XNYS:KR Kroger Co Quarterly Report 10-Q Filing - 8/11/2012

Effective Date 8/11/2012

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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 11, 2012

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from          to         

 

Commission file number 1-303 

 


 

(Exact name of registrant as specified in its charter)

 


 

Ohio

 

31-0345740

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

1014 Vine Street, Cincinnati, OH 45202

(Address of principal executive offices)

(Zip Code)

 

(513) 762-4000

(Registrant’s telephone number, including area code)

 

Unchanged

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

 


 

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

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

(do not check if a smaller reporting company)

 

Smaller reporting company o

 

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

 

There were 527,590,491 shares of Common Stock ($1 par value) outstanding as of September 14, 2012.

 

 

 



 

PART I — FINANCIAL INFORMATION

 

Item 1.           Financial Statements.

 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share amounts)

(unaudited)

 

 

 

Second Quarter Ended

 

Two Quarters Ended

 

 

 

August 11,
2012

 

August 13,
2011

 

August 11,
2012

 

August 13,
2011

 

Sales 

 

$

21,726

 

$

20,913

 

$

50,791

 

$

48,374

 

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

 

17,278

 

16,555

 

40,374

 

38,179

 

Operating, general and administrative

 

3,391

 

3,353

 

7,854

 

7,688

 

Rent 

 

139

 

143

 

331

 

335

 

Depreciation and amortization

 

383

 

374

 

884

 

873

 

 

 

 

 

 

 

 

 

 

 

Operating profit

 

535

 

488

 

1,348

 

1,299

 

Interest expense

 

106

 

97

 

247

 

235

 

 

 

 

 

 

 

 

 

 

 

Earnings before income tax expense

 

429

 

391

 

1,101

 

1,064

 

Income tax expense

 

148

 

108

 

380

 

360

 

 

 

 

 

 

 

 

 

 

 

Net earnings including noncontrolling interests

 

281

 

283

 

721

 

704

 

Net earnings (loss) attributable to noncontrolling interests

 

2

 

2

 

3

 

(9

)

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co.

 

$

279

 

$

281

 

$

718

 

$

713

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.52

 

$

0.47

 

$

1.30

 

$

1.17

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in basic calculation

 

538

 

596

 

548

 

603

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.51

 

$

0.46

 

$

1.29

 

$

1.17

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in diluted calculation

 

541

 

600

 

552

 

607

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.115

 

$

0.105

 

$

0.23

 

$

0.21

 

 

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

 

2



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions and unaudited)

 

 

 

Second Quarter Ended

 

Two Quarters Ended

 

 

 

August 11,
2012

 

August 13,
2011

 

August 11,
2012

 

August 13,
2011

 

Net earnings including noncontrolling interests

 

$

281

 

$

283

 

$

721

 

$

704

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

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

 

 

 

 

2

 

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

 

13

 

8

 

31

 

20

 

Unrealized loss on cash flow hedging activities, net of income tax(3)

 

 

 

(14

)

 

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

 

 

1

 

2

 

1

 

 

 

 

 

 

 

 

 

 

 

Total other comprehensive income

 

13

 

9

 

19

 

23

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

294

 

292

 

740

 

727

 

Comprehensive income (loss) attributable to noncontrolling interests

 

2

 

2

 

3

 

(9

)

Comprehensive income attributable to The Kroger Co.

 

$

292

 

$

290

 

$

737

 

$

736

 

 


(1)

 

Amount is net of tax of $1 for the first two quarters of 2011.

(2)

 

Amount is net of tax of $7 for the second quarter of 2012 and $5 for the second quarter of 2011.  Amount is net of tax of $19 for the first two quarters of 2012 and $12 for the first two quarters of 2011.

(3)

 

Amount is net of tax of $(9) for the first two quarters of 2012.

(4)

 

Amount is net of tax of $1 for the second quarter of 2011.  Amount is net of tax of $1 for the first two quarters of 2011.

 

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

 

3



 

THE KROGER CO.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

(unaudited)

 

 

 

August 11,

 

January 28,

 

 

 

2012

 

2012

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and temporary cash investments

 

$

238

 

$

188

 

Deposits in-transit

 

900

 

786

 

Receivables

 

941

 

949

 

FIFO inventory

 

5,961

 

6,157

 

LIFO reserve

 

(1,124

)

(1,043

)

Prepaid and other current assets

 

335

 

288

 

Total current assets

 

7,251

 

7,325

 

 

 

 

 

 

 

Property, plant and equipment, net

 

14,600

 

14,464

 

Goodwill

 

1,164

 

1,138

 

Other assets

 

532

 

549

 

 

 

 

 

 

 

Total Assets

 

$

23,547

 

$

23,476

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities

 

 

 

 

 

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

 

$

1,340

 

$

1,315

 

Trade accounts payable

 

4,326

 

4,329

 

Accrued salaries and wages

 

900

 

1,056

 

Deferred income taxes

 

190

 

190

 

Other current liabilities

 

2,586

 

2,215

 

Total current liabilities

 

9,342

 

9,105

 

 

 

 

 

 

 

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

 

 

 

 

 

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

 

6,775

 

6,826

 

Adjustment to reflect fair-value interest rate hedges

 

12

 

24

 

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

 

6,787

 

6,850

 

 

 

 

 

 

 

Deferred income taxes

 

740

 

647

 

Pension and postretirement benefit obligations

 

1,403

 

1,393

 

Other long-term liabilities

 

1,482

 

1,515

 

 

 

 

 

 

 

Total Liabilities

 

19,754

 

19,510

 

 

 

 

 

 

 

Commitments and contingencies (see Note 7)

 

 

 

 

 

 

 

 

 

 

 

SHAREOWNERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

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

 

¾

 

¾

 

Common shares, $1 par per share, 1,000 shares authorized; 959 shares issued in 2012 and 2011

 

959

 

959

 

Additional paid-in capital

 

3,426

 

3,427

 

Accumulated other comprehensive loss

 

(825

)

(844

)

Accumulated earnings

 

9,164

 

8,571

 

Common shares in treasury, at cost, 432 shares in 2012 and 398 shares in 2011

 

(8,933

)

(8,132

)

 

 

 

 

 

 

Total Shareowners’ Equity - The Kroger Co.

