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 9, 2013

 

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

 


 

(Exact name of registrant as specified in its charter)

 


 

Ohio

 

31-0345740

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

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):

 

Large accelerated filer

x

 

Accelerated filer

 

o

Non-accelerated filer (do not check if a smaller reporting company)

o

 

Smaller reporting company

 

o

 

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 516,526,256 shares of Common Stock ($1 par value) outstanding as of December 11, 2013.

 

 

 



 

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 9,
2013

 

November 3,
2012

 

November 9,
2013

 

November 3,
2012

 

Sales 

 

$

22,505

 

$

21,807

 

$

75,270

 

$

72,598

 

Merchandise costs, including advertising, warehousing, and transportation, excluding items shown separately below 

 

17,889

 

17,383

 

59,832

 

57,757

 

Operating, general and administrative 

 

3,549

 

3,305

 

11,664

 

11,161

 

Rent 

 

138

 

141

 

466

 

471

 

Depreciation

 

395

 

382

 

1,301

 

1,265

 

Operating profit 

 

534

 

596

 

2,007

 

1,944

 

Interest expense 

 

108

 

103

 

336

 

350

 

Earnings before income tax expense 

 

426

 

493

 

1,671

 

1,594

 

Income tax expense 

 

125

 

175

 

567

 

555

 

Net earnings including noncontrolling interests 

 

301

 

318

 

1,104

 

1,039

 

Net earnings attributable to noncontrolling interests

 

2

 

1

 

7

 

4

 

Net earnings attributable to The Kroger Co.

 

$

299

 

$

317

 

$

1,097

 

$

1,035

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. per basic common share

 

$

0.58

 

$

0.61

 

$

2.11

 

$

1.90

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in basic calculation 

 

515

 

518

 

515

 

539

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. per diluted common share

 

$

0.57

 

$

0.60

 

$

2.09

 

$

1.89

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in diluted calculation 

 

521

 

522

 

521

 

543

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.165

 

$

0.150

 

$

0.465

 

$

0.380

 

 

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

 

2



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions and unaudited)

 

 

 

Third Quarter Ended

 

Three Quarters Ended

 

 

 

November 9,
2013

 

November 3,
2012

 

November 9,
2013

 

November 3,
2012

 

Net earnings including noncontrolling interests

 

$

301

 

$

318

 

$

1,104

 

$

1,039

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on available for sale securities, net of income tax(1)

 

(1

)

 

3

 

 

Amortization of amounts included in net periodic pension expense, net of income tax(2)

 

14

 

13

 

47

 

44

 

Unrealized gains and losses on cash flow hedging activities, net of income tax(3)

 

(2

)

3

 

(11

)

(11

)

Amortization of unrealized gains and losses on cash flow hedging activities, net of income tax(4)

 

 

1

 

1

 

3

 

 

 

 

 

 

 

 

 

 

 

Total other comprehensive income

 

11

 

17

 

40

 

36

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

312

 

335

 

1,144

 

1,075

 

Comprehensive income attributable to noncontrolling interests

 

2

 

1

 

7

 

4

 

Comprehensive income attributable to The Kroger Co.

 

$

310

 

$

334

 

$

1,137

 

$

1,071

 

 


(1)         Amount is net of tax of $2 for the first three quarters of 2013.

(2)         Amount is net of tax of $9 for the third quarter of 2013 and $8 for the third quarter of 2012.  Amount is net of tax of $29 for the first three quarters of 2013 and $27 for the first three quarters of 2012.

(3)         Amount is net of tax of $(3) for the third quarter of 2013 and $2 for the third quarter of 2012.  Amount is net of tax of $(8) for the first three quarters of 2013 and $(7) for the first three quarters of 2012.

(4)         Amount is net of tax of $1 for the third quarter and the first three quarters of 2013.

 

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

 

3



 

THE KROGER CO.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

(unaudited)

 

 

 

November 9,

 

February 2,

 

 

 

2013

 

2013

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and temporary cash investments

 

$

344

 

$

238

 

Store deposits in-transit

 

881

 

955

 

Receivables

 

1,044

 

1,051

 

FIFO inventory

 

6,768

 

6,244

 

LIFO reserve

 

(1,140

)

(1,098

)

Prepaid and other current assets

 

315

 

569

 

Total current assets

 

8,212

 

7,959

 

 

 

 

 

 

 

Property, plant and equipment, net

 

15,456

 

14,849

 

Goodwill

 

1,234

 

1,234

 

Other assets

 

578

 

593

 

 

 

 

 

 

 

Total Assets

 

$

25,480

 

$

24,635

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities

 

 

 

 

 

Current portion of long-term debt including obligations under capital leases and financing obligations

 

$

1,122

 

$

2,734

 

Trade accounts payable

 

4,941

 

4,484

 

Accrued salaries and wages

 

1,047

 

1,017

 

Deferred income taxes

 

284

 

284

 

Other current liabilities

 

2,799

 

2,538

 

Total current liabilities

 

10,193

 

11,057

 

 

 

 

 

 

 

Long-term debt including obligations under capital leases and financing obligations

 

 

 

 

 

Face-value of long-term debt including obligations under capital leases and financing obligations

 

7,148

 

6,141

 

Adjustment to reflect fair-value interest rate hedges

 

¾

 

4

 

Long-term debt including obligations under capital leases and financing obligations

 

7,148

 

6,145

 

 

 

 

 

 

 

Deferred income taxes

 

816

 

800

 

Pension and postretirement benefit obligations

 

1,207

 

1,291

 

Other long-term liabilities

 

1,126

 

1,128

 

 

 

 

 

 

 

Total Liabilities

 

20,490

 

20,421

 

 

 

 

 

 

 

Commitments and contingencies (see Note 8)

 

 

 

 

 

 

 

 

 

 

 

SHAREOWNERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Preferred shares, $100 per share, 5 shares authorized and unissued

 

¾

 

¾

 

Common shares, $1 par per share, 1,000 shares authorized; 959 shares issued in 2013 and 2012

 

959

 

959

 

Additional paid-in capital

 

3,513

 

3,451

 

Accumulated other comprehensive loss

 

(713

)

(753

)

Accumulated earnings

 

10,651

 

9,787

 

Common shares in treasury, at cost, 445 shares in 2013 and 2012

 

(9,426

)

(9,237

)

 

 

 

 

 

 

Total Shareowners’ Equity - The Kroger Co.

 

4,984

 

4,207

 

Noncontrolling interests

 

6

 

7

 

 

 

 

 

 

 

Total Equity

 

4,990

 

4,214

 

 

 

 

 

 

 

Total Liabilities and Equity

 

$

25,480

 

$

24,635

 

 

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

 

4



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions and unaudited)

 

 

 

Three Quarters Ended

 

 

 

November 9,
2013

 

November 3,
2012

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net earnings including noncontrolling interests 

 

$

1,104

 

$

1,039

 

Adjustments to reconcile net earnings including noncontrolling interests to net cash provided by operating activities: 

 

 

 

 

 

Depreciation

 

1,301

 

1,265

 

LIFO charge 

 

42

 

96

 

Stock-based employee compensation 

 

78

 

61

 

Expense for Company-sponsored pension plans 

 

57

 

68

 

Deferred income taxes 

 

21

 

130

 

Other 

 

62

 

37

 

Changes in operating assets and liabilities net of effects from acquisitions of businesses: 

 

 

 

 

 

Store deposits in-transit 

 

74

 

(134

)

Receivables 

 

5

 

(131

)

Inventories 

 

(524

)

(531

)

Prepaid expenses 

 

