-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HwRYMNdlDVmiyKkkQuOgDEm/3E1wioe7WbaZhFRO1xaJ1EstvQdIP4FLiyiBDRII y8EG/AmoUxcuG6yFYlYYDg== 0001021408-02-012110.txt : 20020930 0001021408-02-012110.hdr.sgml : 20020930 20020930130112 ACCESSION NUMBER: 0001021408-02-012110 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20020817 FILED AS OF DATE: 20020930 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KROGER CO CENTRAL INDEX KEY: 0000056873 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-GROCERY STORES [5411] IRS NUMBER: 310345740 STATE OF INCORPORATION: OH FISCAL YEAR END: 0102 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-00303 FILM NUMBER: 02776010 BUSINESS ADDRESS: STREET 1: 1014 VINE ST CITY: CINCINNATI STATE: OH ZIP: 45201 BUSINESS PHONE: 5137624000 10-Q 1 d10q.txt QUARTERLY REPORT ENDED AUGUST 17, 2002 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 August 17, 2002 OR [_] 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) Ohio 31-0345740 - -------------------------------------- -------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 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____. ----- There were 773,232,383 shares of Common Stock ($1 par value) outstanding as of September 25, 2002. PART I - FINANCIAL INFORMATION Item 1. Financial Statements. THE KROGER CO. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (in millions, except per share amounts) (unaudited)
Second Quarter Ended Two Quarters Ended -------------------------- --------------------------- August 17, August 18, August 17, August 18, 2002 2001 2002 2001 ------------- ------------ ------------- ------------ Sales ....................................................................... $11,927 $11,485 $27,594 $26,587 ------- ------- ------- ------- Merchandise costs, including advertising, warehousing, and transportation ... 8,738 8,330 20,177 19,364 Operating, general and administrative ....................................... 2,216 2,184 5,104 5,025 Rent ........................................................................ 151 152 354 354 Depreciation and amortization ............................................... 247 246 570 566 Restructuring charges and related items ..................................... 2 -- 15 -- Merger-related costs ........................................................ (1) 2 1 4 ------- ------- ------- ------- Operating profit ......................................................... 574 571 1,373 1,274 Interest expense ............................................................ 137 152 326 357 ------- ------- ------- ------- Earnings before income tax expense, extraordinary loss and cumulative effect of an accounting change ......................................... 437 419 1,047 917 Income tax expense .......................................................... 164 163 393 358 ------- ------- ------- ------- Earnings before extraordinary loss and cumulative effect of an accounting change ...................................................... 273 256 654 559 Extraordinary loss, net of income tax benefit ............................... (9) -- (12) -- ------- ------- ------- ------- Earnings before cumulative effect of an accounting change ................ 264 256 642 559 Cumulative effect of an accounting change, net of income tax benefit ........ -- -- (16) -- ------- ------- ------- ------- Net earnings ............................................................. $ 264 $ 256 $ 626 $ 559 ======= ======= ======= ======= Earnings per basic common share: Earnings before extraordinary loss and cumulative effect of an accounting change ...................................................... $ 0.35 $ 0.32 $ 0.83 $ 0.69 Extraordinary loss, net of income tax benefit ............................ (0.01) 0.00 (0.02) 0.00 Cumulative effect of an accounting change, net of income tax benefit ..... 0.00 0.00 (0.02) 0.00 ------- ------- ------- ------- Net earnings ........................................................... $ 0.34 $ 0.32 $ 0.79 $ 0.69 ======= ======= ======= ======= Average number of common shares used in basic calculation ................... 786 805 790 809 Earnings per diluted common share: Earnings before extraordinary loss and cumulative effect of an accounting change ...................................................... $ 0.34 $ 0.31 $ 0.81 $ 0.67 Extraordinary loss, net of income tax benefit ............................ (0.01) 0.00 (0.01) 0.00 Cumulative effect of an accounting change, net of income tax benefit ..... 0.00 0.00 (0.02) 0.00 ------- ------- ------- ------- Net earnings ........................................................... $ 0.33 $ 0.31 $ 0.78 $ 0.67 ======= ======= ======= ======= Average number of common shares used in diluted calculation ................. 800 827 805 830
The accompanying notes are an integral part of the consolidated financial statements. 1 THE KROGER CO. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (in millions, except per share amounts) (unaudited)
August 17, February 2, 2002 2002 ------------------ --------------- ASSETS Current assets ............................................................ Cash ................................................................... $ 167 $ 161 Receivables ............................................................ 604 679 Inventories ............................................................ 4,076 4,178 Prepaid and other current assets........................................ 300 494 --------- --------- Total current assets ............................................... 5,147 5,512 Property, plant and equipment, net ........................................ 10,226 9,657 Goodwill, net ............................................................. 3,566 3,594 Fair value interest rate hedges ........................................... 65 18 Other assets .............................................................. 294 306 --------- --------- Total Assets ....................................................... $ 19,298 $ 19,087 ========= ========= LIABILITIES Current liabilities Current portion of long-term debt including obligations under capital leases .................................................... $ 437 $ 436 Accounts payable ....................................................... 3,293 3,005 Salaries and wages ..................................................... 524 584 Other current liabilities .............................................. 1,525 1,460 --------- --------- Total current liabilities .......................................... 5,779 5,485 Long-term debt including obligations under capital leases.................. Face value long-term debt including obligations under capital leases ... 7,848 8,412 Adjustment to reflect fair value interest rate hedges .................. 65 18 --------- --------- Long-term debt including obligations under capital leases .............. 7,913 8,430 Other long-term liabilities ............................................... 1,878 1,670 --------- --------- Total Liabilities .................................................. 15,570 15,585 --------- --------- Commitments and Contingencies (Note 11) SHAREOWNERS' EQUITY Preferred stock, $100 par, 5 shares authorized and unissued ........................................................... -- -- Common stock, $1 par, 1,000 shares authorized: 905 shares issued in 2002 and 901 shares issued in 2001 .................................. 905 901 Additional paid-in capital ................................................ 2,271 2,217 Accumulated other comprehensive loss ...................................... (33) (33) Accumulated earnings ...................................................... 2,773 2,147 Common stock in treasury, at cost, 129 shares in 2002 and 106 shares in 2001 ..................................................... (2,188) (1,730) --------- ---------- Total Shareowners' Equity .......................................... 3,728 3,502 --------- --------- Total Liabilities and Shareowners' Equity .......................... $ 19,298 $ 19,087 ========= =========
- ----------------------------------------------------------------------------- The accompanying notes are an integral part of the consolidated financial statements. 2 THE KROGER CO. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (in millions) (unaudited)
Two Quarters Ended ------------------------------- August 17, August 18, 2002 2001 -------------- -------------- Cash Flows From Operating Activities: Net earnings .......................................................... $ 626 $ 559 Adjustments to reconcile net earnings to net cash provided by operating activities: Cumulative effect of an accounting change ......................... 16 -- Extraordinary loss ................................................ 12 -- Depreciation and other amortization ............................... 570 509 Goodwill amortization ............................................. -- 57 Non-cash items .................................................... 1 4 LIFO charge ....................................................... 12 20 Deferred income taxes ............................................. 100 65 Other ............................................................. 16 10 Changes in operating assets and liabilities net of effects from acquisitions of businesses: Inventories .................................................... 90 22 Receivables .................................................... 75 52 Accounts payable ............................................... 343 292 Other .......................................................... 300 235 -------- -------- Net cash provided by operating activities .................. 2,161 1,825 -------- -------- Cash Flows From Investing Activities: Capital expenditures .................................................. (1,029) (1,148) Proceeds from sale of assets .......................................... 50 25 Payments for acquisitions, net of cash acquired ....................... (109) (85) Other ................................................................. 6 12 -------- -------- Net cash used by investing activities ...................... (1,082) (1,196) -------- -------- Cash Flows From Financing Activities: Proceeds from issuance of long-term debt .............................. 853 1,290 Reductions in long-term debt .......................................... (1,422) (1,292) Debt prepayment costs ................................................. (14) -- Financing charges incurred ............................................ (10) (14) Decrease in book overdrafts ........................................... (55) (198) Proceeds from issuance of capital stock ............................... 28 46 Treasury stock purchases .............................................. (453) (485) -------- -------- Net cash provided (used) by financing activities ........... (1,073) (653) -------- -------- Net increase (decrease) in cash and temporary cash investments ............ 6 (24) Cash and temporary investments: Beginning of year ................................................. 161 161 -------- -------- End of quarter .................................................... $ 167 $ 137 ======== ======== Supplemental disclosure of cash flow information: Cash paid during the year for interest ............................ $ 313 $ 358 Cash paid during the year for income taxes ........................ $ 191 $ 143 Non-cash changes related to purchase acquisitions: Fair value of assets acquired .................................. $ 109 $ 53 Goodwill recorded .............................................. $ -- $ 45 Liabilities assumed ............................................ $ -- $ 14
The accompanying notes are an integral part of the consolidated financial statements. 3 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Certain prior-year amounts have been reclassified to conform to current-year presentation and all amounts presented are in millions except per share amounts. 1. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION The accompanying financial statements include the consolidated accounts of The Kroger Co. and its subsidiaries. The February 2, 2002 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. 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 adjustments (consisting only of 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 generally accepted accounting principles have been omitted pursuant to SEC regulations. Accordingly, the accompanying consolidated financial statements should be read in conjunction with the fiscal 2001 Annual Report on Form 10-K of The Kroger Co. filed with the SEC on May 1, 2002, as amended. The unaudited information included in the consolidated financial statements for the second quarter and two quarters ended August 17, 2002 and August 18, 2001 includes the results of operations of the Company for the 12-week and 28-week periods then ended. 2. MERGER-RELATED COSTS The Company is continuing the process of implementing its integration plan relating to recent mergers. During the first and second quarters of 2001, and the first quarter of 2002, the Company recorded pre-tax, non-cash merger-related costs of $2 resulting from the issuance of restricted stock. The market value adjustment of the restricted stock resulted in a pre-tax, non-cash credit of $1 in the second quarter of 2002. Restrictions on the stock awards lapsed based on the achievement of synergy goals. All synergy-based awards were earned provided that recipients were still employed by the Company on the stated restriction lapsing date. The following table is a summary of the changes in accruals related to various business combinations:
Facility Employee Incentive Awards and Closure Costs Severance Contributions --------------- ----------- ---------------------- Balance at February 3, 2001 ..... $ 113 $ 18 $ 35 Additions ................... -- -- 4 Payments .................... (19) (3) (9) ------- ------- ------- Balance at February 2, 2002 ..... 94 15 30 Additions ................... -- -- 1 Payments .................... (5) (7) (11) ------- ------- ------- Balance at August 17, 2002 ...... $ 89 $ 8 $ 20 ======= ======= =======
4 3. ONE-TIME ITEMS In addition to the merger-related costs described in Note 2, the Company incurred pre-tax one-time expenses of $4 and $9 during the second quarters of 2002 and 2001, respectively. Second quarter 2002 amounts included $1 of expense resulting from the market value adjustment of excess energy purchase contracts. In the first quarter 2002, the Company recorded pre-tax one-time income of $7 from the market value adjustment of these contracts. For the first two quarters of 2002, pre-tax one-time items netted to zero. Pre-tax one-time expense totaled $24 for the first two quarters of 2001. The one-time items were included in merchandise costs and operating, general and administrative expense in 2001 and in operating, general and administrative expense in 2002. Pre-tax expenses of $4 and $7 were included in operating, general and administrative expense in the second quarters of 2002 and 2001, respectively. Pre-tax expenses of $2 were included in merchandise costs in the second quarter, 2001. For the first two quarters of 2002, the pre-tax one-time items included in operating, general and administrative expense netted to zero. For the first two quarters of 2001, the one-time items included in operating, general and administrative expense totaled $19 of pre-tax expense. The remaining $5 of pre-tax expense recorded in the first two quarters of 2001 was included in merchandise costs. Details of these charges are:
Second Quarter Ended Two Quarters Ended ---------------------------------- ------------------------------- August 17, August 18, August 17, August 18, 2002 2001 2002 2001 --------------- -------------- ------------- -------------- One-time items in merchandise costs Costs related to mergers ............................ $ -- $ 2 $ -- $ 5 ------ ------ ------- ------ -- 2 -- 5 One-time items in operating, general and administrative expense Costs related to mergers ............................ 3 7 6 19 Market value adjustments of energy contracts ........ 1 -- (6) -- ------ ------ ------- ------ 4 7 -- 19 Total one-time items ......................................... $ 4 $ 9 $ -- $ 24 ====== ====== ======= ======