 

3,791

 

3,981

 

Noncontrolling interests

 

2

 

(15

)

 

 

 

 

 

 

Total Equity

 

3,793

 

3,966

 

 

 

 

 

 

 

Total Liabilities and Equity

 

$

23,547

 

$

23,476

 

 

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

 

4



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions and unaudited)

 

 

 

Two Quarters Ended

 

 

 

August 11,
2012

 

August 13,
2011

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net earnings including noncontrolling interests 

 

$

721

 

$

704

 

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

 

 

 

 

 

Depreciation and amortization 

 

884

 

873

 

LIFO charge 

 

81

 

81

 

Stock-based employee compensation 

 

41

 

44

 

Expense for Company-sponsored pension plans 

 

48

 

44

 

Deferred income taxes 

 

101

 

(95

)

Other 

 

14

 

54

 

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

 

 

 

 

 

Store deposits in-transit 

 

(113

)

(140

)

Receivables 

 

(26

)

10

 

Inventories 

 

198

 

122

 

Prepaid expenses 

 

(37

)

(39

)

Trade accounts payable 

 

(34

)

107

 

Accrued expenses 

 

142

 

238

 

Income taxes receivable and payable 

 

76

 

202

 

Other 

 

(63

)

(12

)

 

 

 

 

 

 

Net cash provided by operating activities 

 

2,033

 

2,193

 

 

 

 

 

 

 

Cash Flows from Investing Activities: 

 

 

 

 

 

Payments for capital expenditures 

 

(985

)

(924

)

Proceeds from sale of assets 

 

22

 

5

 

Payments for acquisition

 

(12

)

¾

 

Other 

 

(16

)

(7

)

 

 

 

 

 

 

Net cash used by investing activities 

 

(991

)

(926

)

 

 

 

 

 

 

Cash Flows from Financing Activities: 

 

 

 

 

 

Proceeds from issuance of long-term debt

 

846

 

3

 

Dividends paid 

 

(128

)

(129

)

Payments on long-term debt 

 

(894

)

(533

)

Net payments on commercial paper

 

(10

)

¾

 

Excess tax benefits on stock-based awards

 

1

 

6

 

Proceeds from issuance of capital stock 

 

42

 

91

 

Treasury stock purchases 

 

(871

)

(803

)

Net increase (decrease) in book overdrafts

 

30

 

(85

)

Other 

 

(8

)

1

 

 

 

 

 

 

 

Net cash used by financing activities 

 

(992

)

(1,449

)

 

 

 

 

 

 

Net increase (decrease) in cash and temporary cash investments 

 

50

 

(182

)

 

 

 

 

 

 

Cash and temporary cash investments: 

 

 

 

 

 

Beginning of year 

 

188

 

825

 

End of quarter 

 

$

238

 

$

643

 

 

 

 

 

 

 

Reconciliation of capital expenditures: 

 

 

 

 

 

Payments for property and equipment 

 

$

(985

)

$

(924

)

Changes in construction-in-progress payables 

 

(17

)

(98

)

Total capital expenditures 

 

$

(1,002

)

$

(1,022

)

 

 

 

 

 

 

Disclosure of cash flow information: 

 

 

 

 

 

Cash paid during the year for interest 

 

$

221

 

$

241

 

Cash paid during the year for income taxes 

 

$

222

 

$

286

 

 

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

 

5



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY

(in millions, except per share amounts)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

Common Stock

 

Paid-In

 

Treasury Stock

 

Comprehensive

 

Accumulated

 

Noncontrolling

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Gain (Loss)

 

Earnings

 

Interest

 

Total

 

Balances at January 29, 2011

 

959

 

$

959

 

$

3,394

 

339

 

$

(6,732

)

$

(550

)

$

8,225

 

$

2

 

$

5,298

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

 

 

(4

)

91

 

 

 

 

91

 

Restricted stock issued

 

 

 

(53

)

(2

)

32

 

 

 

 

(21

)

Treasury stock activity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Treasury stock purchases, at cost

 

 

 

 

29

 

(703

)

 

 

 

(703

)

Stock options exchanged

 

 

 

 

4

 

(100

)

 

 

 

(100

)

Share-based employee compensation

 

 

 

44

 

 

 

 

 

 

44

 

Other comprehensive gain net of income tax of $14

 

 

 

 

 

 

23

 

 

 

23

 

Other

 

 

 

9

 

 

(6

)

 

 

(2

)

1

 

Cash dividends declared ($0.21 per common share)

 

 

 

 

 

 

 

(127

)

 

(127

)

Net earnings including noncontrolling interests

 

 

 

 

 

 

 

713

 

(9

)

704

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at August 13, 2011

 

959

 

$

959

 

$

3,394

 

366

 

$

(7,418

)

$

(527

)

$

8,811

 

$

(9

)

$

5,210

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at January 28, 2012

 

959

 

$

959

 

$

3,427

 

398

 

$

(8,132

)

$

(844

)

$

8,571

 

$

(15

)

$

3,966

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

 

 

(2

)

42

 

 

 

 

42

 

Restricted stock issued

 

 

 

(56

)

(2

)

38

 

 

 

 

(18

)

Treasury stock activity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Treasury stock purchases, at cost

 

 

 

 

36

 

(824

)

 

 

 

(824

)

Stock options exchanged

 

 

 

 

2

 

(47

)

 

 

 

(47

)

Share-based employee compensation

 

 

 

41

 

 

 

 

 

 

41

 

Other comprehensive gain net of income tax of $10

 

 

 

 

 

 

19

 

 

 

19

 

Other

 

 

 

14

 

 

(10

)

 

 

14

 

18

 

Cash dividends declared ($0.23 per common share)

 

 

 

 

 

 

 

(125

)

 

(125

)

Net earnings including noncontrolling interests

 

 

 

 

 

 

 

718

 

3

 

721

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at August 11, 2012

 

959

 

$

959

 

$

3,426

 

432

 

$

(8,933

)

$

(825

)

$

9,164

 

$

2

 

$

3,793

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

6



 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

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

 

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

 

1.              ACCOUNTING POLICIES

 

Basis of Presentation and Principles of Consolidation

 

The accompanying financial statements include the consolidated accounts of The Kroger Co., its wholly-owned subsidiaries, and the Variable Interest Entities (“VIEs”) in which the Company is the primary beneficiary.  The January 28, 2012 balance sheet was derived from audited financial statements and, due to its summary nature, does not include all disclosures required by generally accepted accounting principles (“GAAP”).  Significant intercompany transactions and balances have been eliminated.  References to the “Company” in these Consolidated Financial Statements mean the consolidated company.

 

In the opinion of management, the accompanying unaudited Consolidated Financial Statements include all normal, recurring adjustments that are necessary for a fair presentation of results of operations for such periods but should not be considered as indicative of results for a full year.  The financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted, pursuant to SEC regulations.  Accordingly, the accompanying Consolidated Financial Statements should be read in conjunction with the financial statements in the Annual Report on Form 10-K of The Kroger Co. for the fiscal year ended January 28, 2012.

 

The unaudited information in the Consolidated Financial Statements for the second quarter and the two quarters ended August 11, 2012 and August 13, 2011, includes the results of operations of the Company for the 12 and 28-week periods then ended.