262

 

(32

)

Trade accounts payable 

 

402

 

386

 

Accrued expenses 

 

142

 

57

 

Income taxes receivable and payable 

 

11

 

115

 

Other 

 

(120

)

(158

)

 

 

 

 

 

 

Net cash provided by operating activities 

 

2,917

 

2,268

 

 

 

 

 

 

 

Cash Flows from Investing Activities: 

 

 

 

 

 

Payments for property and equipment, including payments for lease buyouts 

 

(1,786

)

(1,471

)

Proceeds from sale of assets 

 

15

 

23

 

Payments for acquisitions

 

¾

 

(12

)

Other 

 

(47

)

(28

)

 

 

 

 

 

 

Net cash used by investing activities 

 

(1,818

)

(1,488

)

 

 

 

 

 

 

Cash Flows from Financing Activities: 

 

 

 

 

 

Proceeds from issuance of long-term debt

 

1,025

 

850

 

Dividends paid 

 

(233

)

(189

)

Payments on long-term debt 

 

(431

)

(921

)

Net (payments) borrowings on commercial paper

 

(1,220

)

744

 

Excess tax benefits on stock-based awards

 

24

 

5

 

Proceeds from issuance of capital stock 

 

186

 

72

 

Treasury stock purchases 

 

(384

)

(1,204

)

Net increase in book overdrafts

 

56

 

115

 

Other 

 

(16

)

(5

)

 

 

 

 

 

 

Net cash used by financing activities 

 

(993

)

(533

)

 

 

 

 

 

 

Net increase in cash and temporary cash investments 

 

106

 

247

 

 

 

 

 

 

 

Cash and temporary cash investments: 

 

 

 

 

 

Beginning of year 

 

238

 

188

 

End of quarter 

 

$

344

 

$

435

 

 

 

 

 

 

 

Reconciliation of capital investments: 

 

 

 

 

 

Payments for property and equipment, including payments for lease buyouts 

 

$

(1,786

)

$

(1,471

)

Payments for lease buyouts

 

108

 

24

 

Changes in construction-in-progress payables 

 

(110

)

(11

)

Total capital investments, excluding lease buyouts 

 

$

(1,788

)

$

(1,458

)

 

 

 

 

 

 

Disclosure of cash flow information: 

 

 

 

 

 

Cash paid during the year for interest 

 

$

308

 

$

320

 

Cash paid during the year for income taxes 

 

$

489

 

$

334

 

 

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

 

5



 

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 January 28, 2012

 

959

 

$

959

 

$

3,427

 

398

 

$

(8,132

)

$

(844

)

$

8,571

 

$

(15

)

$

3,966

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

 

 

(4

)

72

 

 

 

 

72

 

Restricted stock issued

 

 

 

(57

)

(2

)

38

 

 

 

 

(19

)

Treasury stock activity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Treasury stock purchases, at cost

 

 

 

 

50

 

(1,137

)

 

 

 

(1,137

)

Stock options exchanged

 

 

 

 

3

 

(67

)

 

 

 

(67

)

Share-based employee compensation

 

 

 

61

 

 

 

 

 

 

61

 

Other comprehensive gain net of income tax of $20

 

 

 

 

 

 

36

 

 

 

36

 

Other

 

 

 

3

 

 

(2

)

 

 

12

 

13

 

Cash dividends declared ($0.38 per common share)

 

 

 

 

 

 

 

(202

)

 

(202

)

Net earnings including noncontrolling interests

 

 

 

 

 

 

 

1,035

 

4

 

1,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at November 3, 2012

 

959

 

$

959

 

$

3,434

 

445

 

$

(9,228

)

$

(808

)

$

9,404

 

$

1

 

$

3,762

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at February 2, 2013

 

959

 

$

959

 

$

3,451

 

445

 

$

(9,237

)

$

(753

)

$

9,787

 

$

7

 

$

4,214

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

 

 

(8

)

186

 

 

 

 

186

 

Restricted stock issued

 

 

 

(58

)

(2

)

26

 

 

 

 

(32

)

Treasury stock activity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Treasury stock purchases, at cost

 

 

 

 

3

 

(126

)

 

 

 

(126

)

Stock options exchanged

 

 

 

 

7

 

(258

)

 

 

 

(258

)

Share-based employee compensation

 

 

 

78

 

 

 

 

 

 

78

 

Other comprehensive gain net of income tax of $24

 

 

 

 

 

 

40

 

 

 

40

 

Other

 

 

 

42

 

 

(17

)

 

 

(8

)

17

 

Cash dividends declared ($0.465 per common share)

 

 

 

 

 

 

 

(233

)

 

(233

)

Net earnings including noncontrolling interests

 

 

 

 

 

 

 

1,097

 

7

 

1,104

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at November 9, 2013

 

959

 

$

959

 

$

3,513

 

445

 

$

(9,426

)

$

(713

)

$

10,651

 

$

6

 

$

4,990

 

 

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

 

6



 

NOTES TO UNAUDITED 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 (“VIEs”) in which the Company is the primary beneficiary.  The February 2, 2013 balance sheet was derived from audited financial statements and, due to its summary nature, does not include all disclosures required by generally accepted accounting principles (“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 financial statements in the Annual Report on Form 10-K of The Kroger Co. for the fiscal year ended February 2, 2013.

 

The unaudited information in the Consolidated Financial Statements for the third quarter and the three quarters ended November 9, 2013 and November 3, 2012, includes the results of operations of the Company for the 12 and 40-week periods then ended.

 

2.  STOCK OPTION PLANS

 

The Company recognized total stock-based compensation of $31 and $20 in the third quarters ended November 9, 2013 and November 3, 2012, respectively.  The Company recognized total stock-based compensation of $78 and $61 in the first three quarters of 2013 and 2012, 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 shares (“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 shares 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.  Beginning in 2013, non-employee directors were awarded incentive shares in lieu of restricted stock and stock options.  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 2013.  Special grants may be made in the other three quarters.  Grants to non-employee directors occur on the same date that the general annual grant to employees occurs.

 

Stock options granted in the first three quarters of 2013 expire 10 years from the date of grant and vest between one year and five years from the date of grant. Restricted stock awards granted in the first three quarters of 2013 have restrictions that lapse between one year and 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.

 

7



 

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

 

Stock Options

 

 

 

Shares subject
to option

 

Weighted-average
exercise price

 

Outstanding, February 2, 2013 

 

26.5

 

$

22.61

 

Granted 

 

4.2

 

$

37.65

 

Exercised 

 

(8.4

)

$

22.25

 

Canceled or Expired 

 

(0.2

)

$

24.81

 

 

 

 

 

 

 

Outstanding, November 9, 2013 

 

22.1

 

$

25.55

 

 

Restricted Stock

 

 

 

Restricted shares
outstanding

 

Weighted-average
grant-date fair value

 

Outstanding, February 2, 2013 

 

4.3

 

$

22.67

 

Granted 

 

2.6

 

$

37.62

 

Vested 

 

(2.5

)

$

22.90

 

Forfeited

 

(0.1

)

$

26.01

 

 

 

 

 

 

 

Outstanding, November 9, 2013 

 

4.3

 

$

31.47

 

 

The weighted-average grant date fair value of stock options granted during the first three quarters of 2013 and 2012, was $8.97 and $4.37, 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 option holders 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 increase in the fair value of the stock options granted during the first three quarters of 2013, compared to the first three quarters of 2012, resulted primarily from an increase in the Company’s share price, which decreased the expected dividend yield and an increase in the weighted average risk-free interest rate.