Costs related to mergers In 2001, product costs for excess capacity totaling $5 were included as merchandise costs. The remaining $19 of expense in 2001 primarily related to employee severance and system conversion costs and was included as operating, general and administrative expenses. In 2002, approximately $6 of expense related to system conversion costs and was included as operating, general and administrative expense. All of the costs in 2001 and $5 of the costs in 2002 represented cash expenditures. Energy contracts During March through May 2001, the Company entered into four separate commitments to purchase electricity from one of its utility suppliers in southern California. At the inception of the contracts, forecasted electricity usage indicated that it was probable that all of the electricity would be utilized in the operations of the Company. The Company, therefore, accounted for the contracts in accordance with the normal purchases and normal sales exception under Statement of Financial Accounting Standards ("SFAS") No. 133, as amended, and no amounts were initially recorded in the financial statements related to these purchase commitments. During the third quarter 2001, the Company determined that one of the contracts, and a portion of a second contract, provided for supplies in excess of the Company's expected demand for electricity. This precluded use of the normal purchases and normal sales exception under SFAS No. 133 for those contracts, and required the contracts to be marked to fair value through current-period earnings. The Company, therefore, recorded a pre-tax non-cash charge of $81 in the third quarter 2001 to accrue liabilities for the estimated fair value of these contracts through December 2006. The remaining portion of the second contract was re-designated as a cash flow hedge of future purchases. The other two purchase commitments continue to qualify for the normal purchases and normal sales exception under SFAS No. 133. 5 SFAS No. 133 requires the excess contracts to be marked to fair value through current-period earnings each quarter. Due to an increase in the forward market prices for electricity in southern California during the first quarter 2002, the Company recorded pre-tax non-cash income of $7 to mark the excess contracts to estimated fair value as of May 25, 2002. Short-term forward market prices decreased in the second quarter 2002, and as a result, the Company recorded a $1 non-cash charge to mark the excess contracts to fair value as of August 17, 2002. For the first two quarters of 2002, the Company recorded $6 of pre-tax, non-cash net income as a result of the changes in forward market prices. Also, the Company made net cash payments totaling $8 to settle the excess energy purchase commitments for the first two quarters of 2002. Details of these liabilities follow: Balance at February 2, 2002 ..................................... $ 78 Net payments (settlement of excess purchase commitments) ...... (8) Revaluation (net decrease in liabilities due to changes in forward market prices) .................................... (6) ------ Balance at August 17, 2002 ...................................... $ 64 ======
4. RESTRUCTURING CHARGES AND RELATED ITEMS On December 11, 2001, the Company outlined a Strategic Growth Plan ("Plan") to support additional investment in its core business to increase sales and market share. The Plan has three key elements: reduction of operating, general and administrative expenses, centralization and increased coordination of merchandising and procurement activities, and targeted retail price reductions. As part of the plan to reduce operating, general and administrative costs, the Company has eliminated slightly over 1,500 positions. The Company also has merged the Nashville division office and distribution center into the Atlanta and Louisville divisions. As of August 17, 2002, execution of the Plan had reduced expenses by approximately $178. Restructuring charges related to the Plan totaled $2, pre-tax, in the second quarter 2002. These charges totaled $15, pre-tax, for the first two quarters of 2002. The majority of these expenses related to severance agreements, distribution center consolidation and conversion costs. All of the second quarter 2002 costs, and approximately $10 of the total 2002 costs, represented cash expenditures. Also during 2002, the Company made cash payments totaling $33, primarily for severance agreements. The Company does not expect to incur any additional expenses related to the Plan. The following table is a summary of changes in the accruals associated with the Plan: Severance & Other Costs ----------------- Balance at February 2, 2002 ................... $ 37 Additions .................................. 15 Payments ................................... (33) ----------- Balance at August 17, 2002 .................... $ 19 =========== 5. GOODWILL As more fully described in Note 9, the Company adopted SFAS No. 142 on February 3, 2002. Adoption of this standard eliminated the amortization of goodwill. In 2001, goodwill generally was amortized over 40 years. Goodwill amortization expense totaled $26, pre-tax, in the second quarter 2001 and $57, pre-tax, for the first two quarters of 2001. The transitional impairment review required by SFAS No. 142 resulted in a $26 pre-tax non-cash loss to writeoff the jewelry store division goodwill based on its implied fair value. Impairment primarily resulted from the recent operating performance of the division and review of the division's projected future cash flows on a discounted basis, rather than on an undiscounted basis, as was the standard under SFAS No. 121, prior to adoption of SFAS No. 142. This loss was recorded as a cumulative effect of an accounting change, net of a $10 tax benefit, in the first quarter 2002. The following table summarizes changes in the Company's goodwill balance during 2002: Balance at February 2, 2002 ............................. $ 3,594 Cumulative effect of an accounting change ....... (26) Reclassifications ............................... (2) ------- Balance at August 17, 2002 .............................. $ 3,566 ======= 6 The following table adjusts net earnings, net earnings per basic common share and net earnings per diluted common share for the adoption of SFAS No. 142:
Second Quarter Ended Two Quarters Ended ----------------------------- ---------------------------- August 17, August 18, August 17, August 18, 2002 2001 2002 2001 ------------ ------------ ------------ ------------ Reported net earnings ............................................ $ 264 $ 256 $ 626 $ 559 Add back: Goodwill amortization (1) ............................... -- 23 -- 50 Cumulative effect of an accounting change (1) ........... -- -- 16 -- ------- ------- ------- ------ Adjusted net earnings ............................................ 264 279 642 609 ------- ------- ------- ------ Add back: Extraordinary loss (1) .................................. 9 -- 12 -- ------- ------- ------- ------ Adjusted earnings before extraordinary loss ...................... $ 273 $ 279 $ 654 $ 609 ======= ======= ======= ====== Reported net earnings per basic common share ..................... $ 0.34 $ 0.32 $ 0.79 $ 0.69 Add back: Goodwill amortization (1) ............................... -- 0.03 -- 0.06 Cumulative effect of an accounting change (1) ........... -- -- 0.02 -- ------- ------- ------- ------ Adjusted net earnings per basic common share ..................... 0.34 0.35 0.81 0.75 ------- ------- ------- ------ Add back: Extraordinary loss (1) .................................. 0.01 -- 0.02 -- ------- ------- ------- ------ Adjusted earnings before extraordinary loss ...................... $ 0.35 $ 0.35 $ 0.83 $ 0.75 ======= ======= ======= ====== Average number of shares used in basic calculation ............... 786 805 790 809 Reported net earnings per diluted common share ................... $ 0.33 $ 0.31 $ 0.78 $ 0.67 Add back: Goodwill amortization (1) ............................... -- 0.03 -- 0.06 Cumulative effect of an accounting change (1) ........... -- -- 0.02 -- ------- ------- ------- ------ Adjusted net earnings per diluted common share ................... 0.33 0.34 0.80 0.73 ------- ------- ------- ------ Add back: Extraordinary loss (1) .................................. 0.01 -- 0.01 -- ------- ------- ------- ------ Adjusted earnings before extraordinary loss ...................... $ 0.34 $ 0.34 $ 0.81 $ 0.73 ======= ======= ======= ====== Average number of shares used in diluted calculation ............. 800 827 805 830
(1) Amounts are net of income tax benefit. 7 6. COMPREHENSIVE INCOME Comprehensive income is as follows:
Second Quarter Ended Two Quarters Ended ---------------------------------- ------------------------------- August 17, August 18, August 17, August 18, 2002 2001 2002 2001 --------------- -------------- -------------- ------------- Net earnings ................................................. $ 264 $ 256 $ 626 $ 559 Cumulative effect of adoption of SFAS No. 133, net of tax .... -- -- -- (6) Unrealized loss on hedging activities, net of tax ............ (2) (3) -- (3) --------- --------- -------- --------- Comprehensive income ......................................... $ 262 $ 253 $ 626 $ 550 ========= ========= ======== =========
During 2002 and 2001, other comprehensive income consisted of market value adjustments to reflect derivative instruments designated as cash flow hedges at fair value, pursuant to SFAS No. 133. 7. INCOME TAXES The effective income tax rate differs from the expected statutory rate primarily because of the effect of certain state taxes. 8. EARNINGS PER COMMON SHARE Earnings per common share equals net earnings divided by the weighted average number of common shares outstanding, after giving effect to dilutive stock options and warrants. The following table provides a reconciliation of earnings before extraordinary loss and cumulative effect of an accounting change and shares used in calculating basic earnings per share to those used in calculating diluted earnings per share:
Second Quarter Ended Second Quarter Ended August 17, 2002 August 18, 2001 ----------------------------------------- ----------------------------------------- Earnings Shares Per Share Earnings Shares Per Share (Numer-ator) (Denomi-nator) Amount (Numer-ator) (Denomi-nator) Amount ----------------------------------------------------------------------------------- Basic earnings per common share ...... $ 273 786 $ 0.35 $ 256 805 $ 0.32 Dilutive effect of stock options and warrants .......................... -- 14 -- 22 -------- -------- -------- -------- Diluted earnings per common share ..... $ 273 800 $ 0.34 $ 256 827 $ 0.31 ======== ======== ======== ========
Two Quarters Ended Two Quarters Ended August 17, 2002 August 18, 2001 ----------------------------------------- ----------------------------------------- Earnings Shares Per Share Earnings Shares Per Share (Numer-ator) (Denomi-nator) Amount (Numer-ator) (Denomi-nator) Amount ----------------------------------------------------------------------------------- Basic earnings per common share ...... $ 654 790 $ 0.83 $ 559 809 $ 0.69 Dilutive effect of stock options and warrants .......................... -- 15 -- 21 -------- -------- -------- -------- Diluted earnings per common share ..... $ 654 805 $ 0.81 $ 559 830 $ 0.67 ======== ======== ======== ========
8 The Company had options outstanding for approximately 27 shares and 9 shares in the second quarter 2002 and second quarter 2001, respectively, that were excluded from the computation of diluted earnings per share because their inclusion would have had an anti-dilutive effect on earnings per share. For the first two quarters of 2002 and 2001, the Company had options outstanding of approximately 23 shares and 13 shares, respectively, that were excluded from the computation of diluted earnings per share because their inclusion would have had an anti-dilutive effect on earnings per share. 9. RECENTLY ISSUED ACCOUNTING STANDARDS Emerging Issues Task Force (EITF) Issue Nos. 00-22, "Accounting for `Points' and Certain Other Time-Based or Volume-Based Sales and Incentive Offers, and Offers for Free Products or Services to be Delivered in the Future;" and 01-09, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of Vendor's Products)," became effective for the Company on February 3, 2002. These issues address the appropriate accounting for certain vendor contracts and loyalty programs. The adoption of this standard did not have a material effect on the Company's financial statements. SFAS No. 141, "Business Combinations," was issued by the Financial Accounting Standards Board ("FASB") in June of 2001. This standard requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method of accounting. The Statement also addresses the recognition of intangible assets in a business combination. Adoption of SFAS No. 141 did not have a material effect on the Company's financial statements. SFAS No. 142, "Goodwill and Other Intangible Assets," was issued by the FASB in June of 2001. The Statement addresses the accounting for intangible assets acquired outside of a business combination. The Statement also addresses the accounting for goodwill and other intangible assets subsequent to initial recognition. SFAS No. 142 provides that goodwill no longer will be amortized and instead will be tested for impairment on an annual basis. The Company adopted SFAS No. 142 on February 3, 2002. Accordingly, the Company performed a transitional impairment review of its goodwill. Goodwill totaled $3,594 as of February 3, 2002. The review was performed at the operating division level. Generally, fair value represented a multiple of earnings before interest, taxes, depreciation, amortization, LIFO charge, extraordinary items and one-time items ("EBITDA") or discounted projected future cash flows. Impairment was indicated when the carrying value of a division, including goodwill, exceeded its fair value. The Company determined that the carrying value of the jewelry store division, which included $26 of goodwill, exceeded its fair value. Impairment was not indicated for the goodwill associated with the other operating divisions. The fair value of the jewelry store division was subsequently measured against the fair value of its underlying assets and liabilities, excluding goodwill, to estimate an implied fair value of the division's goodwill. As a result of this analysis, the Company determined that the jewelry store division goodwill was entirely impaired. Impairment primarily resulted from the recent operating performance of the division and review of the division's projected future cash flows on a discounted basis, rather than on an undiscounted basis, as was the standard under SFAS No. 121, prior to adoption of SFAS No. 142. Accordingly, the Company recorded a $16 charge, net of a $10 tax benefit, as a cumulative effect of an accounting change in the first quarter, 2002. SFAS No. 143, "Asset Retirement Obligations," was issued by the FASB in August of 2001. This standard addresses obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 will become effective for the Company on February 2, 2003. The Company currently is analyzing the effect this standard will have on its financial statements. SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," was issued by the FASB in August of 2001. This standard replaces SFAS No. 121 and APB No. 30 and amends APB No. 51. SFAS No. 144 became effective for the Company on February 3, 2002. Adoption of this standard did not have a material effect on the Company's financial statements. SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued by the FASB in April 2002. SFAS No. 145 becomes effective for the Company on February 2, 2003. The Company currently is analyzing the effect this standard will have on its financial statements. SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," was issued by the FASB in June of 2002. SFAS No. 146 addresses significant issues relating to the recognition, measurement and reporting of costs associated with exit 9 and disposal activities. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The Company currently is analyzing the effect this standard will have on its financial statements. 10. GUARANTOR SUBSIDIARIES The Company's outstanding public debt (the "Guaranteed Notes") is jointly and severally, fully and unconditionally guaranteed by The Kroger Co. and certain of its subsidiaries (the "Guarantor Subsidiaries"). At August 17, 2002, a total of approximately $6,810 of Guaranteed Notes was outstanding. The Guarantor Subsidiaries and non-guarantor subsidiaries are direct or indirect wholly owned subsidiaries of The Kroger Co. Separate financial statements of The Kroger Co. and each of the Guarantor Subsidiaries are not presented because the guarantees are full and unconditional and the Guarantor Subsidiaries are jointly and severally liable. The Company believes that separate financial statements and other disclosures concerning the Guarantor Subsidiaries would not be material to investors. The non-guaranteeing subsidiaries represent less than 3% on an individual and aggregate basis of consolidated assets, pretax earnings, cash flow, and equity. Therefore, the non-guarantor subsidiaries' information is not separately presented in the tables below. There are no current restrictions on the ability of the Guarantor Subsidiaries to make payments under the guarantees referred to above, but the obligations of each guarantor under its guarantee are limited to the maximum amount as will result in obligations of such guarantor under its guarantee not constituting a fraudulent conveyance or fraudulent transfer for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act, or any similar Federal or state law (e.g. laws requiring adequate capital to pay dividends). 10 The following tables present summarized financial information as of August 17, 2002 and February 2, 2002 and for the quarters ended, and two quarters ended, August 17, 2002 and August 18, 2001: Condensed Consolidating Balance Sheets As of August 17, 2002