 

2.              STOCK OPTION PLANS

 

The Company recognized total stock-based compensation of $17 and $20 in the second quarters ended August 11, 2012 and August 13, 2011, respectively.  The Company recognized total stock-based compensation of $41 and $44 in the first two quarters of 2012 and 2011, respectively.  These costs were recognized as operating, general and administrative costs in the Company’s Consolidated Statements of Operations.

 

The Company grants options for common shares (“stock options”) to employees, as well as to its non-employee directors, under various plans at an option price equal to the fair market value of the shares at the date of grant.  In addition to stock options, the Company awards restricted stock to employees and its non-employee directors under various plans.  Equity awards may be made once each quarter on a predetermined date.  It has been the Company’s practice to make a general annual grant to employees, which occurred in the second quarter of 2012.  Special grants may be made in the other three quarters.  Grants to non-employee directors occur on the same date that the general annual grant to employees occurs.

 

Stock options granted in the first two quarters of 2012 expire 10 years from the date of grant and vest between one year and five years from the date of grant. Restricted stock awards granted in the first two quarters of 2012 have restrictions that lapse between one year and five years from the date of the awards.  All grants and awards become immediately exercisable, in the case of options, and restrictions lapse, in the case of restricted stock, upon certain changes of control of the Company.

 

7



 

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

 

Stock Options

 

 

 

Shares subject
to option

 

Weighted-average 
exercise price

 

Outstanding, January 28, 2012 

 

31.0

 

$

21.80

 

Granted 

 

4.0

 

$

21.98

 

Exercised 

 

(2.1

)

$

21.16

 

Canceled or Expired 

 

(1.6

)

$

23.27

 

 

 

 

 

 

 

Outstanding, August  11, 2012 

 

31.3

 

$

21.79

 

 

Restricted Stock

 

 

 

Restricted shares
outstanding

 

Weighted-average
grant-date fair value

 

Outstanding, January 28, 2012 

 

4.2

 

$

23.92

 

Granted 

 

2.5

 

$

22.00

 

Lapsed 

 

(2.3

)

$

24.47

 

Canceled or Expired

 

(0.1

)

$

23.73

 

 

 

 

 

 

 

Outstanding, August  11, 2012 

 

4.3

 

$

22.54

 

 

The weighted-average fair value of stock options granted during the first two quarters ended August 11, 2012 and August 13, 2011, was $4.37 and $6.01, respectively.  The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option-pricing model, based on the assumptions shown in the table below.  The Black-Scholes model utilizes extensive accounting judgment and financial estimates, including the term employees are expected to retain their stock options before exercising them, the volatility of the Company’s stock price over that expected term, the dividend yield over the term, and the number of awards expected to be forfeited before they vest.  Using alternative assumptions in the calculation of fair value would produce fair values for stock option grants that could be different than those used to record stock-based compensation expense in the Consolidated Statements of Operations.

 

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

 

 

 

2012

 

2011

 

Risk-free interest rate 

 

0.97

%

2.16

%

Expected dividend yield 

 

2.49

%

1.90

%

Expected volatility 

 

26.48

%

26.31

%

Expected term 

 

6.9 Years

 

6.9 Years

 

 

8



 

3.              DEBT OBLIGATIONS

 

Long-term debt consists of:

 

 

 

August 11,

 

January 28,

 

 

 

2012

 

2012

 

2.20% to 8.00% Senior Notes due through 2042 

 

$

7,087

 

$

7,078

 

5.00% to 9.50% Mortgages due in varying amounts through 2034

 

58

 

65

 

Commercial paper borrowings

 

360

 

370

 

Other 

 

198

 

230

 

 

 

 

 

 

 

Total debt, excluding capital leases and financing obligations 

 

7,703

 

7,743

 

 

 

 

 

 

 

Less current portion 

 

(1,299

)

(1,275

)

 

 

 

 

 

 

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

 

$

6,404

 

$

6,468

 

 

In the first quarter of 2012, the Company issued $500 of senior notes due in fiscal year 2022 bearing an interest rate of 3.40% and $350 of senior notes due in fiscal year 2042 bearing an interest rate of 5.00%.  In the first quarter of 2012, the Company repaid $491 of senior notes bearing an interest rate of 6.75% upon their maturity.

 

In the second quarter of 2012, the Company repaid $346 of senior notes bearing an interest rate of 6.20% upon their maturity.

 

4.              BENEFIT PLANS

 

The following table provides the components of net periodic benefit costs for the Company-sponsored defined benefit pension plans and other post-retirement benefit plans for the second quarters of 2012 and 2011.

 

 

 

Second Quarter Ended

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

August 11,
2012

 

August 13,
2011

 

August 11,
2012

 

August 13,
2011

 

Components of net periodic benefit cost: 

 

 

 

 

 

 

 

 

 

Service cost 

 

$

9

 

$

12

 

$

4

 

$

3

 

Interest cost 

 

35

 

41

 

4

 

5

 

Expected return on plan assets 

 

(48

)

(48

)

 

 

Amortization of: 

 

 

 

 

 

 

 

 

 

Prior service cost 

 

 

 

(1

)

(2

)

Actuarial loss 

 

21

 

16

 

 

(1

)

 

 

 

 

 

 

 

 

 

 

Net periodic benefit cost 

 

$

17

 

$

21

 

$

7

 

$

5

 

 

The following table provides the components of net periodic benefit costs for the Company-sponsored defined benefit pension plans and other post-retirement benefit plans for the first two quarters of 2012 and 2011.

 

 

 

Two Quarters Ended

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

August 11,
2012

 

August 13,
2011

 

August 11,
2012

 

August 13,
2011

 

Components of net periodic benefit cost: 

 

 

 

 

 

 

 

 

 

Service cost 

 

$

25

 

$

26

 

$

9

 

$

7

 

Interest cost 

 

84

 

93

 

9

 

10

 

Expected return on plan assets 

 

(113

)

(111

)

 

 

Amortization of: 

 

 

 

 

 

 

 

 

 

Prior service cost 

 

 

 

(2

)

(3

)

Actuarial loss 

 

52

 

36

 

 

(1

)

 

 

 

 

 

 

 

 

 

 

Net periodic benefit cost 

 

$

48

 

$

44

 

$

16

 

$

13

 

 

9



 

The Company contributed $7 to Company-sponsored defined benefit pension plans in the first two quarters of 2012 and did not make any contributions to these plans in the first two quarters of 2011.  For 2012, the Company expects to contribute approximately $75 in total to these plans.

 

The Company contributed $77 and $70 to employee 401(k) retirement savings accounts in the first two quarters of 2012 and 2011, respectively.