 

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

 

 

 

2013

 

2012

Risk-free interest rate

 

1.87%

 

0.97%

Expected dividend yield

 

1.82%

 

2.49%

Expected volatility

 

26.34%

 

26.49%

Expected term

 

6.8 Years

 

6.9 Years

 

8



 

3.              DEBT OBLIGATIONS

 

Long-term debt consists of:

 

 

 

November 9,

 

February 2,

 

 

 

2013

 

2013

 

2.20% to 8.00% Senior Notes due through 2043 

 

$

7,186

 

$

6,587

 

5.00% to 12.75% Mortgages due in varying amounts through 2034

 

82

 

60

 

0.28% to 0.45% Commercial paper borrowings due through November 2013

 

425

 

1,645

 

Other 

 

185

 

184

 

 

 

 

 

 

 

Total debt, excluding capital leases and financing obligations 

 

7,878

 

8,476

 

 

 

 

 

 

 

Less current portion 

 

(1,087

)

(2,700

)

 

 

 

 

 

 

Total long-term debt, excluding capital leases and financing obligations 

 

$

6,791

 

$

5,776

 

 

In the first quarter of 2013, the Company repaid $400 of senior notes bearing an interest rate of 5.00% upon their maturity.

 

In the second quarter of 2013, the Company issued $600 of senior notes due in fiscal year 2023 bearing an interest rate of 3.85% and $400 of senior notes due in fiscal year 2043 bearing an interest rate of 5.15%.

 

In the first three quarters of 2013, the Company decreased the amount of commercial paper borrowings outstanding by $1,220.

 

4.              BENEFIT PLANS

 

The following table provides the components of net periodic benefit costs for the Company-sponsored defined benefit pension plans and other post-retirement benefit plans for the third quarters of 2013 and 2012.

 

 

 

Third Quarter Ended

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

November 9,
2013

 

November 3,
2012

 

November 9,
2013

 

November 3,
2012

 

Components of net periodic benefit cost: 

 

 

 

 

 

 

 

 

 

Service cost 

 

$

10

 

$

11

 

$

4

 

$

4

 

Interest cost 

 

35

 

36

 

3

 

3

 

Expected return on plan assets 

 

(52

)

(49

)

 

 

Amortization of: 

 

 

 

 

 

 

 

 

 

Prior service cost 

 

 

 

(1

)

(1

)

Actuarial loss 

 

24

 

22

 

 

 

 

 

 

 

 

 

 

 

 

 

Net periodic benefit cost 

 

$

17

 

$

20

 

$

6

 

$

6

 

 

9



 

The following table provides the components of net periodic benefit costs for the Company-sponsored defined benefit pension plans and other post-retirement benefit plans for the first three quarters of 2013 and 2012.

 

 

 

Three Quarters Ended

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

November 9,
2013

 

November 3,
2012

 

November 9,
2013

 

November 3,
2012

 

Components of net periodic benefit cost: 

 

 

 

 

 

 

 

 

 

Service cost 

 

$

33

 

$

36

 

$

13

 

$

13

 

Interest cost 

 

118

 

120

 

12

 

12

 

Expected return on plan assets 

 

(173

)

(162

)

 

 

Amortization of: 

 

 

 

 

 

 

 

 

 

Prior service cost 

 

 

 

(3

)

(3

)

Actuarial loss 

 

79

 

74

 

 

 

 

 

 

 

 

 

 

 

 

 

Net periodic benefit cost 

 

$

57

 

$

68

 

$

22

 

$

22

 

 

The Company contributed $100 to its Company-sponsored defined benefit pension plans in the first quarter of 2013.  The Company did not make any contributions in the second and third quarters of 2013 and does not expect to make any additional contributions in 2013.

 

The Company contributed $115 and $110 to employee 401(k) retirement savings accounts in the first three quarters of 2013 and 2012, respectively.

 

The Company also contributes to various multi-employer pension plans based on obligations arising from most of its collective bargaining agreements. These plans provide retirement benefits to participants based on their service to contributing employers. The Company recognizes expense in connection with these plans as contributions are funded.

 

5.              EARNINGS PER COMMON SHARE

 

Net earnings attributable to The Kroger Co. per basic common share equal net earnings attributable to The Kroger Co. less income allocated to participating securities divided by the weighted average number of common shares outstanding. Net earnings attributable to The Kroger Co. per diluted common share equal net earnings attributable to The Kroger Co. less income allocated to participating securities divided by the weighted average number of common shares outstanding, after giving effect to dilutive stock options. The following table provides a reconciliation of net earnings attributable to The Kroger Co. and shares used in calculating net earnings attributable to The Kroger Co. per basic common share to those used in calculating net earnings attributable to The Kroger Co. per diluted common share:

 

 

 

Third Quarter Ended

 

Third Quarter Ended

 

 

 

November 9, 2013

 

November 3, 2012

 

 

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Net earnings attributable to The Kroger Co. per basic common share 

 

$

297

 

515

 

$

0.58

 

$

314

 

518

 

$

0.61

 

Dilutive effect of stock options

 

 

 

6

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. per diluted common share 

 

$

297

 

521

 

$

0.57

 

$

314

 

522

 

$

0.60

 

 

 

 

Three Quarters Ended

 

Three Quarters Ended

 

 

 

November 9, 2013

 

November 3, 2012

 

 

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Net earnings attributable to The Kroger Co. per basic common share 

 

$

1,088

 

515

 

$

2.11

 

$

1,027

 

539

 

$

1.90

 

Dilutive effect of stock options

 

 

 

6

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. per diluted common share 

 

$

1,088

 

521

 

$

2.09

 

$

1,027

 

543

 

$

1.89

 

 

10



 

The Company had combined undistributed and distributed earnings to participating securities totaling $2 in the third quarter of 2013 and $3 in the third quarter of 2012.  For the first three quarters of 2013 and 2012, the Company had combined undistributed and distributed earnings to participating securities of $9 and $8, respectively.

 

The Company had options outstanding for approximately 4 and 14 shares during the third quarters of 2013 and 2012, respectively, which were excluded from the computations of earnings per diluted common share because their inclusion would have had an anti-dilutive effect on earnings per share.  The Company had options outstanding for approximately 2 shares in the first three quarters of 2013 and 12 shares in the first three quarters of 2012 that were excluded from the computations of earnings per diluted common share because their inclusion would have had an anti-dilutive effect on earnings per share.

 

6.              RECENTLY ADOPTED ACCOUNTING STANDARDS

 

In February 2013, the Financial Accounting Standards Board (“FASB”) amended its standards on comprehensive income by requiring disclosure of information about amounts reclassified out of accumulated other comprehensive income (“AOCI”) by component.  Specifically, the amendment requires disclosure of the effect of significant reclassifications out of AOCI on the respective line items in net income in which the item was reclassified if the amount being reclassified is required to be reclassified to net income in its entirety in the same reporting period.  It requires cross reference to other disclosures that provide additional detail for amounts that are not required to be reclassified in their entirety in the same reporting period.  This new disclosure became effective for the Company beginning February 3, 2013, and is being adopted prospectively in accordance with the standard.  See Note 11 to the Company’s Consolidated Financial Statements for the Company’s new disclosures related to this amended standard.

 

In December 2011, the FASB amended its standards related to offsetting assets and liabilities.  This amendment requires entities to disclose both gross and net information about certain instruments and transactions eligible for offset in the statement of financial position and certain instruments and transactions subject to an agreement similar to a master netting agreement.  This information is intended to enable users of the financial statements to understand the effect of these arrangements on the Company’s financial position.  The new rules became effective for the Company on February 3, 2013.  In January 2013, the FASB further amended this standard to limit its scope to derivatives, repurchase and reverse repurchase agreements, securities borrowings and lending transactions.  See Note 9 to the Company’s Consolidated Financial Statements for the Company’s new disclosures related to this amended standard.

