	11		$	3		$	3
Interest cost		36			40			5			4
Expected return on plan assets		(53		)	(40		)	—			—
Amortization of:
Prior service cost		1			—			(2		)	(2		)
Actuarial loss		9			8			(2		)	—
Net periodic benefit cost		$	5		$	19		$	4		$	5

 

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