 

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

 

5.              EARNINGS PER COMMON SHARE

 

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

 

 

 

Second Quarter Ended

 

Second Quarter Ended

 

 

 

August 11, 2012

 

August 13, 2011

 

 

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

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

 

$

277

 

538

 

$

0.52

 

$

279

 

596

 

$

0.47

 

Dilutive effect of stock options

 

 

 

3

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

277

 

541

 

$

0.51

 

$

279

 

600

 

$

0.46

 

 

 

 

Two Quarters Ended

 

Two Quarters Ended

 

 

 

August 11, 2012

 

August 13,2011

 

 

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

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

 

$

713

 

548

 

$

1.30

 

$

708

 

603

 

$

1.17

 

Dilutive effect of stock options

 

 

 

4

 

 

 

 

 

4

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

713

 

552

 

$

1.29

 

$

708

 

607

 

$

1.17

 

 

The Company had combined undistributed and distributed earnings to participating securities totaling $2 in both the second quarters of 2012 and 2011.  For each of the first two quarters of 2012 and 2011, the Company had combined undistributed and distributed earnings to participating securities of $5.

 

The Company had options outstanding for approximately 16 and 11 shares during the second quarters of 2012 and 2011, respectively, that were excluded from the computations of earnings per diluted common share because their inclusion would have had an anti-dilutive effect on earnings per share.  The Company had options outstanding for approximately 13 shares in both the first two quarters of 2012 and 2011, respectively, that were excluded from the computations of earnings per diluted common share because their inclusion would have had an anti-dilutive effect on earnings per share.

 

10



 

6.              RECENTLY ADOPTED ACCOUNTING STANDARDS

 

In June 2011, the Financial Accounting Standards Board (“FASB”) amended its rules regarding the presentation of comprehensive income.  The objective of this amendment is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income.  Specifically, this amendment requires that all non-owner changes in shareholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The new rules became effective for interim and annual periods beginning after December 15, 2011.  In December 2011, the FASB deferred certain aspects of this standard beyond the December 15, 2011 effective date, specifically the provisions dealing with reclassification adjustments.  The Company adopted this amended standard effective January 29, 2012 by presenting separate Consolidated Statements of Comprehensive Income immediately following the Consolidated Statements of Operations.  Because this standard only affects the display of comprehensive income and does not affect what is included in comprehensive income, this standard did not have a material effect on the Company’s Consolidated Financial Statements.

 

In May 2011, the FASB amended its rules for disclosure requirements for common fair value measurement.  These amendments, effective for the interim and annual periods beginning on or after December 15, 2011 (early adoption was prohibited), result in a common definition of fair value and common requirements for fair value measurement and disclosure between GAAP and International Financial Accounting Standards.  Consequently, the amendments change some fair value measurement principles and disclosure requirements.  The implementation of the amended accounting guidance did not have a material effect on the Company’s consolidated financial position or results of operations.

 

7.              COMMITMENTS AND CONTINGENCIES

 

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

 

The Company believes that allowances for loss have been provided to the extent necessary and that its assessment of contingencies is reasonable.  To the extent that resolution of contingencies results in amounts that vary from the Company’s estimates, future earnings will be charged or credited.

 

The principal contingencies are described below:

 

Insurance — The Company’s workers’ compensation risks are self-insured in most 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 all 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 — On October 6, 2006, the Company petitioned the Tax Court (Ralphs Grocery Company and Subsidiaries, formerly known as Ralphs Supermarkets, Inc. v. Commissioner of Internal Revenue, Docket No. 20364-06) for a redetermination of deficiencies asserted by the Commissioner of Internal Revenue.  The dispute at issue involves a 1992 transaction in which Ralphs Holding Company acquired the stock of Ralphs Grocery Company and made an election under Section 338(h)(10) of the Internal Revenue Code.  The Commissioner determined that the acquisition of the stock was not a purchase as defined by Section 338(h)(3) of the Internal Revenue Code and that the acquisition therefore did not qualify for a Section 338(h)(10) election.  On January 27, 2011, the Tax Court issued its opinion upholding the Company’s position that the acquisition of the stock qualified as a purchase, granting the Company’s motion for partial summary judgment and denying the Tax Commissioner’s motion.  All remaining issues in the matter have been resolved and the Tax Court entered its decision on May 2, 2012.  On July 24, 2012, the Tax Commissioner filed a notice with The United States Court of Appeals for the 9th Circuit to appeal the decision of the Tax Court.  As of August 11, 2012, an adverse decision would require a cash payment of up to approximately $567, including interest.  Any accounting implications of an adverse decision in this case would be charged through the statement of operations.

 

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

 

11



 

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

 

Assignments — The Company is contingently liable for leases that have been assigned to various third parties in connection with facility closings and dispositions.  The Company could be required to satisfy the obligations under the leases if any of the assignees is unable to fulfill its lease obligations.  Due to the wide distribution of the Company’s assignments among third parties, and various other remedies available, the Company believes the likelihood that it will be required to assume a material amount of these obligations is remote.

 

Benefit Plans — The Company administers certain non-contributory defined benefit retirement plans and contributory defined contribution retirement plans for substantially all non-union employees and some union-represented employees as determined by the terms and conditions of collective bargaining agreements. Funding for the defined benefit pension plans is based on a review of the specific requirements, and an evaluation of the assets and liabilities, of each plan.  Funding for the Company’s matching and automatic contributions under the defined contribution plans is based on years of service, plan compensation, and amount of contributions by participants.

 

In addition to providing pension benefits, the Company provides certain health care benefits for retired employees. Funding for the retiree health care benefits occurs as claims or premiums are paid.

 

The determination of the obligation and expense for the Company’s defined benefit retirement pension plan and other post-retirement benefits is dependent on the Company’s selection of assumptions used by actuaries in calculating those amounts. Those assumptions are described in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012 and include, among other things, the discount rate, the expected long-term rate of return on plan assets, and the rates of increase in compensation and health care costs.  Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect the recognized expense and recorded obligation in such future periods. While the Company believes that the assumptions are appropriate, significant differences in actual experience or significant changes in assumptions may materially affect the pension and other post-retirement obligations and future expense.

 

The Company contributed $7 to its Company-sponsored defined benefit pension plans in the first two quarters of 2012.  The Company expects to contribute approximately $75 in total to these plans in 2012.  The Company expects any contributions made during 2012 will reduce its minimum required contributions in future years.  Among other things, investment performance of plan assets, the interest rates required to be used to calculate pension obligations and future changes in legislation will determine the amounts of any additional contributions.  In addition, the Company expects its cash contributions and expense attributable to the 401(k) Retirement Savings Account Plan from automatic and matching contributions to participants to increase slightly in 2012, compared to 2011.

 

The Company also contributes to various multi-employer pension plans based on obligations arising from most of its collective bargaining agreements. These plans provide retirement benefits to participants based on their service to contributing employers. The benefits are paid from assets held in trust for that purpose. Trustees are appointed in equal number by employers and unions. The trustees typically are responsible for determining the level of benefits to be provided to participants as well as for such matters as the investment of the assets and the administration of the plans.