 

7.              RECENTLY ISSUED ACCOUNTING STANDARDS

 

In July 2013, the FASB amended Accounting Standards Codification (“ASC”) 740, “Income Taxes.” The amendment provides guidance on the financial statement presentation of an unrecognized tax benefit, as either a reduction of a deferred tax asset or as a liability, when a net operating loss carryforward, similar tax loss, or a tax credit carryforward exists. The amendment will be effective for interim and annual periods beginning after December 15, 2013 and may be applied on a retrospective basis.  Early adoption is permitted. The Company does not expect the adoption of this amendment to have a significant effect on the Company’s consolidated financial position or results of operations.

 

8.              COMMITMENTS AND CONTINGENCIES

 

The Company continuously evaluates contingencies based upon the best available evidence.

 

The Company 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 the Company’s estimates, future earnings will be charged or credited.

 

Litigation — Various claims and lawsuits arising in the normal course of business, including suits charging violations of certain antitrust, wage and hour, or civil rights laws, are pending against the Company.  Some of these suits purport or have been determined to be class actions and/or seek substantial damages.  Any damages that may be awarded in antitrust cases will be automatically trebled.  Although it is not possible at this time to evaluate the merits of all of these claims and lawsuits, nor their likelihood of success, the Company is of the belief that any resulting liability will not have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

 

11



 

The Company continually evaluates its exposure to loss contingencies arising from pending or threatened litigation and believes it has made provisions where it is reasonably possible to estimate and where an adverse outcome is probable.  Nonetheless, assessing and predicting the outcomes of these matters involve substantial uncertainties.  Management currently believes that the aggregate range of loss for the Company’s exposure is not material to the Company.  It remains possible that despite management’s current belief, material differences in actual outcomes or changes in management’s evaluation or predictions could arise that could have a material adverse effect on the Company’s financial condition, results of operations, or cash flows.

 

9.              DERIVATIVE FINANCIAL INSTRUMENTS

 

GAAP defines derivatives, requires that derivatives be carried at fair value on the balance sheet, and provides for hedge accounting when certain conditions are met.  The Company’s derivative financial instruments are recognized on the balance sheet at fair value.  Changes in the fair value of derivative instruments designated as “cash flow” hedges, to the extent the hedges are highly effective, are recorded in other comprehensive income, net of tax effects.  Ineffective portions of cash flow hedges, if any, are recognized in current period earnings.  Other comprehensive income or loss is reclassified into current period earnings when the hedged transaction affects earnings.  Changes in the fair value of derivative instruments designated as “fair value” hedges, along with corresponding changes in the fair value of the hedged assets or liabilities, are recorded in current period earnings.  Ineffective portions of fair value hedges, if any, are recognized in current period earnings.

 

The Company assesses, both at the inception of the hedge and on an ongoing basis, whether derivatives used as hedging instruments are highly effective in offsetting the changes in the fair value or cash flow of the hedged items.  If it is determined that a derivative is not highly effective as a hedge or ceases to be highly effective, the Company discontinues hedge accounting prospectively.

 

Interest Rate Risk Management

 

The Company is exposed to market risk from fluctuations in interest rates.  The Company manages its exposure to interest rate fluctuations through the use of interest rate swaps (fair value hedges) and forward-starting interest rate swaps (cash flow hedges).  The Company’s current program relative to interest rate protection contemplates hedging the exposure to changes in the fair value of fixed-rate debt attributable to changes in interest rates.  To do this, the Company uses the following guidelines: (i) use average daily outstanding borrowings to determine annual debt amounts subject to interest rate exposure, (ii) limit the average annual amount subject to interest rate reset and the amount of floating rate debt to a combined total of $2,500 or less, (iii) include no leveraged products, and (iv) hedge without regard to profit motive or sensitivity to current mark-to-market status.

 

Annually, the Company reviews with the Financial Policy Committee of the Board of Directors compliance with these guidelines.  These guidelines may change as the Company’s needs dictate.

 

Fair Value Interest Rate Swaps

 

The table below summarizes the outstanding interest rate swaps designated as fair value hedges as of November 9, 2013 and February 2, 2013.

 

 

 

November 9, 2013

 

February 2, 2013

 

 

 

Pay
Floating

 

Pay
Fixed

 

Pay
Floating

 

Pay
Fixed

 

Notional amount

 

$

100

 

$

 

$

475

 

$

 

Number of contracts

 

2

 

 

6

 

 

Duration in years

 

5.17

 

 

1.41

 

 

Average variable rate

 

5.84

%

 

3.29

%

 

Average fixed rate

 

6.80

%

 

5.38

%

 

Maturity

 

December 2018

 

Between April 2013 and December 2018

 

 

During the first quarter of 2013, four of the Company’s fair value swaps, with a notional amount aggregating $375, matured.

 

12



 

The gain or loss on these derivative instruments as well as the offsetting gain or loss on the hedged items attributable to the hedged risk is recognized in current income as “Interest expense.”  These gains and losses for the third quarters and first three quarters of 2013 and 2012 were as follows:

 

 

 

Third Quarter Ended

 

 

 

November 9, 2013

 

November 3, 2012

 

Income Statement Classification

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Interest Expense

 

$

1

 

$

(2

)

$

(4

)

$

4

 

 

 

 

Three Quarters Ended

 

 

 

November 9, 2013

 

November 3, 2012

 

Income Statement Classification

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Interest Expense

 

$

(4

)

$

3

 

$

(18

)

$

14

 

 

The following table summarizes the location and fair value of derivative instruments designated as fair value hedges on the Company’s Consolidated Balance Sheets:

 

 

 

Asset Derivatives

 

 

 

Fair Value

 

 

 

Derivatives Designated as Fair Value Hedging Instruments

 

November 9,
2013

 

February 2,
2013

 

Balance Sheet Location

 

Interest Rate Hedges

 

$

(3

)

$

1

 

(Other Long-Term Liabilities)/Other Assets

 

 

Cash Flow Forward-Starting Interest Rate Swaps

 

As of November 9, 2013, the Company had 5 forward-starting interest rate swap agreements with maturity dates of January 2014 with an aggregate notional amount totaling $250.  A forward-starting interest rate swap is an agreement that effectively hedges the variability in future benchmark interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt.  The Company entered into these forward-starting interest rate swaps in order to lock in fixed interest rates on its forecasted issuances of debt in fiscal year 2013.  Accordingly, the forward-starting interest rate swaps were designated as cash-flow hedges as defined by GAAP.  As of November 9, 2013, the fair value of the interest rate swaps was recorded in other assets for $18 and accumulated other comprehensive income (“AOCI”) for $11 net of tax.

 

As of February 2, 2013, the Company had 17 forward-starting interest rate swap agreements with maturity dates between April 2013 and January 2014 with an aggregate notional amount totaling $850.  In 2012, the Company entered into 7 of these forward-starting interest rate swap agreements with an aggregate notional amount totaling $350.  The Company entered into the forward-starting interest rate swaps in order to lock in fixed interest rates on its forecasted issuances of debt in fiscal year 2013.  Accordingly, the forward-starting interest rate swaps were designated as cash-flow hedges as defined by GAAP.  As of February 2, 2013, the fair value of the interest rate swaps was recorded in other assets and other long-term liabilities for $14 and $9, respectively, and AOCI and accumulated other comprehensive loss for $9 net of tax and $6 net of tax, respectively.