Guarantor The Kroger Co. Subsidiaries Eliminations Consolidated ----------------- ----------------- -------------- -------------- Current assets Cash ...................................................... $ 20 $ 147 $ -- $ 167 Receivables ............................................... 220 384 -- 604 Net inventories ........................................... 385 3,691 -- 4,076 Prepaid and other current assets .......................... (33) 333 -- 300 ---------- ---------- ---------- ---------- Total current assets ................................. 592 4,555 -- 5,147 Property, plant and equipment, net ............................ 1,215 9,011 -- 10,226 Goodwill, net ................................................. 21 3,545 -- 3,566 Fair value interest rate hedges ............................... 65 -- -- 65 Other assets .................................................. 603 (309) -- 294 Investment in and advances to subsidiaries .................... 10,721 -- (10,721) -- ---------- ---------- ---------- ---------- Total assets ......................................... $ 13,217 $ 16,802 $ (10,721) $ 19,298 ========== ========== ========== ========== Current liabilities Current portion of long-term debt including obligations under capital leases ........................ $ 424 $ 13 $ -- $ 437 Accounts payable .......................................... 176 3,117 -- 3,293 Other current liabilities ................................. 388 1,661 -- 2,049 ---------- ---------- ---------- ---------- Total current liabilities ............................ 988 4,791 -- 5,779 Long-term debt including obligations under capital leases Face value long-term debt including obligations under capital leases .................................... 7,504 344 -- 7,848 Adjustment to reflect fair value interest rate hedges ..... 65 -- -- 65 ---------- ---------- ---------- ---------- Long-term debt including obligations under capital leases .................................... 7,569 344 -- 7,913 Other long-term liabilities ................................... 932 946 -- 1,878 ---------- ---------- ---------- ---------- Total liabilities .................................... 9,489 6,081 -- 15,570 ---------- ---------- ---------- ---------- Shareowners' Equity ........................................... 3,728 10,721 (10,721) 3,728 ---------- ---------- ---------- ---------- Total liabilities and shareowners' equity ............ $ 13,217 $ 16,802 $ (10,721) $ 19,298 ========== ========== ========== ==========
11 Condensed Consolidating Balance Sheets As of February 2, 2002
Guarantor The Kroger Co. Subsidiaries Eliminations Consolidated -------------- ------------ ------------ ------------ Current assets Cash ............................................................. $ 25 $ 136 $ -- $ 161 Receivables ...................................................... 145 534 -- 679 Net inventories .................................................. 386 3,792 -- 4,178 Prepaid and other current assets ................................. 236 258 -- 494 -------- -------- -------- -------- Total current assets ........................................ 792 4,720 -- 5,512 Property, plant and equipment, net ................................... 1,151 8,506 -- 9,657 Goodwill, net ........................................................ 21 3,573 -- 3,594 Fair value interest rate hedges ...................................... 18 -- -- 18 Other assets ......................................................... 621 (315) -- 306 Investment in and advances to subsidiaries ........................... 11,173 -- (11,173) -- -------- -------- -------- -------- Total assets ................................................ $ 13,776 $ 16,484 $(11,173) $ 19,087 ======== ======== ======== ======== Current liabilities Current portion of long-term debt including obligations under capital leases ............................... $ 412 $ 24 $ -- $ 436 Accounts payable ................................................. 246 2,759 -- 3,005 Other current liabilities ........................................ 685 1,359 -- 2,044 -------- -------- -------- -------- Total current liabilities ................................... 1,343 4,142 -- 5,485 Long-term debt including obligations under capital leases ................................................. Face value long-term debt including obligations under capital leases ........................................... 8,022 390 -- 8,412 Adjustment to reflect fair value interest rate hedges ............ 18 -- -- 18 -------- -------- -------- -------- Long-term debt including obligations under capital leases ........................................... 8,040 390 -- 8,430 Other long-term liabilities .......................................... 891 779 -- 1,670 -------- -------- -------- -------- Total liabilities ........................................... 10,274 5,311 -- 15,585 -------- -------- -------- -------- Shareowners' Equity .................................................. 3,502 11,173 (11,173) 3,502 -------- -------- -------- -------- Total liabilities and shareowners' equity ................... $ 13,776 $ 16,484 $(11,173) $ 19,087 ======== ======== ======== ========
12 Condensed Consolidating Statements of Income For the Quarter Ended August 17, 2002
Guarantor The Kroger Co. Subsidiaries Eliminations Consolidated -------------- ------------ ------------ ------------ Sales .................................................. $ 1,660 $10,466 $ (199) $11,927 Merchandise costs, including warehousing and transportation ...................................... 1,408 7,517 (187) 8,738 Operating, general and administrative .................. 330 1,886 -- 2,216 Rent ................................................... 38 125 (12) 151 Depreciation and amortization .......................... 18 229 -- 247 Merger-related costs, restructuring charges and related items ....................................... 11 (10) -- 1 ------- ------- ------- ------- Operating profit (loss) ......................... (145) 719 -- 574 Interest expense ....................................... (126) (11) -- (137) Equity in earnings of subsidiaries ..................... 443 -- (443) -- ------- ------- ------- ------- Earnings before tax expense ............................ 172 708 (443) 437 Tax expense (benefit) .................................. (101) 265 -- 164 ------- ------- ------- ------- Earnings before extraordinary loss ..................... 273 443 (443) 273 Extraordinary loss, net of income tax benefit .......... (9) -- -- (9) ------- ------- ------- ------- Net earnings .................................... $ 264 $ 443 $ (443) $ 264 ======= ======= ======= =======
13 Condensed Consolidating Statements of Income For the Quarter Ended August 18, 2001
Guarantor The Kroger Co. Subsidiaries Eliminations Consolidated ---------------- -------------- -------------- -------------- Sales .................................................... $ 1,588 $ 10,092 $ (195) $ 11,485 Merchandise costs, including warehousing and transportation ....................................... 1,274 7,239 (183) 8,330 Operating, general and administrative .................... 316 1,868 -- 2,184 Rent ..................................................... 39 125 (12) 152 Depreciation and amortization ............................ 6 240 -- 246 Merger-related costs, restructuring charges and related items ........................................ 2 -- -- 2 -------- -------- -------- -------- Operating profit (loss) ......................... (49) 620 -- 571 Interest expense ......................................... (142) (10) -- (152) Equity in earnings of subsidiaries ....................... 372 -- (372) -- -------- -------- -------- -------- Earnings before tax expense .............................. 181 610 (372) 419 Tax expense (benefit) .................................... (75) 238 -- 163 -------- -------- -------- -------- Earnings before extraordinary loss ....................... 256 372 (372) 256 Extraordinary loss, net of income tax benefit ............ -- -- -- -- -------- -------- -------- -------- Net earnings .................................... $ 256 $ 372 $ (372) $ 256 ======== ======== ======== ========
14 Condensed Consolidating Statements of Income For the Two Quarters Ended August 17, 2002
Guarantor The Kroger Co. Subsidiaries Eliminations Consolidated -------------- -------------- -------------- -------------- Sales ....................................................... $ 3,871 $ 24,183 $ (460) $ 27,594 Merchandise costs, including warehousing and transportation ............................................ 3,210 17,399 (432) 20,177 Operating, general and administrative ....................... 694 4,410 -- 5,104 Rent ........................................................ 89 293 (28) 354 Depreciation and amortization ............................... 45 525 -- 570 Merger-related costs, restructuring charges and related items ............................................. 10 6 -- 16 -------- -------- ------- -------- Operating profit (loss) ............................... (177) 1,550 -- 1,373 Interest expense ............................................ (306) (20) -- (326) Equity in earnings of subsidiaries .......................... 940 -- (940) -- -------- -------- ------- -------- Earnings before tax expense ................................. 457 1,530 (940) 1,047 Tax expense (benefit) ....................................... (181) 574 -- 393 -------- -------- ------- -------- Earnings before extraordinary loss and cumulative effect of an accounting change ........................ 638 956 (940) 654 Extraordinary loss, net of income tax benefit ............... (12) -- -- (12) -------- -------- ------- -------- Earnings before cumulative effect of an accounting change ................................................ 626 956 (940) 642 Cumulative effect of an accounting change ................... -- (16) -- (16) -------- -------- ------- -------- Net earnings .......................................... $ 626 $ 940 $ (940) $ 626 ======== ======== ======= ========
15 Condensed Consolidating Statements of Income For the Two Quarters Ended August 18, 2001
Guarantor The Kroger Co. Subsidiaries Eliminations Consolidated ---------------- ----------------- ---------------- ---------------- Sales ................................................... $ 3,712 $ 23,319 $ (444) $ 26,587 Merchandise costs, including warehousing and transportation ...................................... 2,961 16,819 (416) 19,364 Operating, general and administrative ................... 607 4,418 -- 5,025 Rent .................................................... 92 290 (28) 354 Depreciation and amortization ........................... 39 527 -- 566 Merger-related costs, restructuring charges and related items ....................................... 4 -- -- 4 ---------- ---------- ---------- ---------- Operating profit (loss) ........................ 9 1,265 -- 1,274 Interest expense ........................................ (336) (21) -- (357) Equity in earnings of subsidiaries ...................... 758 -- (758) -- ---------- ---------- ---------- ---------- Earnings before tax expense ............................. 431 1,244 (758) 917 Tax expense (benefit) ................................... (128) 486 -- 358 ---------- ---------- ---------- ---------- Earnings before extraordinary loss ...................... 559 758 (758) 559 Extraordinary loss, net of income tax benefit ........... -- -- -- -- ---------- ---------- ---------- ---------- Net earnings ................................... $ 559 $ 758 $ (758) $ 559 ========== ========== ========== ==========
16 Condensed Consolidating Statements of Cash Flows For the Two Quarters Ended August 17, 2002
Guarantor The Kroger Co. Subsidiaries Consolidated ----------------- ---------------- ----------------- Net cash provided by operating activities .................. $ 1,471 $ 690 $ 2,161 ----------- ----------- ----------- Cash flows from investing activities: Capital expenditures ................................ (94) (935) (1,029) Other ............................................... 25 (78) (53) ----------- ----------- ----------- Net cash used by investing activities ...................... (69) (1,013) (1,082) ----------- ----------- ----------- Cash flows from financing activities: Proceeds from issuance of long-term debt ............ 853 -- 853 Reductions in long-term debt ........................ (1,365) (57) (1,422) Proceeds from issuance of capital stock ............. 28 -- 28 Capital stock reacquired ............................ (453) -- (453) Other ............................................... (18) (61) (79) Net change in advances to subsidiaries .............. (452) 452 -- ----------- ----------- ---------- Net cash provided (used) by financing activities ........... (1,407) 334 (1,073) ----------- ----------- ----------- Net (decrease) increase in cash and temporary cash investments ............................................ (5) 11 6 Cash and temporary investments: Beginning of year ................................... 25 136 161 ----------- ----------- ---------- End of year ......................................... $ 20 $ 147 $ 167 =========== =========== ==========
Condensed Consolidating Statements of Cash Flows For the Two Quarters Ended August 18, 2001
Guarantor The Kroger Co. Subsidiaries Consolidated ----------------- ---------------- ----------------- Net cash provided by operating activities .................. $ 805 $ 1,020 $ 1,825 ----------- ----------- ----------- Cash flows from investing activities: Capital expenditures ................................ (85) (1,063) (1,148) Other ............................................... (80) 32 (48) ----------- ----------- ----------- Net cash used by investing activities ...................... (165) (1,031) (1,196) ----------- ----------- ----------- Cash flows from financing activities: Proceeds from issuance of long-term debt ............ 1,290 -- 1,290 Reductions in long-term debt ........................ (1,262) (30) (1,292) Proceeds from issuance of capital stock ............. 46 -- 46 Capital stock reacquired ............................ (485) -- (485) Other ............................................... (214) 2 (212) Net change in advances to subsidiaries .............. (19) 19 -- ----------- ----------- ---------- Net used by financing activities ........................... (644) (9) (653) ----------- ----------- ----------- Net decrease in cash and temporary cash investments ............................................ (4) (20) (24) Cash and temporary investments: Beginning of year ................................... 25 136 161 ----------- ----------- ---------- End of year ......................................... $ 21 $ 116 $ 137 =========== =========== ==========