 

Based on the most recent information available to it, the Company believes that the present value of actuarial accrued liabilities in most of these multi-employer plans exceeds the value of the assets held in trust to pay benefits.  Because the Company is one of a number of employers contributing to these plans, it is difficult to ascertain what the Company’s “share” of the underfunding would be, although we anticipate the Company’s contributions to these plans will increase each year.  The Company believes that levels of underfunding have not changed significantly since year-end.  As a result, excluding the UFCW consolidated pension plan, the Company expects meaningful increases in expense as a result of increases in multi-employer pension plan contributions over the next few years to reduce this underfunding.  Moreover, if the Company were to exit certain markets or otherwise cease making contributions to these funds, the Company could trigger a substantial withdrawal liability.  Any adjustment for withdrawal liability will be recorded when it is probable that a liability exists and can be reasonably determined.

 

12



 

The Company has $311 accrued as of both August 11, 2012 and January 28, 2012 in other long-term liabilities related to the Company’s contractual obligation under the UFCW consolidated pension plan, which resulted from the consolidation of four UFCW multi-employer pension plans into one multi-employer pension plan in the fourth quarter of 2011.  For more information regarding this other long-term liability and the consolidation of the four UFCW multi-employer pension plans into one multi-employer pension plan in the fourth quarter of 2011, please refer to Note 14 to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012.

 

8.              DERIVATIVE FINANCIAL INSTRUMENTS

 

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

 

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

 

Interest Rate Risk Management

 

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

 

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

 

Fair Value Interest Rate Swaps

 

The table below summarizes the outstanding interest rate swaps designated as fair value hedges as of August 11, 2012 and January 28, 2012.

 

 

 

August 11, 2012

 

January 28, 2012

 

 

 

Pay
Floating

 

Pay
Fixed

 

Pay
Floating

 

Pay
 Fixed

 

Notional amount

 

$

850

 

$

 

$

1,625

 

$

 

Number of contracts

 

9

 

 

18

 

 

Duration in years

 

0.57

 

 

0.74

 

 

Average variable rate

 

3.04

%

 

3.84

%

 

Average fixed rate

 

5.28

%

 

5.87

%

 

Maturity

 

Between February and April 2013

 

Between April 2012 and April 2013

 

 

During the first two quarters of 2012, nine of the Company’s fair value swaps, with a notional amount of $775, matured.

 

The gain or loss on these derivative instruments as well as the offsetting gain or loss on the hedged items attributable to the hedged risk are recognized in current income as “Interest expense.”  These gains and losses for the second quarters and first two quarters of 2012 and 2011 were as follows:

 

13



 

 

 

Second Quarter Ended

 

 

 

August 11, 2012

 

August 13, 2011

 

Income Statement Classification

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Interest Expense

 

$

(4

)

$

1

 

$

(3

)

$

4

 

 

 

 

Two Quarters Ended

 

 

 

August 11, 2012

 

August 13, 2011

 

Income Statement Classification

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Gain/(Loss) on
Swaps

 

Gain/(Loss) on
Borrowings

 

Interest Expense

 

$

(14

)

$

9

 

$

(7

)

$

9

 

 

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

 

 

 

Asset Derivatives

 

 

 

Fair Value

 

 

 

Derivatives Designated as Fair Value Hedging Instruments

 

August 11,
2012

 

January 28,
2012

 

Balance Sheet Location

 

Interest Rate Hedges

 

$

11

 

$

25

 

Other Assets

 

 

Cash Flow Forward-Starting Interest Rate Swaps

 

As of August 11, 2012, the Company had 17 forward-starting interest rate swap agreements with maturity dates between April 2013 and January 2014 with an aggregate notional amount totaling $850.  In the second quarter of 2012, the Company entered into seven of these forward-starting interest rate swap agreements with an aggregate notional amount totaling $350.  A forward-starting interest rate swap is an agreement that effectively hedges the variability in future benchmark interest payments attributable to changes in interest rates on the forecasted issuance of fixed-rate debt.  The Company entered into these forward-starting interest rate swaps in order to lock in fixed interest rates on its forecasted issuances of debt in fiscal year 2013.  Accordingly, the forward-starting interest rate swaps were designated as cash-flow hedges as defined by GAAP.  As of August 11, 2012, the fair value of the interest rates swaps was recorded in other long-term liabilities for $38 and accumulated other comprehensive loss for $24 net of tax.

 

As of January 28, 2012, the Company had 24 forward-starting interest rate swap agreements with maturity dates between May 2012 and April 2013 with an aggregate notional amount totaling $1,200.  The Company entered into the forward-starting interest rate swaps in order to lock in fixed interest rates on its forecasted issuances of debt in fiscal years 2012 and 2013.  Accordingly, the forward-starting interest rate swaps were designated as cash-flow hedges as defined by GAAP.  As of January 28, 2012, the fair value of the interest rates swaps was recorded in other long-term liabilities for $41 and accumulated other comprehensive loss for $26 net of tax.

 

During the first two quarters of 2012, the Company terminated 14 forward-starting interest rate swap agreements with maturity dates of May 2012 with an aggregate notional amount totaling $700.  These forward-starting interest rate swap agreements were hedging the variability in future benchmark interest payments attributable to changing interest rates on the forecasted issuance of fixed-rate debt to be issued in the first quarter of 2012.  As discussed in Note 3, the Company issued $850 of senior notes in the first quarter of 2012.  Since these forward-starting interest rate swap agreements were classified as cash flow hedges, the unamortized loss of $27 has been deferred net of tax in accumulated other comprehensive income (“AOCI”) and will be amortized to earnings as the interest payments are made.

 

14



 

The following tables summarize the effect of the Company’s derivative instruments designated as cash flow hedges for the second quarters and first two quarters of 2012 and 2011:

 

 

 

Second Quarter Ended

 

 

 

 

 

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

 

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

 

Location of Gain/(Loss)

 

Derivatives in Cash Flow Hedging
Relationships

 

August 11,
2012

 

August 13,
2011

 

August 11,
2012

 

August 13,
2011

 

Reclassified into Income
(Effective Portion)

 

Forward-Starting Interest Rate Swaps, net of tax*

 

$

(42

)

$

(4

)

$

 

$

1

 

Interest expense

 

 


*The amounts of Gain/(Loss) in AOCI on derivatives include unamortized proceeds and payments from forward-starting interest rate swaps once classified as cash flow hedges that were terminated prior to the second quarter of 2012.