 

During the first quarter of 2013, the Company terminated 12 forward-starting interest rate swap agreements with maturity dates of April 2013 with an aggregate notional amount totaling $600.  In addition, in the first quarter of 2013, the Company entered into and terminated 7 forward-starting interest rate swap agreements with an aggregate notional amount totaling $600.  These 19 forward-starting interest rate swap agreements were hedging the variability in future benchmark interest payments attributable to changing interest rates on $600 of fixed-rate debt that the Company anticipated issuing at the time.  As discussed in Note 3, the Company issued $1,000 of senior notes in the second quarter of 2013.  Since these forward-starting interest rate swap agreements were classified as cash flow hedges, the unamortized loss of $32, $20 net of tax, is deferred in accumulated other comprehensive loss and will be amortized to earnings as interest payments are made on the related debt.

 

13



 

The following tables summarize the effect of the Company’s derivative instruments designated as cash flow hedges for the third quarters and first three quarters of 2013 and 2012:

 

 

 

Third Quarter Ended

 

 

 

 

 

Amount of Gain/(Loss) in
AOCI on Derivatives
(Effective Portion)

 

Amount of Gain/(Loss)
Reclassified from AOCI into
Income (Effective Portion)

 

Location of Gain/(Loss)

 

Derivatives in Cash Flow Hedging
Relationships

 

November 9,
2013

 

November 3,
2012

 

November 9,
2013

 

November 3,
2012

 

Reclassified into Income
(Effective Portion)

 

Forward-Starting Interest Rate Swaps, net of tax*

 

$

(24

)

$

(39

)

$

 

$

(1

)

Interest expense

 

 


*The amounts of Gain/(Loss) in AOCI on derivatives include unamortized proceeds and payments from forward-starting interest rate swaps once classified as cash flow hedges. 

 

 

 

Three Quarters Ended

 

 

 

 

 

Amount of Gain/(Loss) in
AOCI on Derivatives
(Effective Portion)

 

Amount of Gain/(Loss)
Reclassified from AOCI into
Income (Effective Portion)

 

Location of Gain/(Loss)

 

Derivatives in Cash Flow Hedging
Relationships

 

November 9,
2013

 

November 3,
2012

 

November 9,
2013

 

November 3,
2012

 

Reclassified into Income
(Effective Portion)

 

Forward-Starting Interest Rate Swaps, net of tax*

 

$

(24

)

$

(39

)

$

(1

)

$

(3

)

Interest expense

 

 


*The amounts of Gain/(Loss) in AOCI on derivatives include unamortized proceeds and payments from forward-starting interest rate swaps once classified as cash flow hedges. 

 

For the above fair value and cash flow interest rate swaps, the Company has entered into International Swaps and Derivatives Association master netting agreements that permit the net settlement of amounts owed under their respective derivative contracts.  Under these master netting agreements, net settlement generally permits the Company or the counterparty to determine the net amount payable for contracts due on the same date and in the same currency for similar types of derivative transactions.  These master netting agreements generally also provide for net settlement of all outstanding contracts with a counterparty in the case of an event of default or a termination event.

 

Collateral is generally not required of the counterparties or of the Company under these master netting agreements. As of November 9, 2013 and February 2, 2013, no cash collateral was received or pledged under the master netting agreements.

 

14



 

The effect of the net settlement provisions of these master netting agreements on the Company’s derivative balances upon an event of default or termination event is as follows as of November 9, 2013 and February 2, 2013:

 

 

 

 

 

Gross Amounts Offset

 

Net Amount
Presented in the

 

Gross Amounts Not Offset in the
Statement of Financial Position

 

 

 

November 9, 2013

 

Gross Amount
Recognized

 

in the Statement of
Financial Position

 

Statement of
Financial Position

 

Financial
Instruments

 

Cash Collateral

 

Net Amount

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flow Forward-Starting Interest Rate Swaps

 

$

18

 

$

 

$

18

 

$

 

$

 

$

18

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Interest Rate Swaps

 

$

3

 

$

 

$

3

 

$

 

$

 

$

3

 

 

 

 

 

 

Gross Amounts Offset

 

Net Amount
Presented in the

 

Gross Amounts Not Offset in the
Statement of Financial Position

 

 

 

February 2, 2013

 

Gross Amount
Recognized

 

in the Statement of
Financial Position

 

Statement of
Financial Position

 

Financial
Instruments

 

Cash Collateral

 

Net Amount

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flow Forward-Starting Interest Rate Swaps

 

$

16

 

$

(2

)

$

14

 

$

 

$

 

$

14

 

Fair Value Interest Rate Swaps

 

1

 

 

1

 

 

 

1

 

Total

 

$

17

 

$

(2

)

$

15

 

$

 

$

 

$

15

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash Flow Forward-Starting Interest Rate Swaps

 

$

11

 

$

(2

)

$

9

 

$

 

$

 

$

9

 

 

Commodity Price Protection

 

The Company enters into purchase commitments for various resources, including raw materials utilized in its manufacturing facilities and energy to be used in its stores, warehouses, manufacturing facilities and administrative offices.  The Company enters into commitments expecting to take delivery of and to utilize those resources in the conduct of normal business.  Those commitments for which the Company expects to utilize or take delivery in a reasonable amount of time in the normal course of business qualify as normal purchases and normal sales.

 

10.       FAIR VALUE MEASUREMENTS

 

GAAP establishes a fair value hierarchy that prioritizes the inputs used to measure fair value.  The three levels of the fair value hierarchy defined in the standards are as follows:

 

Level 1 — Quoted prices are available in active markets for identical assets or liabilities;

 

Level 2 — Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable;

 

Level 3 — Unobservable pricing inputs in which little or no market activity exists, therefore requiring an entity to develop its own assumptions about the assumptions that market participants would use in pricing an asset or liability.

 

15



 

For items carried at (or adjusted to) fair value in the Consolidated Financial Statements, the following tables summarize the fair value of these instruments at November 9, 2013 and February 2, 2013:

 

November 9, 2013 Fair Value Measurements Using

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)

 

Significant Other
Observable Inputs

(Level 2)

 

Significant
Unobservable
Inputs

(Level 3)

 

Total

 

Available-for-Sale Securities

 

$

33

 

$

 

$

 

$

33

 

Warrants

 

 

13

 

 

13

 

Long-Lived Assets

 

 

 

18

 

18

 

Interest Rate Hedges

 

 

15

 

 

15

 

Total

 

$

33

 

$

28

 

$

18

 

$

79

 

 

February 2, 2013 Fair Value Measurements Using

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)

 

Significant Other
Observable Inputs

(Level 2)

 

Significant
Unobservable
Inputs

(Level 3)

 

Total

 

Available-for-Sale Securities

 

$

8

 

$

 

$

20

 

$

28

 

Long-Lived Assets

 

 

 

8

 

8

 

Interest Rate Hedges

 

 

6

 

 

6

 

Total

 

$

8

 

$

6

 

$

28

 

$

42

 

 

In the first quarter of 2013, one of the Company’s available-for-sale securities began trading in an active market.  Because of this, the Company transferred the $20 fair value of securities from a Level 3 asset to a Level 1 asset in the first quarter of 2013.  In the first three quarters of 2013, unrealized gains on the Level 1 available-for-sale securities totaled $5.

 

The Company values warrants using the Black-Scholes option-pricing model.  The Black-Scholes option-pricing model is classified as a Level 2 input.