17 11. COMMITMENTS AND CONTINGENCIES The Company continuously evaluates contingencies based upon the best available evidence. Management believes that allowances for loss have been provided to the extent necessary and that its assessment of contingencies is reasonable. Allowances for loss are included in other current liabilities and other long-term liabilities. To the extent that resolution of contingencies results in amounts that vary from management's estimates, future earnings will be charged or credited. The principal contingencies are described below. Insurance - The Company's workers' compensation risks are self-insured in certain states. In addition, other workers' compensation risks and certain levels of insured general liability risks are based on retrospective premium plans, deductible plans and self-insured retention plans. The liability for workers' compensation risks is accounted for on a present value basis. Actual claim settlements and expenses incident thereto may differ from the provisions for loss. Property risks have been underwritten by a subsidiary and are reinsured with unrelated insurance companies. Operating divisions and subsidiaries have paid premiums, and the insurance subsidiary has provided loss allowances, based upon actuarially determined estimates. Litigation - The Company is involved in various legal actions arising in the normal course of business. Although occasional adverse decisions (or settlements) may occur, the Company believes that the final disposition of such matters will not have a material effect on the financial position of the Company. Purchase Commitment - The Company indirectly owns a 50% interest in the Santee Dairy ("Santee") and has a product supply arrangement with Santee that requires the Company to purchase 9 million gallons of fluid milk and other products annually. The product supply agreement expires on July 29, 2007. Upon acquisition of Ralphs/Food 4 Less, Santee became excess capacity and a duplicate facility. The joint venture is managed independently and has a board comprised of an equal number of members from each partner, plus one independent member. When there is a split vote, this member generally votes with the other partner. The other partner has filed suit against the Company claiming, among other things, that the Company is obligated to purchase its requirements of fluid milk from Santee as opposed to minimum gallons. 12. OTHER EVENTS On June 17, 2002, the Company issued $350, 6.20% Senior Notes due in 2012. On June 27, 2002, the Company filed a shelf registration statement with the SEC for the issuance of up to $2,000 of securities. The SEC declared the registration statement effective on July 23, 2002. On August 16, 2002, the Company retired early $250 of Puttable Reset Securities. The Company incurred a termination fee as a result of the early retirement of these securities and therefore recorded an after-tax extraordinary loss of $9 in the second quarter 2002. 18 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. RESULTS OF OPERATIONS Sales for the second quarter of 2002 totaled $11.9 billion, an increase of 3.8% over the second quarter of 2001. Sales for the first two quarters of 2002 totaled $27.6 billion, an increase of 3.8% over the first two quarters of 2001. The increases in sales are attributable to increases in comparable and identical store sales, an increase in the number of stores and the implementation of Kroger's Strategic Growth Plan. Identical food store sales, which include stores that have been in operation and have not been expanded or relocated for four quarters, grew 0.8% from the second quarter of 2001. Comparable food store sales, which include relocations and expansions, increased 1.7% over the prior year. We estimate that our product cost deflation was negative 0.7% for the second quarter 2002. A portion of the increase in sales was due to an increase in the number of stores. During the second quarter of 2002, we opened, acquired, relocated or expanded 39 food stores versus 38 food stores in the second quarter of 2001. Additionally, we remodeled 26 food stores and closed 19 food stores. We operated 2,447 food stores as of August 17, 2002 compared to 2,392 food stores as of August 18, 2001. As of August 17, 2002, food store square footage totaled 133 million. This represents an increase of 4.1% over August 18, 2001. As of the second quarter 2002, we operated 307 supermarket fuel centers compared to 143 supermarket fuel centers at the end of the second quarter 2001. Excluding sales at supermarket fuel centers, identical food store sales increased 0.2% and comparable food store sales grew 0.9%. Without supermarket fuel centers, we estimate that our product cost deflation was negative 0.6%. The tables below summarizes our identical and comparable food store sales information: IDENTICAL FOOD STORE SALES
Estimated inflation (deflation) ----------------------------------- Second Quarter Second Quarter Second Quarter Second Quarter 2002 2001 2002 2001 ------------------------------------------------------------------------- Including supermarket fuel centers 0.8% 0.8% (0.7)% 0.2% Excluding supermarket fuel centers 0.2% 0.3% (0.6)% 0.2% Total supermarket fuel centers 307 143 307 143
COMPARABLE FOOD STORE SALES
Estimated inflation (deflation) ----------------------------------- Second Quarter Second Quarter Second Quarter Second Quarter 2002 2001 2002 2001 ------------------------------------------------------------------------- Including supermarket fuel centers 1.7% 1.6% (0.7)% 0.2% Excluding supermarket fuel centers 0.9% 1.0% (0.6)% 0.2% Total supermarket fuel centers 307 143 307 143
The FIFO gross profit rate was 26.7% in the second quarter 2002 versus 27.5% in the second quarter 2001. Year-to-date, the FIFO gross profit rate was 26.9% and 27.2% in 2002 and 2001, respectively. During 2002, no one-time items were included in merchandise costs compared to $5 million of one-time expense incurred during 2001. In 2001, $2 million of the one-time expenses were incurred in the second quarter. Excluding these costs, the second quarter 2001 FIFO gross profit rate was 27.6% and the year-to-date 2001 rate was 27.3%. The decrease in the FIFO gross profit rate in 2002 from 2001 was primarily the result of Kroger's investment in lower retail prices as part of the Strategic Growth Plan. Approximately 18 basis points of the decrease in the second quarter 2002 versus the second quarter 2001 was related to the increase in the percent of total sales from supermarket fuel centers in 2002 versus 2001. Supermarket fuel center sales have a negative impact on our overall FIFO gross profit rate. In the second quarter 2002, Kroger's private-label grocery market share in terms of units sold increased approximately 0.8%, but decreased approximately 0.3% in terms of dollar sales, compared to the second quarter of 2001. Operating, general and administrative expenses as a percent of sales were 18.6% in the second quarter of 2002, 19.0% in the second quarter of 2001, 18.5% year-to-date 2002, and 18.9% year-to-date 2001. We recorded one-time expenses of $4 million 19 and $7 million in operating, general and administrative expense in the second quarters of 2002 and 2001, respectively. For the first two quarters of 2002, one-time items included in operating, general and administrative expense netted zero. For the first two quarters of 2001, one-time expenses included in operating, general and administrative expense totaled $19 million. Excluding these one-time items, operating, general and administrative expenses as a percent of sales were 18.6% during the second quarter of 2002, 19.0% during the second quarter of 2001, 18.5% year-to-date 2002, and 18.8% year-to-date 2001. Operating, general and administrative expenses decreased as a percent of sales partially due to our successful cost reduction and productivity initiatives. Approximately 11 basis points of the decrease in the second quarter 2002 versus the second quarter 2001 was related to the increase in the percent of total sales from supermarket fuel centers in 2002 versus 2001. Supermarket fuel center sales have a positive impact on our overall operating, general and administrative expense rate. These results were achieved despite the negative impact of higher health care benefit costs, pension costs and credit card fees. Depreciation expense totaled $247 million in the second quarter of 2002, an increase of $27 million over $220 million in the second quarter of 2001. For the first two quarters of 2002, depreciation expense totaled $570 million, an increase of $61 million compared to $509 million during the same period of 2001. The increases in depreciation expense primarily were due to Kroger's capital investment program. Net interest expense totaled $137 million for the second quarter of 2002, a decrease of approximately 9.4% from the second quarter of 2001. For the first two quarters of 2002, net interest expense totaled $326 million, a decrease of approximately 8.7% compared to the same period of 2001. These decreases resulted from lower interest rates on our floating-rate debt in 2002 and an overall reduction of outstanding debt versus the second quarter 2001. The effective tax rate differs from the expected statutory rate primarily because of the effect of certain state taxes. Net earnings were $264 million or $0.33 per diluted share for the second quarter of 2002. These results represent an increase of approximately 6.5% over net earnings of $0.31 per diluted share for the second quarter of 2001. For the first two quarters of 2002, net earnings totaled $626 million, or $0.78 per diluted share, an increase of 16.4% over net earnings of $0.67 per diluted share for the first two quarters of 2001. As described below in "Other Issues," Kroger's adoption of Statement of Financial Accounting Standards ("SFAS") No. 142 eliminated the amortization of goodwill beginning in fiscal 2002. Goodwill amortization expense totaled $26 million, pre-tax, in the second quarter of 2001 and $57 million, pre-tax, year-to-date, 2001. In the first quarter 2002, we performed a transitional impairment review of goodwill in accordance with SFAS No. 142, and as a result, we recorded a $16 million after-tax impairment loss as a cumulative effect of an accounting change. Adjusting 2002 results to eliminate the cumulative effect of the accounting change, and 2001 results to eliminate the amortization of goodwill and its tax effect, net earnings were $0.33 per diluted share in the second quarter 2002, a decrease of approximately 2.9% from net earnings of $0.34 per diluted share for the second quarter, 2001. On this basis, year-to-date, 2002, net earnings were $0.80 per diluted share, an increase of approximately 9.6% over net earnings of $0.73 per diluted share for the same period of 2001. As described below in "Merger-Related Costs and Other One-Time Items," Kroger incurred pre-tax one-time expenses totaling $5 million and $11 million in the second quarters of 2002 and 2001, respectively. Year-to-date, these items totaled $16 million and $28 million, pre-tax, in 2002 and 2001, respectively. Also, we incurred an after-tax loss of $16 as a result of the implementation of SFAS No. 142. This loss was recorded as the cumulative effect of an accounting change, in the first quarter of 2002. We incurred after-tax extraordinary losses related to the early retirement of debt totaling $9 million and $12 million in the second quarter 2002, and year-to-date 2002, respectively. Excluding these items, earnings were $276 million, or $0.35 per diluted share, in the second quarter of 2002, and $665 million, or $0.83 per diluted share, for the first two quarters of 2002. On this basis, and adjusting 2001 results to eliminate the amortization of goodwill and its tax effect, earnings per diluted share for the second quarter were flat compared to the second quarter of 2001, and earnings per diluted for the first two quarters of 2002 increased 10.7% over earnings of $0.75 for the first two quarters of 2001. 20 MERGER-RELATED COSTS AND OTHER ONE-TIME ITEMS Merger-related costs We are continuing the process of implementing our integration plan relating to recent mergers. During the first and second quarters of 2001, and the first quarter of 2002, we recorded pre-tax, non-cash merger-related costs of $2 million resulting from the issuance of restricted stock. The market value adjustment of the restricted stock resulted in a pre-tax, non-cash credit of $1 million in the second quarter of 2002. Restrictions on the stock awards lapsed based on the achievement of synergy goals. All synergy-based awards were earned provided that recipients were still employed by Kroger on the stated restriction lapsing date. One-time items In addition to the merger-related costs that are shown separately on the Consolidated Statement of Income, we incurred pre-tax one-time expenses of $4 million and $9 million during the second quarters of 2002 and 2001, respectively. Second quarter 2002 amounts included $1 million of expense resulting from the market value adjustment of excess energy purchase contracts. In the first quarter 2002, we recorded pre-tax one-time income of $7 million from the market value adjustment of these contracts. For the first two quarters of 2002, pre-tax one-time items netted to zero. Pre-tax one-time expense totaled $24 million for the first two quarters of 2001. The one-time items were included in merchandise costs and operating, general and administrative expense in 2001 and in operating, general and administrative expense in 2002. Pre-tax expenses of $4 million and $7 million were included in operating, general and administrative expense in the second quarters of 2002 and 2001, respectively. Pre-tax expenses of $2 million were included in merchandise costs in the second quarter, 2001. For the first two quarters of 2002, the pre-tax one-time items included in operating, general and administrative expense netted to zero. For the first two quarters of 2001, the one-time items included in operating, general and administrative expense totaled $19 million of pre-tax expense. The remaining $5 million of pre-tax expense recorded in the first two quarters of 2001 was included in merchandise costs. All of the items included as merchandise costs in 2001 were product costs for excess capacity. The remaining $19 million of expense in 2001 primarily related to employee severance and system conversion costs and was included as operating, general and administrative expenses. In 2002, approximately $6 million of expense related to system conversion costs and was included in operating, general and administrative expense. All of the costs in 2001 and $5 million of the costs in 2002 represented cash expenditures. During March through May 2001, we entered into four separate commitments to purchase electricity from one of our utility suppliers in southern California. At the inception of the contracts, forecasted electricity usage indicated that it was probable that all of the electricity would be utilized in the operations of the company. We, therefore, accounted for the contracts in accordance with the normal purchases and normal sales exception under SFAS No. 133, as amended, and no amounts were initially recorded in the financial statements related to these purchase commitments. During the third quarter 2001, we determined that one of the contracts, and a portion of a second contract, provided for supplies in excess of our expected demand for electricity. This precluded use of the normal purchases and normal sales exception under SFAS No. 133 for those contracts, and required the contracts to be marked to fair value through current-period earnings. We therefore recorded a pre-tax charge of $81 million in the third quarter 2001 to accrue liabilities for the estimated fair value of these contracts through December 2006. The remaining portion of the second contract was re-designated as a cash flow hedge of future purchases. The other two purchase commitments continue to qualify for the normal purchases and normal sales exception under SFAS No. 133. SFAS No. 133 requires the excess contracts to be marked to fair value through current-period earnings each quarter. Due to an increase in the forward market prices for electricity in southern California during the first quarter 2002, we recorded pre-tax income of $7 million to mark the excess contracts to estimated fair value as of May 25, 2002. Short-term forward market prices decreased in the second quarter 2002, and as a result, we recorded a $1 million non-cash charge to mark the excess contracts to fair value as of August 17, 2002. For the first two quarters of 2002, we recorded $6 of pre-tax, non-cash net income as a result of the changes in forward market prices. Also, we made net cash payments totaling $8 to settle the excess energy purchase commitments for the first two quarters of 2002. 21 Restructuring charges On December 11, 2001, we outlined a Strategic Growth Plan ("Plan") to support additional investment in our core business to increase sales and market share. The Plan has three key elements: reduction of operating, general and administrative expenses, centralization and increased coordination of merchandising and procurement activities, and targeted retail price reductions. As part of the plan to reduce operating, general and administrative costs, we have eliminated slightly over 1,500 positions. We also have merged the Nashville division office and distribution center into the Atlanta and Louisville divisions. As of August 17, 2002, execution of the Plan had reduced expenses by approximately $178 million. Restructuring charges related to the Plan totaled $2 million, pre-tax, in the second quarter 2002. These charges totaled $15 million, pre-tax, for the first two quarters of 2002. The majority of these expenses related to severance agreements, distribution center consolidation and conversion costs. All of the second quarter 2002 costs, and approximately $10 million of the total 2002 costs, represented cash expenditures. Also during 2002, we made cash payments totaling $33, primarily for severance agreements. We do not expect to incur any additional expenses related to the Plan. Cumulative effect of an accounting change As described below in "Other Issues," adoption of SFAS No. 142 required Kroger to perform a transitional impairment review of goodwill in 2002. This review has been completed and resulted in a $16 million after-tax impairment loss, recorded as a cumulative effect of an accounting change in the first quarter 2002. The table below details our merger-related costs and other one-time items. Amounts shown are pre-tax, except for the cumulative effect of an accounting change, which is shown net of tax:
Second Quarter Ended Two Quarters Ended --------------------------- -------------------------- August 17, August 18, August 17, August 18, 2002 2001 2002 2001 --------------------------- -------------------------- (in millions) (in millions) Merger-related costs ........................................... $ (1) $ 2 $ 1 $ 4 ----- ----- ----- ----- One-time items related to mergers included in: Merchandise costs ........................................... -- 2 -- 5 Operating, general and administrative ....................... 3 7 6 19 Other one-time items included in: Operating, general and administrative - energy contracts .... 1 -- (6) -- ----- ----- ----- ----- Total one-time items ........................................... 4 9 -- 24 Restructuring charges and related items ........................ 2 -- 15 -- Cumulative effect of an accounting change, net of tax .......... -- -- 16 -- ----- ----- ----- ----- Total merger-related costs and other one-time items ............ $ 5 $ 11 $ 32 $ 28 ===== ===== ===== =====
Refer to Notes two, three, four and nine to the financial statements for more information on these costs. LIQUIDITY AND CAPITAL RESOURCES Debt Management During the second quarter 2002, we invested $337 million to repurchase 17.2 million shares of Kroger stock at an average price of $19.60 per share. For the first two quarters of 2002, we repurchased 22.7 million shares of Kroger stock for a total investment of $458 million. These amounts include shares acquired by Kroger in connection with awards of shares and exercises of stock options by participants in Kroger's stock option and long-term incentive plans. In the second quarter 2002, we purchased 16.4 million shares under our $1 billion stock repurchase plan and we purchased an additional 0.8 million shares under our program to repurchase common stock funded by the proceeds and tax benefits from stock option exercises. We had several lines of credit with borrowing capacity totaling approximately $2.76 billion at August 17, 2002. Outstanding credit agreement and commercial paper borrowings, and certain outstanding letters of credit, reduce funds available under our lines of credit. In addition, we had a $75 million money market line, borrowings under which also reduce the funds available under our lines of credit. At August 17, 2002, our outstanding commercial paper borrowings totaled $557 million and our money market line borrowings totaled $21 million. The outstanding letters of credit that reduced the funds available under our 22 credit agreement totaled $118 million. We did not have any outstanding credit agreement borrowings as of August 17, 2002. In addition, we had a $202 million synthetic lease credit facility as further described below. On June 17, 2002, we issued $350 million, 6.20% Senior Notes due in 2012. On June 27, 2002, we filed a shelf registration statement with the SEC for the issuance of up to $2.0 billion of securities. The SEC declared the registration statement effective on July 23, 2002. On August 16, 2002, we retired early $250 million of Puttable Reset Securities. We incurred a termination fee as a result of the early retirement of these securities and therefore recorded an after-tax extraordinary loss of $9 million in the second quarter 2002. As part of the Fred Meyer merger, we became party to a financing transaction related to 16 properties constructed for total costs of approximately $202 million. Under the terms of the financing transaction, which was structured as a synthetic lease, a special purpose trust owns the properties and leases them to subsidiaries of Kroger. The lease expires in February 2003. We pay a variable lease rate that was approximately 2.7% at August 17, 2002. The synthetic lease qualifies as an operating lease and the owner of the special purpose trust has made a substantive residual equity investment. The transaction, therefore, is accounted for off-balance sheet and the related costs are reported as rent expense. As of August 17, 2002, the assets and liabilities of the special purpose trust were composed primarily of the properties and $187 million of bank debt used to fund the construction of the properties. In connection with these financing transactions, we have made a residual value guarantee for the leased property equal to 85% of the financing, or $172 million. We believe the market value of the property subject to this financing exceeded the residual value guarantee at August 17, 2002. Approximately $202 million were outstanding under the synthetic lease at August 17, 2002. Net total debt decreased $260 million to $8.2 billion at the end of the second quarter of 2002 compared to $8.5 billion at the end of the second quarter of 2001. Net total debt is defined as long-term debt, including capital leases and current portion thereof, less investments in debt securities, prefunded employee benefits and mark-to-market adjustments necessary to record fair value interest rate hedges of our fixed rate debt, pursuant to SFAS No. 133. Net total debt decreased $293 million from year-end 2001. Total debt decreased $213 million to $8.4 billion at the end of the second quarter of 2002 compared to $8.6 billion at the second quarter of 2001. Total debt decreased $498 million versus year-end 2001. These decreases are the result of the use of cash flow to reduce outstanding debt. Our bank credit facilities and the indentures underlying our publicly issued debt contain various restrictive covenants. Some of these covenants are based on EBITDA, which we define as earnings before interest, taxes, depreciation, amortization, LIFO, extraordinary losses, and one-time items. The ability to generate EBITDA at levels sufficient to satisfy the requirements of these agreements is a key measure of our financial strength. We do not intend to present EBITDA as an alternative to any generally accepted accounting principle measure of performance. Rather, we believe the presentation of EBITDA is important for understanding our performance compared to our debt covenants. The calculation of EBITDA is based on the definition contained in our bank credit facilities. This may be a different definition than other companies use. We were in compliance with all EBITDA-based bank credit facilities and indenture covenants on August 17, 2002. 23 The following is a summary of the calculation of EBITDA for the second quarters of 2002 and 2001 and for the two-quarter periods then-ended.
Second Quarter Ended Two Quarters Ended ---------------------------- -------------------------- August 17, August 18, August 17, August 18, 2002 2001 2002 2001 ------------ ------------ ------------ ------------ (in millions) (in millions) Earnings before tax expense, extraordinary loss and the cumulative effect of an accounting change .......... $ 437 $ 419 $1,047 $ 917 Interest .................................................. 137 152 326 357 Depreciation .............................................. 247 220 570 509 Goodwill amortization ..................................... -- 26 -- 57 LIFO ...................................................... -- 8 12 20 One-time items included in merchandise costs .............. -- 2 -- 5 One-time items included in operating, general and administrative expenses ................................ 4 7 -- 19 Merger-related costs ...................................... (1) 2 1 4 Restructuring charges and related items ................... 2 -- 15 -- Rounding .................................................. -- 1 -- -- ------ ------ ------ ------ EBITDA .................................................... $ 826 $ 837 $1,971 $1,888 ====== ====== ====== ======
Cash Flow We generated $2.2 billion of cash from operating activities during the first two quarters of 2002 compared to $1.8 billion in the first two quarters of 2001. Cash flow from operating activities increased in the first two quarters of 2002 primarily due to increased earnings and decreased working capital. Investing activities used $1.1 billion of cash during the first two quarters of 2002 compared to $1.2 billion in 2001. This decrease in the use of cash was due to decreased capital spending. Financing activities used $1.1 billion of cash in the first two quarters of 2002 compared to $653 million in the first two quarters of 2001. This increase in the use of cash was due primarily to a reduction in the issuance of debt and the use of free cash flow to pay down outstanding debt balances. CAPITAL EXPENDITURES Capital expenditures excluding acquisitions totaled $420 million for the second quarter of 2002 compared to $530 million for the second quarter of 2001. Including acquisitions, capital expenditures totaled $420 million and $540 million in the second quarters of 2002 and 2001, respectively. For the first two quarters of 2002 and 2001, capital expenditures including acquisitions totaled $1.1 billion and $1.2 billion, respectively. Year-to-date expenditures in 2002 include the first quarter purchase of $192 million of assets previously financed under a synthetic lease. During the second quarter of 2002, we opened, acquired, expanded or relocated 39 food stores versus 38 food store openings during the same period of 2001. We had 19 operational closings and completed 26 within the wall remodels. Square footage increased 4.1% versus the second quarter of 2001. OTHER ISSUES As of August 17, 2002, we had $254 million remaining under Kroger's $1 billion stock repurchase program authorized in March of 2001. At current prices, we continue to repurchase common stock under this program and the program funded by the proceeds and tax benefits from stock option exercises. We indirectly own a 50% interest in the Santee Dairy ("Santee") and have a product supply arrangement with Santee that requires us to purchase 9 million gallons of fluid milk and other products annually. The product supply agreement expires on July 29, 2007. Upon acquisition of Ralphs/Food 4 Less, Santee became excess capacity and a duplicate facility. The joint venture is managed independently and has a board composed of an equal number of members from each partner, plus one 24 independent member. When there is a split vote, this member generally votes with the other partner. The other partner has filed suit against Kroger claiming, among other things, that Kroger is obligated to purchase its requirements of fluid milk from Santee as opposed to minimum gallons. We are a party to 345 collective bargaining agreements with local unions representing approximately 205,000 employees. We have agreements that have expired covering store employees in Oregon and North Carolina and the Southern California Teamsters. We cannot be certain that agreements will be reached without work stoppage. A prolonged work stoppage affecting a substantial number of stores could have a material effect on the results of our operations. Emerging Issues Task Force (EITF) Issue Nos. 00-22, "Accounting for 'Points' and Certain Other Time-Based or Volume-Based Sales and Incentive Offers, and Offers for Free Products or Services to be Delivered in the Future;" and 01-09, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of Vendor's Products)," became effective for Kroger on February 3, 2002. These issues address the appropriate accounting for certain vendor contracts and loyalty programs. The adoption of this standard did not have a material effect on our financial statements. SFAS No. 141, "Business Combinations," was issued by the Financial Accounting Standards Board ("FASB") in June of 2001. This standard requires that all business combinations initiated after June 30, 2001 be accounted for under the purchase method of accounting. The Statement also addresses the recognition of intangible assets in a business combination. Adoption of SFAS No. 141 did not have a material effect on our financial statements. SFAS No. 142, "Goodwill and Other Intangible Assets," was issued by the FASB in June of 2001. The Statement addresses the accounting for intangible assets acquired outside of a business combination. The Statement also addresses the accounting for goodwill and other intangible assets subsequent to initial recognition. SFAS No. 142 provides that goodwill no longer will be amortized and instead will be tested for impairment on an annual basis. Kroger adopted SFAS No. 142 on February 3, 2002. Accordingly, we performed a transitional impairment review of our goodwill. Goodwill totaled $3.6 billion as of February 3, 2002. The review was performed at the operating division level. Generally, fair value represented a multiple of earnings before interest, taxes, depreciation, amortization, LIFO charge, extraordinary items and one-time items ("EBITDA") or discounted projected future cash flows. Impairment was indicated when the carrying value of a division, including goodwill, exceeded its fair value. We determined that the carrying value of the jewelry store division, which included $26 million of goodwill, exceeded its fair value. Impairment was not indicated for the goodwill associated with the other operating divisions. The fair value of the jewelry store division was subsequently measured against the fair value of its underlying assets and liabilities, excluding goodwill, to estimate an implied fair value of the division's goodwill. As a result of this analysis, we determined that the jewelry store division goodwill was entirely impaired. Impairment primarily resulted from the recent operating performance of the division and review of the division's projected future cash flows on a discounted basis, rather than on an undiscounted basis, as was the standard under SFAS No. 121, prior to adoption of SFAS No. 142. Accordingly, we recorded a $16 million charge, net of a $10 million tax benefit, as a cumulative effect of an accounting change in the first quarter, 2002. SFAS No. 143, "Asset Retirement Obligations," was issued by the FASB in August of 2001. This standard addresses obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 will become effective for Kroger on February 2, 2003. We currently are analyzing the effect this standard will have on its financial statements. SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," was issued by the FASB in August of 2001. This standard replaces SFAS No. 121 and APB No. 30 and amends APB No. 51. SFAS No. 144 became effective for Kroger on February 3, 2002. Adoption of this standard did not have a material effect on our financial statements. SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections," was issued by the FASB in April 2002. SFAS No. 145 becomes effective for Kroger on February 2, 2003. We currently are analyzing the effect this standard will have on our financial statements. SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," was issued by the FASB in June of 2002. SFAS No. 146 addresses significant issues relating to the recognition, measurement and reporting of costs associated with exit and disposal activities. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. We currently are analyzing the effect this standard will have on its financial statements. 