 

 

 

Two Quarters Ended

 

 

 

 

 

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

 

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

 

Location of Gain/(Loss)

 

Derivatives in Cash Flow Hedging
Relationships

 

August 11,
2012

 

August 13,
2011

 

August 11,
2012

 

August 13,
2011

 

Reclassified into Income
(Effective Portion)

 

Forward-Starting Interest Rate Swaps, net of tax*

 

$

(42

)

$

(4

)

$

(2

)

$

1

 

Interest expense

 

 


*The amounts of Gain/(Loss) in AOCI on derivatives include unamortized proceeds and payments from forward-starting interest rate swaps once classified as cash flow hedges that were terminated prior to the second quarter of 2012.

 

Commodity Price Protection

 

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

 

9.              FAIR VALUE MEASUREMENTS

 

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

 

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

 

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

 

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

 

15



 

For items carried at (or adjusted to) fair value in the consolidated financial statements, the following tables summarize the fair value of these instruments at August 11, 2012 and January 28, 2012:

 

August 11, 2012 Fair Value Measurements Using

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)

 

Significant Other
Observable Inputs

(Level 2)

 

Significant
Unobservable
Inputs

(Level 3)

 

Total

 

Available-for-Sale Securities

 

$

8

 

$

 

$

20

 

$

28

 

Long-Lived Assets

 

 

 

3

 

3

 

Interest Rate Hedges

 

 

(27

)

 

(27

)

Total

 

$

8

 

$

(27

)

$

23

 

$

4

 

 

January 28, 2012 Fair Value Measurements Using

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)

 

Significant Other
Observable Inputs

(Level 2)

 

Significant
Unobservable
Inputs

(Level 3)

 

Total

 

Available-for-Sale Securities

 

$

8

 

$

 

$

20

 

$

28

 

Long-Lived Assets

 

 

 

23

 

23

 

Interest Rate Hedges

 

 

(16

)

 

(16

)

Total

 

$

8

 

$

(16

)

$

43

 

$

35

 

 

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

 

Fair value measurements of non-financial assets and non-financial liabilities are primarily used in the impairment analysis of goodwill, other intangible assets, and long-lived assets, and in the valuation of store lease exit costs.  The Company reviews goodwill and other intangible assets for impairment annually, during the fourth quarter of each fiscal year, and as circumstances indicate the possibility of impairment.  See Note 2 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended January 28, 2012 for further discussion related to the Company’s carrying value of goodwill.  Long-lived assets and store lease exit costs were measured at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy.  See Note 1 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended January 28, 2012 for further discussion of the Company’s policies regarding the valuation of long-lived assets and store lease exit costs.  For the first two quarters of 2012, long-lived assets with a carrying amount of $12 were written down to their fair value of $3 resulting in an impairment charge of $9.  For the first two quarters of 2011, long-lived assets with a carrying amount of $21 were written down to their fair value of $7 resulting in an impairment charge of $14.

 

For the first two quarters of 2011, the Company recorded unrealized gains on its Level 3 Available-for-Sale Securities in the amount of $3.

 

Fair Value of Other Financial Instruments

 

Current and Long-term Debt

 

The fair value of the Company’s long-term debt, including current maturities, was estimated based on the quoted market prices for the same or similar issues adjusted for illiquidity based on available market evidence.  If quoted market prices were not available, the fair value was based on the net present value of the future cash flow using the forward interest rate yield curve in effect at August 11, 2012, and January 28, 2012, which is a Level 3 measurement technique.  At August 11, 2012, the fair value of total debt was $8,687 compared to a carrying value of $7,703.  At January 28, 2012, the fair value of total debt was $8,700 compared to a carrying value of $7,743.

 

16



 

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

 

The carrying amounts of these items approximated fair value.

 

Long-term Investments

 

The fair values of these investments were estimated based on quoted market prices for those or similar investments, or estimated cash flows, if appropriate.  At August 11, 2012, and January 28, 2012, the carrying and fair value of long-term investments for which fair value is determinable was $44 and $50, respectively.

 

10.  INCOME TAXES

 

The effective income tax rate was 34.5% and 27.6% for the second quarters of 2012 and 2011, respectively.  The effective income tax rate was 34.5% and 33.8% for the first two quarters of 2012 and 2011, respectively.  The effective income tax rate for the second quarters and first two quarters of 2012 and 2011 differed from the federal statutory rate primarily due to the favorable resolution of certain tax issues, partially offset by the effect of state income taxes.

 

11. SUBSEQUENT EVENT

 

On September 13, 2012, the Company’s Board of Directors declared a quarterly dividend of $0.15 per share, payable on December 1, 2012, to shareholders of record as of the close of business on November 15, 2012.  This represents an increase of approximately 30% over the previous quarterly dividend of $0.115 per share.

 

17



 

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

 

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

 

OVERVIEW

 

Second quarter 2012 total sales were $21.7 billion compared with $20.9 billion for the same period of 2011.  This increase was attributable to identical supermarket sales increases and increased fuel gallon sales, offset partially by lower average retail fuel prices.  Identical supermarket sales without fuel increased 3.6% in the second quarter of 2012, compared to the second quarter of 2011, primarily due to product cost inflation, an increased transaction count, an increase in the average sale per shopping trip and an increase in the number of households shopping with us.  Every supermarket store department and operating division had positive identical sales.  This marks positive identical supermarket sales growth for 35 consecutive quarters.  Total sales for the first two quarters of 2012 were $50.8 billion compared with $48.4 billion for the same period of 2011.  This increase was attributable to identical supermarket sales increases and increased fuel gallon sales.  Identical supermarket sales without fuel increased 3.9% in the first two quarters of 2012, compared to the same period in 2011, primarily due to product cost inflation, an increased transaction count, an increase in the average sale per shopping trip and an increase in the number of households shopping with us.  Our Customer 1st strategy continues to deliver solid results.

 

For the second quarter of 2012, net earnings totaled $279 million, or $0.51 per diluted share, compared to $281 million, or $0.46 per diluted share for the same period of 2011.  The decrease in net earnings for the second quarter of 2012, compared to the second quarter of 2011, resulted primarily from an increase in our effective tax rate, an increase in interest expense, continued investments in lower prices for our customers and increases in health care costs, offset partially by increased supermarket sales, productivity improvements, effective cost controls, increased pharmacy results, decreased incentive compensation expense and lower operating expenses resulting from the consolidation of four multi-employer pension plans in the prior year.  Earnings from our fuel operations remained consistent in the second quarter of 2012, compared to the second quarter of 2011.  For the first two quarters of 2012, net earnings totaled $718 million, or $1.29 per diluted share, compared to $713 million, or $1.17 per diluted share for the same period of 2011.  The increase in our net earnings for the first two quarters of 2012, compared to the same period in 2011, resulted primarily from an increase in non-fuel operating profit, offset partially by increases in our effective tax rate and interest expense.  Earnings from our fuel operations remained consistent in the first two quarters of 2012, compared to the same period in 2011.