 

The Company values interest rate hedges using observable forward yield curves.  These forward yield curves are classified as Level 2 inputs.

 

Fair value measurements of non-financial assets and non-financial liabilities are primarily used in the impairment analysis of goodwill, other intangible assets, and long-lived assets, and in the valuation of store lease exit costs.  The Company reviews goodwill and other intangible assets for impairment annually, during the fourth quarter of each fiscal year, and as circumstances indicate the possibility of impairment.  See Note 2 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended February 2, 2013 for further discussion related to the Company’s carrying value of goodwill.  Long-lived assets and store lease exit costs were measured at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy.  See Note 1 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended February 2, 2013 for further discussion of the Company’s policies regarding the valuation of long-lived assets and store lease exit costs.  For the first three quarters of 2013, long-lived assets with a carrying amount of $48 were written down to their fair value of $18 resulting in an impairment charge of $30.  For the first three quarters of 2012, long-lived assets with a carrying amount of $14 were written down to their fair value of $4 resulting in an impairment charge of $10.

 

16



 

Fair Value of Other Financial Instruments

 

Current and Long-term Debt

 

The fair value of the Company’s long-term debt, including current maturities, was estimated based on the quoted market prices for the same or similar issues adjusted for illiquidity based on available market evidence.  If quoted market prices were not available, the fair value was based on the net present value of the future cash flow using the forward interest rate yield curve in effect at November 9, 2013, and February 2, 2013, which is a Level 3 measurement technique.  At November 9, 2013, the fair value of total debt was $8,440 compared to a carrying value of $7,878.  At February 2, 2013, the fair value of total debt was $9,339 compared to a carrying value of $8,476.

 

Cash and Temporary Cash Investments, Store Deposits In-Transit, Receivables, Prepaid and Other Current Assets, Trade Accounts Payable, Accrued Salaries and Wages and Other Current Liabilities

 

The carrying amounts of these items approximated fair value.

 

Other Assets

 

The fair values of these other assets were estimated based on quoted market prices for those or similar assets, or estimated cash flows, if appropriate.  At November 9, 2013, and February 2, 2013, the carrying and fair value of other assets for which fair value is determinable was $52 and $44, respectively.

 

11.  OTHER COMPREHENSIVE INCOME (LOSS)

 

The following table represents the changes in AOCI by component for the first three quarters of 2013:

 

 

 

Cash Flow
Hedging
Activities(1)

 

Available for sale
Securities(1)

 

Pension and
Postretirement
Defined Benefit
Plans(1)

 

Total(1)

 

Balance at February 2, 2013

 

$

(14

)

$

7

 

$

(746

)

$

(753

)

OCI before reclassifications(2)

 

(11

)

3

 

 

(8

)

Amounts reclassified out of AOCI

 

1

 

 

47

 

48

 

Net current-period OCI

 

(10

)

3

 

47

 

40

 

Balance at November 9, 2013

 

$

(24

)

$

10

 

$

(699

)

$

(713

)

 


(1) All amounts are net of tax.

(2) Net of tax of $(8) and $2 for cash flow hedging activities and available for sale securities, respectively.

 

17



 

The following table represents the items reclassified out of AOCI and the related tax effects for the third quarter and first three quarters of 2013:

 

 

 

Third Quarter Ended

 

Three Quarters Ended

 

 

 

November 9, 2013

 

November 9, 2013

 

 

 

 

 

 

 

Gains on cash flow hedging activities

 

 

 

 

 

Amortization of unrealized gains and losses on cash flow hedging activities(1)

 

$

1

 

$

2

 

Tax expense

 

(1

)

(1

)

Net of tax

 

 

1

 

 

 

 

 

 

 

Pension and postretirement defined benefit plan items

 

 

 

 

 

Amortization of amounts included in net periodic pension expense(2)

 

23

 

76

 

Tax expense

 

(9

)

(29

)

Net of tax

 

14

 

47

 

Total reclassifications, net of tax

 

$

14

 

$

48

 

 


(1) Reclassified from AOCI into interest expense.

(2) Reclassified from AOCI into merchandise costs and operating, general and administrative expense.  These components are included in the computation of net periodic pension expense (see Note 4 to the Company’s Consolidated Financial Statements for additional details).

 

12.  INCOME TAXES

 

The effective income tax rate was 29.3% and 35.5% for the third quarters of 2013 and 2012, respectively.  The effective income tax rate was 33.9% and 34.8% for the first three quarters of 2013 and 2012, respectively.  The effective income tax rates for the third quarter and first three quarters of 2013 differed from the federal statutory rate primarily due to the benefit of certain tax items, offset partially by the effect of state income taxes.  The effective tax rate for the third quarter of 2012 approximates the federal statutory rate.  The effective income tax rate for the first three quarters of 2012 differed from the federal statutory rate primarily due to the favorable resolution of certain tax issues, partially offset by the effect of state income taxes.

 

On September 13, 2013, the U.S. Department of the Treasury and Internal Revenue Service released final tangible property regulations that provide guidance on the tax treatment regarding the deduction and capitalization of expenditures related to tangible property.  These regulations are effective for tax years beginning on or after January 1, 2014.  The Company is currently assessing these rules and their effect to its financial statements, and believes adoption of these regulations will not have an effect on net income and will not have a material effect on the reclassification between long-term deferred tax liabilities and current income tax liabilities.

 

13.  POTENTIAL MERGER

 

During the second quarter, the Company announced that it had entered into a merger agreement with Harris Teeter Supermarkets, Inc. under which the Company will purchase all outstanding shares of Harris Teeter Supermarkets, Inc. for approximately $2,500 in cash.  In the second quarter of 2013, the Company also entered into an unsecured bridge loan agreement (the “Bridge Loan Agreement”) to provide an additional source of financing, if necessary, to fund a portion of the merger with Harris Teeter. The Bridge Loan Agreement provides the Company the ability to borrow, based on certain conditions, including the consummation of the Harris Teeter merger, up to $850, and matures 364 days after closing.  The Company expects to fund the merger through a combination of cash on hand and the issuance of short-term and long-term debt.

 

18



 

Borrowings under the Bridge Loan Agreement would bear interest at the three-month LIBOR rate plus an applicable margin determined by the Company’s credit ratings, as determined by S&P and Moody’s.  The applicable margin will also increase by 25 basis points every 90 days after funding. The Company will also pay a funding fee to each lender equal to 0.5% of such lender’s loan advance on the closing date of the financing, and duration fees on any loan amounts still outstanding of 0.5%, 0.75% and 1.0% on each of the 90th, 180th and 270th day, respectively, following the closing of the Harris Teeter merger.  The Company also will pay an annual ticking fee of 0.15% of the amount the lenders have committed, regardless of whether any borrowings are made under the Bridge Loan Agreement.  The Bridge Loan Agreement contains covenants, which, among other things, require the maintenance of a leverage ratio of not greater than 3.50:1.00 and a fixed charge coverage ratio of not less than 1.70:1.00.  The covenants and representations and warranties in the Bridge Loan Agreement are substantially the same as those contained in the existing $2,000 unsecured revolving credit facility.

 

The Company may repay borrowings under the Bridge Loan Agreement in whole or in part at any time without premium or penalty.  The Bridge Loan Agreement is not guaranteed by the Company’s subsidiaries.

 

The pending merger is expected to close during the fourth quarter of fiscal year 2013, subject to Federal Trade Commission review and certain customary closing conditions.

 

19



 

Item 2.         Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following analysis should be read in conjunction with the Consolidated Financial Statements.