25 OUTLOOK Information provided by us, including written or oral statements made by our representatives, may contain forward-looking information as defined in the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, which address activities, events or developments that we expect or anticipate will or may occur in the future, including such things as integration of the operations of acquired or merged companies, expansion and growth of our business, future capital expenditures and our business strategy, contain forward-looking information. Statements elsewhere in this report and below regarding our expectations, hopes, beliefs, intentions, or strategies are also forward looking statements. This forward-looking information is based on various factors and was derived utilizing numerous assumptions. While we believe that the statements are accurate, uncertainties and other factors could cause actual results to differ materially from those statements. In particular: . On December 11, 2001, we outlined a Strategic Growth Plan ("Plan") to support additional investment in core business, through targeted retail price reductions, to grow sales and increase market share. We intend to achieve identical supermarket store sales growth of 2% to 3% above product cost inflation and to reduce operating, general and administrative costs by more than $500 million over the next two years. We had expected to achieve approximately two-thirds of this reduction by the end of fiscal 2002. We now believe our fiscal 2002 savings will be slightly less than this goal because shrink reduction has proven more difficult to achieve than originally anticipated. As of August 17, 2002, we had reduced costs by approximately $178 million. We have eliminated slightly over 1,500 positions targeted for reduction under the Plan. We also have merged the Nashville division office and distribution center into the Atlanta and Louisville divisions. We remain committed to achieving the $500 million cost reduction by the end of fiscal 2003. As a result of the Plan, we established a long-term, sustainable annual earnings-per-share ("EPS") growth target of 13% - 15%, before one-time items, beginning in fiscal 2004, and 10% - 12%, before one-time items, for fiscal 2002 and 2003. For fiscal 2002, we have lowered our EPS growth estimate to 5% to 7%, before one-time items. For the remaining quarters of fiscal 2002, we expect EPS growth, before one-time items, to be flat to slightly positive. At this time, we do not plan to modify our EPS growth guidance for 2003 and beyond. Additionally, we believe identical food store sales for the third quarter of 2002 may increase less than the 0.8% growth achieved in the second quarter of 2002 because of continued product cost deflation and the unusually strong sales in the third quarter of 2001 during the weeks immediately following September 11, 2001. As of August 17, 2002, restructuring costs related to the Plan totaled approximately $52 million. These charges consisted primarily of severance agreements, distribution center consolidation and conversion costs. We believe there will not be any additional expenses associated with the Plan. The cumulative total of restructuring charges is below our original estimate of $85 million to $100 million. . We expect to reduce net operating working capital as compared to the third quarter of 1999 by a total of $500 million by the end of the third quarter 2004. Our ability to achieve this reduction will depend on results of our programs to improve net operating working capital management. We calculate net operating working capital as detailed in the table below. As of the end of the second quarter 2002, net operating working capital decreased $138 million compared to the second quarter of 2001. A calculation of net operating working capital based on our definition for the second quarters of 2002, 2001 and 2000 is shown below. 26
Second Second Second Quarter Quarter Quarter 2002 2001 2000 ------------ ---------- ----------- (in millions) Cash ................................ $ 167 $ 137 $ 155 Receivables ......................... 604 649 583 FIFO inventory ...................... 4,428 4,375 4,133 Operating prepaid and other assets .. 244 256 252 Accounts payable .................... (3,293) (3,118) (2,940) Operating accrued liabilities ....... (1,858) (1,851) (1,932) Prepaid VEBA ........................ -- (18) (56) --------- --------- --------- Net operating working capital ...... $ 292 $ 430 $ 195 ========= ========= ========
.. We obtain sales growth from new square footage, as well as from increased productivity from existing locations. We expect full year 2002 square footage to grow 3.5% to 4.5%. We expect combination stores to increase our sales per customer by including numerous specialty departments, such as pharmacies, natural food products, supermarket fuel centers, seafood shops, floral shops, and bakeries. We believe the combination store format will allow us to withstand continued competition from other food retailers, supercenters, mass merchandisers, club or warehouse stores, drug stores and restaurants. .. We are a party to 345 collective bargaining agreements with local unions representing approximately 205,000 employees. We have agreements that have expired covering store employees in Oregon and North Carolina and the Southern California Teamsters. We cannot be certain that agreements will be reached without work stoppage. A prolonged work stoppage affecting a substantial number of stores could have a material effect on the results of our operations. .. We define free cash flow as a rolling four quarters total of earnings before interest, taxes, depreciation, amortization and one-time items ("EBITDA"), less capital expenditures excluding the $192 million purchase of assets previously financed under a synthetic lease, less cash paid for interest and taxes, plus improvement in net operating working capital. During the past four quarters, we generated free cash flow of $1.1 billion, after capital expenditures of $1.7 billion, excluding the purchase of assets previously financed under a synthetic lease. We expect fiscal 2002 free cash flow to total approximately $650 million to $750 million, excluding the purchase of assets previously financed under a synthetic lease. .. Capital expenditures reflect our strategy of growth through expansion and acquisition as well as our emphasis on self-development and ownership of real estate, and on logistics and technology improvements. The continued capital spending in technology focusing on improved store operations, logistics, manufacturing procurement, category management, merchandising and buying practices, should reduce merchandising costs as a percent of sales. For fiscal 2002, we expect capital spending to be approximately $100 million less than our prior forecast of $2.4 billion to $2.5 billion. This estimate includes acquisitions and the purchase of assets previously financed under a synthetic lease. We intend to use the combination of free cash flow from operations, including reductions in working capital, and borrowings under credit facilities to finance capital expenditure requirements. If determined preferable, we may fund capital expenditure requirements by mortgaging facilities, entering into sale/leaseback transactions, or by issuing additional debt or equity. .. This analysis contains certain forward-looking statements about Kroger's future performance. These statements are based on management's assumptions and beliefs in light of the information currently available. Such statements relate to, among other things: projected growth in earnings per share ("EPS"); working capital reduction; a decline in our net total debt-to-EBITDA ratio; our ability to generate free cash flow; and our strategic growth plan, and are indicated by words or phrases such as "comfortable," "committed," "expects," "goal," and similar words or phrases. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially. Our ability to achieve annual EPS growth goals will be affected primarily by customer response to lower retail prices offered through our Strategic Growth Plan, pricing and promotional activities of existing and new competitors, including non-traditional food retailers, and our response to these actions intended to increase market share. In addition, Kroger's EPS growth goals could be affected by: increases in product costs; newly opened or 27 consolidated distribution centers; our stock repurchase program; our ability to obtain sales growth from new square footage; competitive activity in the markets in which we operate; changes in our product mix; and changes in laws and regulations. Our ability to reduce our net total debt-to-EBITDA ratio could be adversely affected by: our ability to generate sales growth and free cash flow; interest rate fluctuations and other changes in capital market conditions; Kroger's stock repurchase activity; unexpected increases in the cost of capital expenditures; acquisitions; and other factors. The results of our strategic growth plan and our ability to generate free cash flow to the extent expected could be adversely affected if any of the factors identified above negatively impact our operations. In addition, the timing of the execution of the plan could adversely impact our EPS and sales results. .. The results of our Strategic Growth Plan, including the amount and timing of cost savings expected, could be adversely affected due to pricing and promotional activities of existing and new competitors, including non-traditional food retailers; our response actions; the state of the economy, including deflationary trends in certain commodities; recessionary times in the economy; our ability to achieve the cost reductions that we have identified, including those to reduce shrink and operating, general and administrative expense; increases in health care, pension and credit card fees; and the success of our capital investments. .. The amount and timing of future merger-related and other one-time costs could be adversely affected by our ability to convert remaining systems as planned and on budget. The cost associated with implementation of our Strategic Growth Plan, as well as the amount and timing of our expected cost reductions, could be affected by a worsening economy; increased competitive pressures; and an inability on our part to implement the Strategic Growth Plan when expected. .. Based on current operating results, we believe that operating cash flow and other sources of liquidity, including borrowings under our commercial paper program and bank credit facilities, will be adequate to meet anticipated requirements for working capital, capital expenditures, interest payments and scheduled principal payments for the foreseeable future. We also believe we have adequate coverage of our debt covenants to continue to respond effectively to competitive conditions. .. A decline in the generation of sufficient cash flows to support capital expansion plans, share repurchase programs and general operating activities could cause our growth to slow significantly and may cause us to miss our earnings per share growth targets, because we obtain some of our sales growth from new square footage. .. The grocery retailing industry continues to experience fierce competition from other food retailers, supercenters, mass merchandisers, club or warehouse stores, and drug stores. Our continued success is dependent upon our ability to compete in this industry and continue to reduce operating expenses, including health care and pension costs contained in our collective bargaining agreements. The competitive environment may cause us to reduce our prices in order to gain or maintain share of sales, thus reducing margins. While we believe our opportunities for sustained, profitable growth are considerable, unanticipated actions of competitors could impact our share of sales and net income. .. Changes in laws and regulations, including changes in accounting standards, taxation requirements, and environmental laws may have a material impact on our financial statements. .. Changes in the general business and economic conditions in our operating regions, including the rate of inflation, population growth, and employment and job growth in the markets in which we operate may affect our ability to hire and train qualified employees to operate our stores. This would negatively affect earnings and sales growth. General economic changes may also effect the shopping habits of our customers, which could affect sales and earnings. .. Changes in our product mix may negatively affect certain financial indicators. For example, we have added and will continue to add supermarket fuel centers. Since gasoline is a low profit margin item with high sales dollars, we expect to see our gross profit margins decrease as we sell more gasoline. Although this negatively affects our gross profit margin, gasoline provides a positive effect on operating, general and administrative expense as a percent of sales. .. Our ability to integrate any companies we acquire or have acquired and achieve operating improvements at those companies will affect our operations. .. We retain a portion of the exposure for our workers' compensation and general liability claims. It is possible that these claims may cause significant expenditures that would affect our operating cash flows. 28 . Our capital expenditures could fall outside of the expected range if we are unsuccessful in acquiring suitable sites for new stores, if development costs exceed those budgeted, or if our logistics and technology projects are not completed in the time frame expected or on budget. . Adverse weather conditions could increase the cost our suppliers charge for their products, or may decrease the customer demand for certain products. Additionally, increases in the cost of inputs, such as utility costs or raw material costs, could negatively impact financial ratios and net earnings. . Although we presently operate only in the United States, civil unrest in foreign countries in which our suppliers do business may affect the prices we are charged for imported goods. If we are unable to pass these increases on to our customers, our gross margin and net earnings will suffer. . Interest rate fluctuation and other capital market conditions may cause variability in earnings. Although we use derivative financial instruments to reduce our net exposure to financial risks, we are still exposed to interest rate fluctuations and other capital market conditions. . We cannot fully foresee the effects of the general economic downtown on Kroger's business. We have assumed the economic situation and competitive situations will not change significantly for 2002 and 2003. Other factors and assumptions not identified above could also cause actual results to differ materially from those set forth in the forward-looking information. Accordingly, actual events and results may vary significantly from those included in or contemplated or implied by forward-looking statements made by us or our representatives. 29 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. There have been no significant changes in our exposure to market risk from the information provided in Item 7A. Quantitative and Qualitative Disclosures About Market Risk on our Form 10-K filed with the SEC on May 1, 2002. 30 ITEM 4. Controls and Procedures. There have been no significant changes in our internal controls or in other factors that could have significantly affected those controls subsequent to the date of our most recent evaluation of internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses. 31 PART II - OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders (a) June 27, 2002 - Annual Meeting (b) The shareholders elected five directors to serve until the annual meeting of shareholders in 2005, and one director to serve until the annual meeting of shareholders in 2004, or until their successors have been elected and qualified, approved the 2002 Long-Term Incentive Plan, and ratified the selection of PricewaterhouseCoopers LLP, as Company auditors for 2002. The shareholders also adopted a shareholder proposal requesting that the Board of Directors take steps to implement the annual election of all Board members as opposed to election in classes and defeated a shareholder proposal recommending the Company label and identify all products sold under its brand names or private labels that may contain genetically engineered crops, organisms or products. Votes were cast as follows: To Serve Until 2005 For Withheld ------------------- -------------- -------------- Robert D. Beyer 524,489,099 168,468,981 John T. LaMacchia 522,374,319 170,583,761 Edward M. Liddy 524,586,676 168,371,404 Katherine D. Ortega 522,871,873 170,086,207 Bobby S. Shackouls 528,321,911 164,636,169 To Serve Until 2004 For Withheld ------------------- -------------- -------------- David B. Lewis 648,384,449 44,573,631
For Against Withheld Broker Non-Votes ----------- ---------- ------------ -------------------- 2002 Long-Term Incentive Plan 629,994,362 56,600,551 6,363,167 -- For Against Withheld Broker Non-Votes PricewaterhouseCoopers LLP 663,454,639 25,674,758 3,828,683 -- For Against Withheld Broker Non-Votes Shareholder proposal (declassify Board) 399,663,862 190,206,086 20,381,245 82,706,887 For Against Withheld Broker Non-Votes Shareholder proposal (genetically engineered items) 32,000,436 523,630,923 54,619,834 82,706,887