 

Based on our results for the first two quarters of 2012, we have increased both the lower and upper range of our guidance for net earnings per diluted share for fiscal year 2012.  Please refer to the “Outlook” section for more information on our expectations.  Our Customer 1st strategy is continuing to connect with customers.  We have shown that our focus on people, products, prices and the shopping experience is meaningful to customers.  As a result, we are rewarding shareholders through net earnings per diluted share growth, through increasing dividends over time and through share buybacks.

 

RESULTS OF OPERATIONS

 

Net Earnings

 

Net earnings totaled $279 million for the second quarter of 2012, a decrease of 0.7% from net earnings of $281 million for the second quarter of 2011.  The decrease in our net earnings for the second quarter of 2012, compared to the second quarter of 2011, resulted primarily from an increase in our effective tax rate and interest expense, offset partially by an increase in non-fuel operating profit.  Earnings from our fuel operations remained consistent in the second quarter of 2012, compared to the second quarter of 2011.  The increase in non-fuel operating profit for the second quarter of 2012, compared to the second quarter of 2011, resulted primarily from increased supermarket sales, productivity improvements, effective cost controls, increased pharmacy results, decreased incentive compensation expense, and lower operating expenses resulting from the consolidation of four multi-employer pension plans in the prior year, partially offset by continued investments in lower prices for our customers and increases in health care costs.  Our effective tax rate was higher in the second quarter of 2012, compared to the second quarter of 2011, primarily because of the favorable resolution of certain tax issues in the second quarter of 2011.

 

18



 

Net earnings totaled $718 million for the first two quarters of 2012, an increase of 0.7% from net earnings of $713 million for the first two quarters of 2011.  The increase in our net earnings for the first two quarters of 2012, compared to the same period in 2011, resulted primarily from an increase in non-fuel operating profit, offset partially by an increase in our effective tax rate and interest expense.  Earnings from our fuel operations remained consistent in the first two quarters of 2012, compared to the same period in 2011.  The increase in non-fuel operating profit for the first two quarters of 2012, compared to the same period in 2011, resulted primarily from the benefit of increased supermarket sales, productivity improvements, effective cost controls, increased pharmacy results, decreased incentive compensation expense and the benefit received in lower operating expenses from the consolidation of four multi-employer pension plans in the prior year, partially offset by continued investments in lower prices for our customers and increases in health care costs.  Our effective tax rate increased in the first two quarters of 2012, compared to the same period in 2011, primarily due to the favorable resolution of certain tax issues in the second quarter of 2011.

 

Net earnings of $0.51 per diluted share for the second quarter of 2012 represented an increase of 10.9% over net earnings of $0.46 per diluted share for the second quarter of 2011.  Net earnings per diluted share increased in the second quarter of 2012, compared to the second quarter of 2011, due to the repurchase of 71 million common shares over the past four quarters resulting in a lower weighted average number of shares outstanding.  Net earnings of $1.29 per diluted share for the first two quarters of 2012 represented an increase of 10.3% over net earnings of $1.17 per diluted share for the first two quarters of 2011.  Net earnings per diluted share increased in the first two quarters of 2012, compared to the first two quarters of 2011, due to increased net earnings and the repurchase of 71 million common shares over the past four quarters resulting in a lower weighted average number of shares outstanding.

 

Sales

 

Total Sales

(in millions)

 

 

 

Second Quarter Ended

 

Two Quarters Ended

 

 

 

August 11,
2012

 

Percentage
Increase

 

August 13,
2011

 

Percentage
Increase
(2)

 

August 11,
2012

 

Percentage
Increase

 

August 13,
2011

 

Percentage
Increase(3)

 

Total supermarket sales without fuel 

 

$

16,890

 

3.8

%

$

16,273

 

5.2

%

$

39,350

 

4.1

%

$

37,809

 

4.9

%

Fuel sales

 

4,249

 

4.2

%

4,076

 

47.6

%

10,122

 

8.7

%

9,309

 

48.2

%

Other sales(1) 

 

587

 

4.1

%

564

 

6.8

%

1,319

 

5.0

%

1,256

 

6.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total sales 

 

$

21,726

 

3.9

%

$

20,913

 

11.5

%

$

50,791

 

5.0

%

$

48,374

 

11.2

%

 


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

(2)   This column represents the percentage increase in the second quarter of 2011, compared to the second quarter of 2010.

(3)   This column represents the percentage increase in the first two quarters of 2011, compared to the first two quarters of 2010.

 

The increase in total sales for the second quarter of 2012, compared to the second quarter of 2011, was primarily the result of our identical supermarket sales increase, excluding fuel, of 3.6% and an increase in fuel sales of 4.2%.  The increase in total supermarket sales without fuel for the second quarter of 2012, compared to the second quarter of 2011, was primarily the result of our identical supermarket sales increase, excluding fuel of 3.6%.  Total fuel sales increased in the second quarter of 2012, compared to the same period of 2011, due to an increase in fuel gallons sold of 8.7%, offset slightly by a decrease in the average retail fuel price of 4.1%.  The decrease in the average retail fuel price was caused by a decrease in the product cost of fuel.  Identical supermarket sales, excluding fuel, increased primarily due to product cost inflation, increased transaction count, an increase in the average sale per shopping trip and an increase in the number of households shopping with us.

 

The increase in total sales for the first two quarters of 2012, compared to the same period of 2011, was primarily the result of our identical supermarket sales increase, excluding fuel, of 3.9% and an increase in fuel sales of 8.7%.  The increase in total supermarket sales without fuel for the first two quarters of 2012, compared to the same period of 2011, was primarily the result of our identical supermarket sales increase, excluding fuel of 3.9%.  Total fuel sales increased in the first two quarters of 2012, compared to the same period of 2011, primarily due to a 8.1% increase in fuel gallons sold.  Identical supermarket sales, excluding fuel, increased primarily due to product cost inflation, increased transaction count, an increase in the average sale per shopping trip and an increase in the number of households shopping with us.

 

19



 

We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters.  Fuel discounts received at our fuel centers and earned based on in-store purchases are included in all of the supermarket identical sales results calculations illustrated below.  Differences between total supermarket sales and identical supermarket sales primarily relate to changes in supermarket square footage.  Identical supermarket sales include sales from all departments at identical Fred Meyer multi-department stores.  Our identical supermarket sales results are summarized in the table below.  We used the identical supermarket dollar figures presented below to calculate second quarter 2012 percent changes.

 

Identical Supermarket Sales

($ in millions)

 

 

 

Second Quarter

 

 

 

August 11,
2012

 

Percentage
Increase

 

August 13,
2011

 

Percentage
Increase(1)

 

Including fuel centers

 

$

19,443

 

3.6

%

$

18,759

 

10.4

%

Excluding fuel centers

 

$

16,269

 

3.6

%

$

15,710

 

5.3

%

 


(1)

 

This column represents the percentage increase in identical supermarket sales in the second quarter of 2011, compared to the second quarter of 2010.