 

OVERVIEW

 

Third quarter 2013 total sales were $22.5 billion compared with $21.8 billion for the same period of 2012.  This increase was attributable to identical supermarket sales increases, a shift in the calendar and increased fuel gallon sales, offset partially by a decrease in the average retail fuel price.  Identical supermarket sales without fuel increased 3.5% in the third quarter of 2013, compared to the third quarter of 2012, primarily due to an increase in the number of households shopping with us, an increase in the average sale per customer and product cost inflation.  Every supermarket store department, excluding fuel, and every operating division had positive identical sales.  This marks positive identical supermarket sales growth for 40 consecutive quarters.  The 53rd week in 2012 caused a one week shift in the fiscal year calendar when comparing fiscal year 2013 to fiscal year 2012.  In the third quarter, the one week shift in the fiscal year calendar resulted in a high volume sales week being added to total sales for the third quarter of 2013 replacing a lower volume sales week in the third quarter of 2012.

 

Total sales for the first three quarters of 2013 were $75.3 billion compared to $72.6 billion for the same period of 2012.  This increase was attributable to identical supermarket sales increases and increased fuel gallon sales, offset partially by a decrease in the average retail fuel price.  Identical supermarket sales without fuel increased 3.4% in the first three quarters of 2013, compared to the same period in 2012, primarily due to an increase in the number of households shopping with us, an increase in the average sale per customer and product cost inflation.  Our Customer 1st strategy continues to deliver solid results.

 

For the third quarter of 2013, net earnings totaled $299 million, or $0.57 per diluted share, compared to $317 million, or $0.60 per diluted share for the same period of 2012.  The net earnings for the third quarter of 2013 include a net $23 million adjustment for benefits from certain tax items ($25 million), offset partially by an after-tax increase of $2 million ($1 million in interest and $1 million in operating, general and administrative expenses) in expenses related to our pending merger with Harris Teeter (“Third Quarter 2013 adjusted items”).  The net earnings for the third quarter of 2012 include a $74 million after-tax reduction of operating, general and administrative expenses resulting from a settlement with Visa and MasterCard and a reduction in our obligation to fund the UFCW consolidated pension fund created in January 2012 (“2012 adjusted items”).  Excluding the Third Quarter 2013 adjusted items, net earnings for third quarter 2013 totaled $276 million, or $0.53 per diluted share, compared to net earnings for the third quarter of 2012 of $243 million, or $0.46 per diluted share, which excludes the 2012 adjusted items.  We believe the adjusted net earnings per diluted share figure presents a more accurate quarter-over-quarter and year-over year comparison of our financial results because the adjusted items were not the result of our normal operations.  The increase in adjusted net earnings for the third quarter of 2013, compared to the third quarter of 2012, resulted primarily from an increase in non-fuel First-In, First Out (“FIFO”) operating profit and an increase in net earnings from our fuel operations, offset partially by an increase in income tax expense.

 

For the first three quarters of 2013, net earnings totaled $1.1 billion, or $2.09 per diluted share, compared to $1.0 billion, or $1.89 per diluted share for the same period of 2012.  The net earnings for the first three quarters of 2013 include a net $14 million adjustment for benefits from certain tax items ($19 million), offset partially by the after-tax effect of $5 million (including $3 million in interest and $2 million in operating, general and administrative expenses) in expenses related to our pending merger with Harris Teeter (“2013 adjusted items”).  The 2013 adjusted items are less than the Third Quarter 2013 adjusted items due to an adjustment made during the third quarter of 2013 for certain tax items that relate to the expected tax rate for the full year of 2013, offset partially by the increase in the full year expenses related to the pending Harris Teeter merger.  Excluding these adjustments, net earnings for the first three quarters of 2013 totaled $1.1 billion, or $2.06 per diluted share, which excludes the 2013 adjusted items, compared to adjusted net earnings for the first three quarters of 2012 of $961 million, or $1.76 per diluted share, which excludes the 2012 adjusted items.  The increase in our adjusted net earnings for the first three quarters of 2013, compared to the same period in 2012, resulted primarily from an increase in non-fuel FIFO operating profit, a decrease in the Last-In, First-Out (“LIFO”) charge, an increase in net earnings from our fuel operations and a decrease in interest expense, offset partially by an increase in our effective tax rate.

 

Please refer to the “Outlook” section for information on our expectations for fiscal year 2013.

 

20



 

RESULTS OF OPERATIONS

 

Net Earnings

 

Net earnings totaled $299 million for the third quarter of 2013, a decrease of 5.7% from net earnings of $317 million for the third quarter of 2012.  Adjusted net earnings for the third quarter of 2013 totaled $276 million, excluding the Third Quarter adjusted items, an increase of 13.6% from adjusted net earnings of $243 million for the third quarter of 2012, excluding the 2012 adjusted items.  The increase in our adjusted net earnings for the third quarter of 2013, compared to the third quarter of 2012, resulted primarily from an increase in non-fuel FIFO operating profit and an increase in net earnings from our fuel operations.  The increase in non-fuel FIFO operating profit for the third quarter of 2013, compared to the third quarter of 2012, resulted primarily from increased supermarket sales and improvements to operating, general and administrative expenses, rent and depreciation, as a percentage of sales, offset partially by continued investments in lower prices for our customers and increased shrink, as a percentage of sales.  The increase in net earnings from our fuel operations for the third quarter of 2013, compared to the third quarter of 2012, resulted primarily from an increase in the average margin per gallon of fuel sold and an increase in fuel gallons sold.

 

Net earnings totaled $1.1 billion for the first three quarters of 2013, an increase of 6.0% from net earnings of $1.0 billion for the first three quarters of 2012.  Adjusted net earnings for the first three quarters of 2013 totaled $1.1 billion, excluding the 2013 adjusted items, an increase of 12.7% from adjusted net earnings of $961 million for the first three quarters of 2012, excluding the 2012 adjusted items.  The increase in our adjusted net earnings for the first three quarters of 2013, compared to the same period in 2012, resulted primarily from an increase in non-fuel FIFO operating profit, a decrease in the LIFO charge, an increase in net earnings from our fuel operations and a decrease in interest expense, offset partially by an increase in our effective tax rate.  The increase in non-fuel operating profit for the first three quarters of 2013, compared to the same period in 2012, resulted primarily from the benefit of increased supermarket sales and improvements to operating, general and administrative expenses, rent and depreciation, as a percentage of sales, partially offset by continued investments in lower prices for our customers and increased shrink, as a percentage of sales.  The increase in net earnings from fuel operations for the first three quarters of 2013, compared to the first three quarters of 2012, resulted primarily from an increase in fuel gallons sold and an increase in average margin per gallon of fuel sold.

 

Net earnings of $0.57 per diluted share for the third quarter of 2013 represented a decrease of 5.0% over net earnings of $0.60 per diluted share for the third quarter of 2012.  Adjusted net earnings for the third quarter of 2013 of $0.53 per diluted share, excluding the Third Quarter 2013 adjusted items, represented an increase of 15.2% over adjusted net earnings of $0.46 per diluted share for the third quarter of 2012, excluding the 2012 adjusted items.  Adjusted net earnings per diluted share increased in the third quarter of 2013, compared to the third quarter of 2012, due to increased net earnings.

 

Net earnings of $2.09 per diluted share for the first three quarters of 2013 represented an increase of 10.6% over net earnings of $1.89 per diluted share for the first three quarters of 2012.  Adjusted net earnings for the first three quarters of 2013 of $2.06 per diluted share, excluding the 2013 adjusted items, represented an increase of 17.0% over adjusted net earnings of $1.76 per diluted share for the first three quarters of 2012, excluding the 2012 adjusted items.  Adjusted net earnings per diluted share increased in the first three quarters of 2013, compared to the first three quarters of 2012, due to increased net earnings and the repurchase of common shares over the past two years resulting in a lower weighted average number of shares outstanding.