32 Item 6. Exhibits and Reports on Form 8-K. (a) EXHIBIT 3.1 - Amended Articles of Incorporation of the Company are hereby incorporated by reference to Exhibit 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended October 3, 1998. The Company's Regulations are incorporated by reference to Exhibit 4.2 of the Company's Registration Statement on Form S-3 as filed with the Securities and Exchange Commission on January 28, 1993, and bearing Registration No. 33-57552. EXHIBIT 4.1 - Instruments defining the rights of holders of long-term debt of the Company and its subsidiaries are not filed as Exhibits because the amount of debt under each instrument is less than 10% of the consolidated assets of the Company. The Company undertakes to file these instruments with the Commission upon request. EXHIBIT 10.1 - Material Contracts. Executive Employment Agreement dated as of June 7, 2002, between the Company and Michael S. Heschel. EXHIBIT 99.1 - Additional Exhibits - Statement of Computation of Ratio of Earnings to Fixed Charges. (b) The Company disclosed and filed an underwriting agreement, pricing agreement and the Fourteenth Supplemental Indenture related to the issuance of $350,000,000, 6.20% Senior Notes in its Current Report on Form 8-K dated June 17, 2002; announcement of first quarter 2002 earnings results in its Current Report on Form 8-K dated June 25, 2002; and a disclosure of amendments to its Annual Report on Form 10-K for the fiscal year ended February 2, 2002, and its Quarterly Report on Form 10-Q for the quarter ended May 25, 2002, both filed with the SEC on August 14, 2002, in its Current Report on Form 8-K dated August 14, 2002, and its CEO and CFO certifications with respect thereto. 33 SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE KROGER CO. Dated: September 30, 2002 By: /s/ Joseph A. Pichler ------------------------------- Joseph A. Pichler Chairman of the Board and Chief Executive Officer Dated: September 30, 2002 By: /s/ M. Elizabeth Van Oflen ------------------------------- M. Elizabeth Van Oflen Vice President and Corporate Controller 34 CERTIFICATIONS I, Joseph A. Pichler, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Kroger Co.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; Date: September 30, 2002 (Joseph A. Pichler) Joseph A. Pichler Chairman of the Board and Chief Executive Officer (principal executive officer) I, J. Michael Schlotman, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The Kroger Co.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; Date: September 30, 2002 (J. Michael Schlotman) J. Michael Schlotman Group Vice President and Chief Financial Officer (principal financial officer) 35 Exhibit Index Exhibit 3.1 - Amended Articles of Incorporation of the Company are hereby incorporated by reference to Exhibit 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended October 3, 1998. The Company's Regulations are incorporated by reference to Exhibit 4.2 of the Company's Registration Statement on Form S-3 as filed with the Securities and Exchange Commission on January 28, 1993, and bearing Registration No. 33-57552. Exhibit 4.1 - Instruments defining the rights of holders of long-term debt of the Company and its subsidiaries are not filed as Exhibits because the amount of debt under each instrument is less than 10% of the consolidated assets of the Company. The Company undertakes to file these instruments with the Commission upon request. Exhibit 10.1 - Material Contracts. Executive Employment Agreement dated as of June 7, 2002, between the Company and Michael S. Heschel. Exhibit 99.1 - Additional Exhibits - Statement of Computation of Ratio of Earnings to Fixed Charges. EX-10.1 3 dex101.txt EXECUTIVE EMPLOYMENT AGREEMENT DATED JUNE 7, 2002 EXHIBIT 10.1 EXECUTIVE EMPLOYMENT AGREEMENT This Executive Employment Agreement (the "Agreement") is made as of the 7th day of June, 2002 (the "Effective Date") between THE KROGER CO., an Ohio corporation ("Employer"), and MICHAEL S. HESCHEL ("Executive"). RECITALS A. Executive is currently serving as Executive Vice President of Employer, and Employer desires to secure the continued employment of Executive in accordance with this Agreement. B. Executive is willing to continue to remain in the employ of Employer, and any successor to Employer, on the terms and conditions set forth in this Agreement. C. The parties entered into a letter agreement dated as of June 27, 1991 (the "Pre-Hire Letter") under which Employer agreed to provide 15 years of credited service under Employer's pension plan provided that Executive remain in the employ of Employer for at least seven years, and Executive's benefits under Employer's pension plan were to be offset by benefits payable to Executive under pension plans of his previous employers. A copy of the Pre-Hire Letter is attached as Exhibit A to this Agreement. D. The parties intend that this Agreement will replace and supersede any and all prior employment agreements between Employer and Executive, except the Pre-Hire Letter as modified by this Agreement. In consideration of the foregoing premises, the mutual covenants and agreements set forth herein, and other good and valuable consideration, the sufficiency and receipt of which is hereby acknowledged by the parties, the parties agree as follows: 1. Employment. By this Agreement, Employer and Executive set forth the terms of Employer's employment of Executive on and after the Effective Date. Any prior agreements or understandings with respect to Executive's employment by Employer are cancelled as of the Effective Date. 2. Term of Agreement. The term of this Agreement shall commence on the Effective Date and end at 11:59 p.m. on September 27, 2004. Notwithstanding the foregoing, the term of this Agreement is subject to termination as provided in Section 8. 3. Duties: A. Executive will serve as Executive Vice President of Employer or in such other equivalent capacity as may be designated by the Board of Directors of Employer, and he will have such responsibilities, duties and authority as are customary for someone of that position. B. Executive shall furnish such managerial, executive, financial, technical, and other skills, advice, and assistance in operating Employer and its Affiliates as Employer may reasonably request. For purposes of this Agreement, "Affiliate" means each corporation which is a member of a controlled group of corporations (within the meaning of section 1563(a) of the Internal Revenue Code of 1986, as amended (the "Code")) which includes Employer. C. Executive shall also perform such duties as are reasonably assigned to Executive by the Board of Directors of Employer or by such officer of the Employer to whom Executive may now or hereafter be assigned to report. D. Executive shall devote Executive's entire time, attention, and energies to the business of Employer and its Affiliates. The words "entire time, attention, and energies" are intended to mean that Executive shall devote Executive's full effort during reasonable working hours to the business of Employer and its Affiliates. Executive shall travel to such places as are necessary in the performance of Executive's duties. 4. Compensation. A. Subject to Section 4.C. below, Executive shall receive a base salary (the "Base Salary") of at least $565,000 per year, payable in equal installments over 13 pay periods, or such other pay periods as Employer may establish for its management and executive employees, for each year during the term of this Agreement, subject to proration for any partial year. Such Base Salary, and all other amounts payable under this Agreement, shall be subject to withholding as required by law. B. Subject to Section 4.C. below, in addition to the Base Salary, Executive shall be entitled to receive an annual bonus (the "Bonus") (if earned) for each calendar year for which services are performed under this Agreement. Any Bonus for a calendar year shall be payable after the conclusion of the calendar year in accordance with Employer's regular bonus payment policies. Each year, Executive shall be given a Bonus target, by Employer's Compensation Committee, of not less than $540,000, subject to terms applicable to the annual bonus arrangements of management and executive employees generally. C. On at least an annual basis, Executive shall be considered for Base Salary and/or Bonus target increases. During periods of adverse business conditions that, in the judgment of the Compensation Committee of the Board of Directors (the "Compensation Committee"), require reductions in the salaries or bonuses of other elected senior officers of Employer, the Compensation Committee may reduce the amount of Executive's Base Salary or Bonus, or both, by the same average percentage reduction applied to salaries or bonuses of such other elected officers. 5. Expenses. All reasonable and necessary expenses incurred by Executive in the course of the performance of Executive's duties to Employer shall be reimbursable in accordance with Employer's then current travel and expense policies. -2- 6. Benefits. A. While Executive remains in the employ of Employer, Executive shall be entitled to participate in and shall receive all benefits under savings and retirement programs, welfare benefits plans, fringe benefit programs and perquisites provided by Employer to its management and executive employees generally. B. Notwithstanding anything contained herein to the contrary, the Base Salary and Bonus otherwise payable to Executive shall be reduced by any benefits paid to Executive by Employer under any disability plans made available to Executive by Employer. 7. Covenant Not to Compete. For purposes of this Section 7 only, the term "Employer" shall mean, collectively, Employer and each of its Affiliates. Executive acknowledges and agrees that, in the course of employment with Employer or any of its Affiliates, he has been and will be entrusted with and provided access to and gained intimate, detailed, and comprehensive knowledge of Employer's confidential, proprietary, and trade secret information and supplier relationships (the "Information"). Executive also acknowledges and agrees that, to protect and preserve the Information and related goodwill, the following covenants against certain employment are reasonably necessary and appropriate limitations on Executive. During the period from the Effective Date and continuing until June 18, 2006 even if such date is after the Termination Date (the "Non-competition Period"), Executive shall not engage in any business offering services related to the business of Employer, whether as a principal, partner, joint venturer, agent, employee, salesman, consultant, director or officer, where such engagement would involve Executive (i) in any business activity in competition with the retail business conducted by Employer during the three years preceding the Termination Date or (ii) in any business activity that provides retail food services or retail drug/pharmaceutical services. This restriction shall be limited to the geographical area where Employer is then engaged in such competing business activity or to such other geographical area as a court shall find reasonably necessary to protect the goodwill, business and Information of the Employer. For purposes of this Agreement, the "Termination Date" means the date on which Executive's employment as an executive under this Agreement terminates for any reason. During the Non-competition Period (or if this period is unenforceable by law, then for such period as shall be enforceable), Executive shall not interfere with or adversely affect, either directly or indirectly, Employer's relationships with any person, firm, association, corporation or other entity which is known by Executive to be, or is included on any listing to which Executive had access during the course of employment as, a customer, client, supplier, consultant or employee of Employer, and Executive shall not divert or change, or attempt to divert or change, any such relationship to the detriment of Employer or to the benefit of any other person, firm, association, corporation or other entity. Executive shall not, during or at any time within the Non-competition Period, induce or seek to induce, any other employee of Employer to terminate his or her employment relationship with Employer. -3- 8. Termination. A. (i) Employer or Executive may terminate this Agreement upon Executive's failure or inability to perform the services required hereunder over a period of one hundred twenty consecutive working days during any twelve consecutive month period (a "Terminating Disability"), because of any physical or mental infirmity for which Executive receives disability benefits under any disability benefit plans made available to Executive by Employer (the "Disability Plans"). (ii) If Employer or Executive elects to terminate this Agreement in the event of a Terminating Disability, such termination shall be effective immediately upon the giving of written notice by the terminating party to the other. (iii) Upon termination of this Agreement on account of a Terminating Disability, Employer shall pay Executive Executive's accrued compensation hereunder, whether Base Salary, Bonus or otherwise (subject to offset for any amounts received pursuant to the Disability Plans), to the Termination Date. For as long as such Terminating Disability may exist, Executive shall continue to be an employee of Employer for all other purposes, and Employer shall provide Executive with disability benefits and all other benefits according to the provisions of the Disability Plans and any other Employer plans in which Executive is then participating. (iv) If the parties elect not to terminate this Agreement upon an event of a Terminating Disability and Executive returns to active employment with Employer prior to such a termination, or if such disability exists for less than one hundred twenty consecutive working days, the provisions of this Agreement shall remain in full force and effect. B. This Agreement terminates immediately and automatically on the death of Executive, provided, however, that Executive's estate shall be paid Executive's accrued compensation hereunder, whether Base Salary, Bonus or otherwise, to the date of death. C. Employer may terminate this Agreement immediately, upon written notice to Executive, for Cause, and Employer shall pay Executive Executive's accrued compensation hereunder, whether Base Salary, Bonus or otherwise (subject to offset for any amount of damages suffered by Employer as a result of Executive's actions or omissions) to the Termination Date. For purposes of this Agreement, "Cause," when used in connection with the termination of Executive's employment by Employer, shall mean the occurrence of any of the following events: (i) Executive's extreme misconduct, including reckless or willful destruction of Employer property, unauthorized disclosure of confidential information or sexual, racial or other actionable harassment; (ii) Executive's conviction of or plea of nolo contendere to a felony or other crime involving moral turpitude; (iii) Executive's illegal, immoral, dishonest or fraudulent conduct in connection with the performance of his duties with Employer that results in material harm to the business reputation of Employer or subjects Employer to material financial loss or material loss of business; or (iv) the willful and continued failure by Executive to substantially perform Executive's duties under this Agreement (other than any such failure resulting from Executive's incapacity due to physical or mental illness) after the Board of Directors or the Chief Executive Officer has delivered to Executive a written demand for -4- substantial performance, which demand specifically identifies the manner in which Executive has not substantially performed his duties. D. This Agreement otherwise may terminate for any of the following reasons (a "Qualifying Termination"): (i) Employer may terminate this Agreement immediately, upon written notice to Executive, for any reason other than those set forth in Sections 8.A., B. and C. (ii) Executive may terminate this Agreement in the event that there is a Change in Control and Executive's employment with Employer is actually or constructively terminated by Employer within one year after the Change in Control for any reason other than those set forth in Sections 8.A., B. and C. For purposes of the preceding sentence, a "constructive" termination of Executive's employment shall be deemed to have occurred if, without Executive's consent, there is a material reduction in Executive's authority or responsibilities or if there is a reduction in Executive's Base Salary or Bonus target from the amount in effect immediately prior to the Change in Control (even if such reduction is pursuant to Section 4.C. above) or if Executive is required by Employer to relocate from the city where Executive is residing immediately prior to the Change in Control. (iii) Executive may terminate this Agreement upon forty-five (45) days advance written notice to Employer upon any breach by Employer of any material provision of this Agreement, which breach is not cured within a