 

Management believes adjusted net earnings (and adjusted net earnings per diluted share) are useful metrics to investors and analysts because they more accurately reflect our day-to-day business operations than do the generally accepted accounting principle (“GAAP”) measures of net earnings and net earnings per diluted share.  Adjusted net earnings (and adjusted net earnings per diluted share) are non-generally accepted accounting principle (“non-GAAP”) financial measures and should not be considered alternatives to net earnings (and net earnings per diluted share) or any other GAAP measure of performance.  Adjusted net earnings (and adjusted net earnings per diluted share) should not be reviewed in isolation or considered substitutes for our financial results as reported in accordance with GAAP.  Management uses adjusted net earnings (and adjusted net earnings per diluted share) in evaluating our results of operations as it believes these measures are more meaningful indicators of operating performance since, as adjusted, those earnings relate more directly to our day-to-day operations.  Management also uses adjusted earnings (and adjusted net earnings per diluted share) as a performance metric for management incentive programs, and to measure our progress against internal budgets and targets.

 

21



 

The following table provides a reconciliation of net earnings attributable to The Kroger Co. to net earnings attributable to The Kroger Co. excluding the adjusted items and a reconciliation of net earnings attributable to The Kroger Co. per diluted common share to net earnings attributable to The Kroger Co. per diluted common share excluding the adjusted items, for the third quarters and first three quarters of 2013 and 2012:

 

 

 

Third Quarter Ended

 

Three Quarters Ended

 

 

 

November 9,
 2013

 

November 3, 
2012

 

November 9,
 2013

 

November 3,
 2012

 

Net earnings attributable to The Kroger Co.

 

$

299

 

$

317

 

$

1,097

 

$

1,035

 

Benefit from certain tax items offset by Harris Teeter merger expenses(1)

 

(23

)

 

(14

)

 

Adjustments for the UFCW consolidated pension plan liability and credit card settlement(1)(2) 

 

 

(74

)

 

(74

)

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. excluding the adjusted items above

 

$

276

 

$

243

 

$

1,083

 

$

961

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. per diluted common share

 

$

0.57

 

$

0.60

 

$

2.09

 

$

1.89

 

Benefit from certain tax items offset by Harris Teeter merger expenses(3)

 

(0.04

)

 

(0.03

)

 

Adjustments for the UFCW consolidated pension plan liability and credit card settlement(3) 

 

 

(0.14

)

 

(0.13

)

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. per diluted common share excluding the adjusted items above

 

$

0.53

 

$

0.46

 

$

2.06

 

$

1.76

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in diluted calculation

 

521

 

522

 

521

 

543

 

 


(1)   The amounts presented represent the after-tax effect of each adjustment.

(2)   The pre-tax adjustments for the UFCW consolidated pension plan liability and credit card settlement were $115.

(3)   The amounts presented represent the net earnings per diluted common share effect of each adjustment.

 

Sales

 

Total Sales

(in millions)

 

 

 

Third Quarter Ended

 

Three Quarters Ended

 

 

 

November 9, 
2013

 

Percentage
Increase 
(Decrease)

 

November 3,
2012

 

Percentage
Increase
(2)

 

November 9,
2013

 

Percentage
Increase

 

November 3,
2012

 

Percentage
Increase
(3)

 

Total supermarket sales without fuel

 

$

17,474

 

4.5

%

$

16,716

 

3.6

%

$

58,249

 

3.9

%

$

56,066

 

3.9

%

Fuel sales

 

4,404

 

(2.6

)%

4,520

 

15.2

%

14,936

 

2.0

%

14,643

 

10.7

%

Other sales(1) 

 

627

 

9.8

%

571

 

6.3

%

2,085

 

10.4

%

1,889

 

5.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total sales 

 

$

22,505

 

3.2

%

$

21,807

 

5.9

%

$

75,270

 

3.7

%

$

72,598

 

5.3

%

 


(1)         Other sales primarily relate to sales by convenience stores, excluding fuel; jewelry stores; manufacturing plants to outside customers; variable interest entities; a specialty pharmacy; and in-store health clinics.

(2)   This column represents the percentage increase in the third quarter of 2012, compared to the third quarter of 2011.

(3)   This column represents the percentage increase in the first three quarters of 2012, compared to the first three quarters of 2011.

 

22



 

The increase in total sales for the third quarter of 2013, compared to the third quarter of 2012, was primarily the result of our identical supermarket sales increase, excluding fuel, of 3.5% and a shift in the calendar, offset partially by a decrease in fuel sales of 2.6%.  Identical supermarket sales, excluding fuel for the third quarter of 2013, compared to the third quarter of 2012, increased primarily due to an increase in the number of households shopping with us, an increase in the average sale per customer and product cost inflation.  Total fuel sales decreased 2.6% in the third quarter of 2013, compared to the third quarter of 2012, due to a decrease in the average retail fuel price of 8.3%, offset partially by an increase in fuel gallons sold of 6.3%.

 

The increase in total sales for the first three quarters of 2013, compared to the same period of 2012, was primarily the result of our identical supermarket sales increase, excluding fuel, of 3.4% and an increase of fuel sales of 2.0%.  Identical supermarket sales, excluding fuel for the first three quarters of 2013, compared to the first three quarters of 2012, increased primarily due to an increase in the number of households shopping with us, an increase in the average sale per customer and product cost inflation.  Fuel sales increased 2.0% in the first three quarters of 2013, compared to the same period of 2012, due to an increase in fuel gallons sold of 5.4%, partially offset by a decrease in the average retail fuel price of 3.2%.

 

We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters.  Although identical supermarket sales is a relatively standard term, numerous methods exist for calculating identical supermarket sales growth.  As a result, the method used by our management to calculate identical supermarket sales may differ from methods other companies use to calculate identical supermarket sales.  We urge you to understand the methods used by other companies to calculate identical supermarket sales before comparing our identical supermarket sales to those of other such companies.  Fuel discounts received at our fuel centers and earned based on in-store purchases are included in all of the identical supermarket sales results calculations illustrated below and reduce our identical supermarket sales results.  Differences between total supermarket sales and identical supermarket sales primarily relate to changes in supermarket square footage.  Identical supermarket sales include sales from all departments at identical Fred Meyer multi-department stores.  Our identical supermarket sales results are summarized in the table below.  We used the identical supermarket dollar figures presented below to calculate percentage changes for the third quarter and the first three quarters of 2013.

 

Identical Supermarket Sales

($ in millions)

 

 

 

Third Quarter

 

 

 

November 9,
2013

 

Percentage
Increase

 

November 3, 
2012

 

Percentage
Increase(1)

 

Including fuel centers

 

$

20,211

 

2.5

%

$

19,714

 

5.2

%

Excluding fuel centers

 

$

16,866

 

3.5

%

$

16,294

 

3.2

%

 


(1)         This column represents the percentage increase in identical supermarket sales in the third quarter of 2012, compared to the third quarter of 2011.

 

Identical Supermarket Sales

($ in millions)

 

 

 

Three Quarters Ended

 

 

 

November 9, 
2013

 

Percentage
Increase

 

November 3, 
2012

 

Percentage
Increase(1)

 

Including fuel centers

 

$

67,443

 

3.1

%

$

65,422

 

4.8

%

Excluding fuel centers

 

$

56,125

 

3.4