reasonable time after receipt by Employer of written notice of breach from Executive. In the event of a Qualifying Termination, or upon the expiration of this Agreement on September 27, 2004 if Executive remains employed by the Employer through that date, Employer shall pay or provide Executive the following benefits: (a) Employer will waive its right to offset Executive's pension benefits by the amount of his pension benefits from other employers (the "Pension Offset Waiver") and provide Executive, upon retirement, the full amount of benefits earned under Employer's pension plan including benefits based on the 15 additional years of credited service earned by Executive pursuant to the Pre-Hire Letter; (b) all stock options shall become immediately exercisable (and Executive shall be afforded the opportunity to exercise them during the original term of the option grant) and all restrictions applicable to all restricted stock grants shall lapse; (c) to the extent that Executive is deemed to have received an excess parachute payment by reason of a Change in Control, Employer shall pay Executive an additional sum sufficient to pay (i) any taxes imposed under section 4999 of the Code plus (ii) any federal, state and local taxes applicable to any taxes imposed under section 4999 of the Code. At any time, Employer may stop providing the Pension Offset Waiver if at any time during the Non-competitive Period Executive engages in any business activity in -5- violation of Section 7 hereof, regardless of whether such violative behavior occurs after this Agreement expires on September 27, 2004. For purposes of this Agreement, a "Change in Control" shall be deemed to have occurred if at any time after the Effective Date of this Agreement any of the following occurs: (1) without prior approval of Employer's Board of Directors, any person, group, entity or group thereof, excluding Employer employee benefit plans, becomes the owner of, or obtains the right to acquire, 20% or more of the voting power of Employer's then outstanding voting securities; or (2) a tender offer or exchange offer has expired, other than an offer by Employer, under which 20% or more of Employer's then outstanding voting securities have been purchased; (3) as a result of, or in connection with, or within two years following (i) a merger or business combination, (ii) a reorganization, or (iii) a proxy contest, in any case which was not approved by the Board of Directors of Employer, the individuals who were directors of Employer immediately before the transaction cease to constitute at least a majority thereof, except for changes caused by death, disability or normal retirement; or (4) Employer's shareholders have approved (i) an agreement to merge or consolidate with or into another corporation and Employer is not the surviving corporation, or (ii) an agreement, including a plan of liquidation, to sell or otherwise dispose of all or substantially all of Employer's assets. E. Executive may resign upon 30 days' prior written notice to Employer. In the event of a resignation under this Section 8.E., this Agreement shall terminate and Executive shall be entitled to receive Executive's Base Salary through the Termination Date and any other vested compensation or benefits called for under any compensation plan or program of Employer, and all further compensation under this Agreement shall terminate. F. Upon termination of this Agreement as a result of an event of termination described in this Section 8 and, except for Employer's payment of the required payments under this Section 8 (including any Base Salary accrued through the Termination Date, any Bonus earned for the year preceding the year in which the termination occurs and any nonforfeitable amounts payable under any employee plan), all further compensation under this Agreement shall terminate. 9. Remedies. A. Employer and Executive hereby acknowledge and agree that the services rendered by Executive to Employer, the information disclosed to Executive during and by virtue of Executive's employment, and Executive's commitments and obligations to Employer and its Affiliates herein are of a special, unique and extraordinary character, and that the breach of any provision of this Agreement by Executive will cause Employer irreparable injury and damage, -6- and consequently Employer shall be entitled to, in addition to all other remedies available to it, temporary, preliminary and permanent injunctive and equitable relief from a court of competent jurisdiction to prevent a breach of Sections 7 and 11 of this Agreement and to secure the enforcement of this Agreement. B. Except as provided in Section 9.A., the parties agree to submit to final and binding arbitration any dispute, claim or controversy, whether for breach of this Agreement or for violation of any of Executive's statutorily created or protected rights, arising between the parties that either party would have been otherwise entitled to file or pursue in court or before any administrative agency (herein "claim"), and waives all right to sue the other party. (i) This agreement to arbitrate and any resulting arbitration award are enforceable under and subject to the Federal Arbitration Act, 9 U.S.C.(S) 1 et seq. ("FAA"). If the FAA is held not to apply for any reason, then Ohio Revised Code Chapter 2711 regarding the enforceability of arbitration agreements and awards will govern this Agreement and the arbitration award. (ii) (a) All of a party's claims must be presented at a single arbitration hearing. Any claim not raised at the arbitration hearing is waived and released. The arbitration hearing will take place in Cincinnati, Ohio. (b) The arbitration process will be governed by the Employment Dispute Resolution Rules of the American Arbitration Association ("AAA") except to the extent they are modified by this Agreement. (c) Executive has had an opportunity to review the AAA rules and the requirements that Executive must pay a filing fee for which the Employer has agreed to split on an equal basis. (d) The arbitrator will be selected from a panel of arbitrators chosen by the AAA in Cincinnati, Ohio. After the filing of a Request for Arbitration, the AAA will send simultaneously to Employer and Executive an identical list of names of five persons chosen from the panel. Each party will have 10 days from the transmittal date in which to strike up to two names, number the remaining names in order of preference and return the list to the AAA. (e) Any pre-hearing disputes will be presented to the arbitrator for expeditious, final and binding resolution. (f) The award of the arbitrator will be in writing and will set forth each issue considered and the arbitrator's finding of fact and conclusions of law as to each such issue. (g) The remedy and relief that may be granted by the arbitrator to Executive are limited to lost wages, benefits, cease and desist and affirmative relief, compensatory, liquidated and punitive damages and reasonable attorney's fees, and will not include reinstatement or promotion. If the arbitrator would have awarded reinstatement or -7- promotion, but for the prohibition of this Agreement, the arbitrator may award front pay. The arbitrator may assess to either party, or split, the arbitrator's fee and expenses and the cost of the transcript, if any, in accordance with the arbitrator's determination of the merits of each party's position, but each party will bear any cost for its witnesses and proof. (h) Employer and Executive recognize that a primary benefit each derives from arbitration is avoiding the delay and costs normally associated with litigation. Therefore, neither party will be entitled to conduct any discovery prior to the arbitration hearing except that: (i) Employer will furnish Executive with copies of all non-privileged documents in Executive's personnel file; (ii) if the claim is for discharge, Executive will furnish Employer will records of earnings and benefits relating to Executive's subsequent employment (including self-employment) and all documents relating to Executive's efforts to obtain subsequent employment; (iii) the parties will exchange copies of all documents they intend to introduce as evidence at the arbitration hearing at least 10 days prior to such hearing; (iv) Executive will be allowed (at Executive's expense) to take the depositions, for a period not to exceed four hours each, of two representatives of Employer, and Employer will be allowed (at its expense) to depose Executive for a period not to exceed four hours; and (v) Employer or Executive may ask the arbitrator to grant additional discovery to the extent permitted by AAA rules upon a showing that such discovery is necessary. (i) Nothing herein will prevent either party from taking the deposition of any witness where the sole purpose for taking the deposition is to use the deposition in lieu of the witness testifying at the hearing and the witness is, in good faith, unavailable to testify in person at the hearing due to poor health, residency and employment more than 50 miles from the hearing site, conflicting travel plans or other comparable reason. (iii) Arbitration must be requested in writing no later than 6 months from the date of the party's knowledge of the matter disputed by the claim. A party's failure to initiate arbitration within the time limits herein will be considered a waiver and release by that party with respect to any claim subject to arbitration under this Agreement. (iv) Employer and Executive consent that judgment upon the arbitration award may be entered in any federal or state court that has jurisdiction. (v) Except as provided in Section 9.A., neither party will commence or pursue any litigation or any claim that is or was subject to arbitration under this Agreement. (vi) All aspects of any arbitration procedure under this Agreement, including the hearing and the record of the proceedings, are confidential and will not be open to the public, except to the extent the parties agree otherwise in writing, or as may be appropriate in any subsequent proceedings between the parties, or as may otherwise be appropriate in response to a governmental agency or legal process. 10. Survival After Termination. The termination of this Agreement shall not amend, alter or modify the rights and obligations of the parties under Sections 7, 9 and 11 hereof, the terms of which shall survive the termination of this Agreement. -8- 11. Goodwill. Executive shall not disparage Employer or any of its Affiliates in any way that could adversely affect the goodwill, reputation and business relationships of Employer or any of its Affiliates with the public generally, or with any of their customers, suppliers or employees. Employer shall not disparage Executive. 12. Assignment. As this is an agreement for personal services involving a relation of confidence and trust between Employer and Executive, all rights and duties of Executive arising under this Agreement, and the Agreement itself, are non-assignable by Executive. Executive agrees and consents that this Agreement and the rights, duties, and obligations contained in it may be and are fully transferable and/or assignable by Employer and shall be binding upon and inure to the benefit of Employer's successors, transferees, and assigns. 13. Notices. Any notice required or permitted to be given under this Agreement shall be in writing and shall be effective when given by personal delivery or four business days after being sent by certified mail, return receipt requested, to Executive at Executive's place of residence as then recorded on the books of Employer or to Employer at its principal office. 14. Modification. No waiver or modification of this Agreement or the terms contained herein shall be valid unless in writing and duly executed by the party to be charged therewith. The waiver by any party hereto of a breach of any provision of this Agreement by the other party shall not operate or be construed as a waiver of any subsequent breach by such party. 15. Governing Law. This Agreement shall be governed by the laws of the State of Ohio without regard to conflict of laws principles. 16. Entire Agreement. This Agreement contains the entire agreement of the parties with respect to Executive's employment by Employer. There are no other contracts, agreements or understandings, whether oral or written, existing between them except as contained or referred to in this Agreement. This Agreement replaces and supercedes in its entirety the Executive Employment Agreement of even date herewith between the parties which shall be of no further force and effect. 17. Severability. In case any one or more of the provisions of this Agreement is held to be invalid, illegal, or unenforceable in any respect, such invalidity, illegality, or other enforceability shall not affect any other provisions hereof, and this Agreement shall be construed as if such invalid, illegal, or unenforceable provisions have never been contained herein. 18. Successors and Assigns. Subject to the requirements of paragraph 12 above, this Agreement shall be binding upon Executive, Employer and Employer's successors and assigns. 19. Waiver and Release. In consideration of Employer's entering into this Agreement, and the receipt of other good and valuable consideration, the sufficiency of which is expressly acknowledged, Executive, for himself and his successors, assigns, heirs, executors and administrators, hereby waives and releases and forever discharges Employer and its affiliates and their officers, directors, agents, employees, shareholders, successors and assigns from all claims, demands, damages, actions and causes of action whatsoever which he now has on account of any matter, whether known or unknown to him and whether or not previously disclosed to Executive -9- or Employer, that relates to or arises out of (i) any existing or former employment agreement (written or oral) entered into between Executive and Employer or any of its affiliates (or any amendment or supplement to any such agreement), (ii) any agreement providing for a payment or payments or extension of the employment relationship triggered by a merger or sale or other disposition of stock or assets or restructuring of Employer or any affiliate of Employer, or (iii) any applicable severance plan. 20. Confidentiality of Agreement Terms. The terms of this Agreement shall be held in strict confidence by Executive and shall not be disclosed by Executive to anyone other than Executive's spouse, Executive's legal counsel, and Executive's other advisors, unless required by law. Further, except as provided in the preceding sentence, Executive shall not reveal the existence of this Agreement or discuss its terms with any person (including but not limited to any employee of Employer or its Affiliates) without the express authorization of the Board of Directors of Employer. To the extent that the terms of this Agreement have been disclosed by Employer, in a public filing or otherwise, the confidentiality requirements of this Section 20 shall no longer apply to such terms. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the day and year first above written. THE KROGER CO. By (Joseph A. Pichler) ------------------------------- EXECUTIVE (Michael S. Heschel) ---------------------------------- Michael S. Heschel -10- EX-99.1 4 dex991.txt COMPUTATION OF EARNINGS TO FIXED CHARGES EXHIBIT 99.1 Schedule of computation of ratio of earnings to fixed charges of The Kroger Co. and consolidated subsidiary companies for the five fiscal years ended February 2, 2002 and for the two quarters ended August 17, 2002 and August 18, 2001.
August 17, August 18, February 2, February 3, January 29, January 2, December 27, 2002 2001 2002 2001 2000 1999 1997 (16 weeks) (16 weeks) (52 weeks) (53 weeks) (52 weeks) (53 weeks) (52 weeks) ------------ ------------ ------------- ------------ ------------ ------------ ----------- (in millions of dollars) Earnings: Earnings before tax expense (credit), and extraordinary loss ..... $ 1,047 $ 917 $ 1,711 $ 1,508 $ 1,102 $ 889 $ 954 Fixed charges ........... 530 565 1,030 1,058 1,010 1,038 679 Capitalized interest .... (2) (6) (9) (7) (5) (9) (10) ------- -------- -------- -------- -------- -------- -------- $ 1,575 $ 1,476 $ 2,732 $ 2,559 $ 2,107 $ 1,918 $ 1,623 ======= ======== ======== ======== ======== ======== ======== Fixed charges: Interest ................ $ 328 $ 363 $ 659 $ 683 $ 644 $ 654 $ 397 Portion of rental Payments deemed to be interest ......... 202 202 371 375 366 384 282 ------- -------- -------- -------- -------- -------- -------- $ 530 $ 565 $ 1,030 $ 1,058 $ 1,010 $ 1,038 $ 679 ======= ======== ======== ======== ======== ======== ======== Ratio of earnings to fixed charges ........... 3.0 2.6 2.7 2.4 2.1 1.8 2.4
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