 

Identical Supermarket Sales

($ in millions)

 

 

 

Two Quarters Ended

 

 

 

August 11,
2012

 

Percentage
Increase

 

August 13,
2011

 

Percentage
Increase(1)

 

Including fuel centers

 

$

45,544

 

4.7

%

$

43,505

 

10.1

%

Excluding fuel centers

 

$

37,922

 

3.9

%

$

36,484

 

4.9

%

 


(1)

 

This column represents the percentage increase in identical supermarket sales in the first two quarters of 2011, compared to the first two quarters of 2010.

 

Gross Margin and FIFO Gross Margin

 

Our gross margin rate was 20.47% for the second quarter of 2012, as compared to 20.84% for the second quarter of 2011.  Our gross margin rate was 20.51% for the first two quarters of 2012, as compared to 21.08% for the first two quarters of 2011.  The decrease in the second quarter of 2012, compared to the second quarter of 2011, resulted primarily from increased fuel sales, continued investments in lower prices for our customers and increased shrink and warehouse costs as a percentage of sales.  The decrease in the first two quarters of 2012, compared to the first two quarters of 2011, resulted primarily from increased fuel sales, continued investments in lower prices for our customers and increased shrink costs as a percentage of sales.  Retail fuel sales lower our gross margin rate due to the very low gross margin on retail fuel sales as compared to non-fuel sales.

 

We calculate First-In, First-Out (“FIFO”) gross margin as sales minus merchandise costs, including advertising, warehousing, and transportation expenses, but excluding the Last-In, First-Out (“LIFO”) charge.  Our LIFO charge was $35 million for the second quarters of both 2012 and 2011.  For the first two quarters of both 2012 and 2011, our LIFO charge was $81 million.  FIFO gross margin is a non-generally accepted accounting principle (“non-GAAP”) financial measure and should not be considered as an alternative to gross margin or any other generally accepted accounting principle (“GAAP”) measure of performance.  FIFO gross margin should not be reviewed in isolation or considered as a substitute for our financial results as reported in accordance with GAAP.  Merchandise costs exclude depreciation and rent expenses.  FIFO gross margin is an important measure used by management to evaluate merchandising and operational effectiveness.  Management believes FIFO gross margin is a useful metric to investors and analysts because it measures our day-to-day merchandising and operational effectiveness.

 

Our FIFO gross margin rate was 20.63% for the second quarter of 2012, as compared to 21.00% for the second quarter of 2011.  Retail fuel sales lower our FIFO gross margin rate due to the very low FIFO gross margin on retail fuel sales as compared to non-fuel sales.  Excluding the effect of retail fuel operations, our second quarter 2012 FIFO gross margin rate decreased 43 basis points, as a percentage of sales, compared to the second quarter of 2011.  This decrease in the second quarter of 2012, compared to the second quarter of 2011, was approximately 55% due to continued investments in lower prices for our customers and 45% due to higher expenses for shrink and warehouse costs.

 

20



 

Our FIFO gross margin rate was 20.67% for the first two quarters of 2012, as compared to 21.24% for the first two quarters of 2011.  Excluding the effect of retail fuel operations, as a percentage of sales, our FIFO gross margin rate decreased 48 basis points for the first two quarters of 2012, compared to the first two quarters of 2011.  This decrease in the first two quarters of 2012, compared to the first two quarters of 2011, was approximately 85% due to continued investments in lower prices for our customers and 15% due to increased shrink costs.

 

Operating, General and Administrative Expenses

 

Operating, general and administrative (“OG&A”) expenses consist primarily of employee-related costs such as wages, health care benefit costs and retirement plan costs, utilities, and credit card fees.  Rent expense, depreciation and amortization expense, and interest expense are not included in OG&A.

 

OG&A expenses, as a percentage of sales, decreased 43 basis points to 15.61% for the second quarter of 2012 from 16.04% for the second quarter of 2011, primarily due to the benefit of increased supermarket sales, productivity improvements, effective cost controls, the benefit received in lower operating expenses from the consolidation of four UFCW multi-employer pension plans in the prior year and decreased incentive compensation expense, offset partially by increased health care costs.  Retail fuel sales lower our OG&A rate due to the very low OG&A rate, as a percentage of sales, of retail fuel sales compared to non-fuel sales.  OG&A expenses, as a percentage of sales excluding fuel, decreased 51 basis points in the second quarter of 2012, compared to the second quarter of 2011.  This decrease in our OG&A rate, as a percentage of sales excluding the effect of fuel, resulted primarily from increased supermarket sales, productivity improvements, effective cost controls, lower operating expenses resulting from the consolidation of four UFCW multi-employer pension plans in the prior year and decreased incentive compensation expense, offset partially by increased health care costs.

 

OG&A expenses, as a percentage of sales, decreased 43 basis points to 15.46% for the first two quarters of 2012 from 15.89% for the first two quarters of 2011.  OG&A expenses, as a percentage of sales excluding fuel, decreased 38 basis points in the first two quarters of 2012 compared to the first two quarters of 2011.  This decrease in our OG&A rate, as a percentage of sales excluding the effect of fuel, resulted primarily from increased supermarket sales, productivity improvements, effective cost controls, lower operating expenses resulting from the consolidation of four UFCW multi-employer pension plans in the prior year and decreased incentive compensation expense, offset partially by increased health care costs.

 

Rent Expense

 

Rent expense was $139 million, or 0.64% of sales, for the second quarter of 2012, compared to $143 million, or 0.68% of sales, for the second quarter of 2011.  For the first two quarters of 2012, rent expense was $331 million, or 0.65% of sales, compared to $335 million, or 0.69% of sales, in the first two quarters of 2011.  Rent expense, as a percentage of sales excluding fuel, decreased 5 basis points in the second quarter of 2012 compared to the second quarter of 2011.  Rent expense, as a percentage of sales excluding fuel, decreased 4 basis points in the first two quarters of 2012 compared to the first two quarters of 2011.  These decreases in rent expense, as a percentage of sales both including and excluding fuel, primarily reflect our continued emphasis on owning rather than leasing, whenever possible, and the benefit of increased supermarket sales.

 

Depreciation Expense

 

Depreciation expense was $383 million, or 1.76% of total sales, for the second quarter of 2012 compared to $374 million, or 1.79% of total sales, for the second quarter of 2011.  The increase in depreciation expense, in total dollars, was the result of additional depreciation on capital expenditures, including acquisitions and lease buyouts of $2.0 billion, during the rolling four quarter period ending with the second quarter of 2012.  The decrease in depreciation expense for the second quarter of 2012, compared to the second quarter of 2011, as a percentage of sales, was primarily due to the benefit of increased supermarket sales.  Excluding the effect of retail fuel operations, depreciation, as a percentage of sales, decreased three basis points in the second quarter of 2012, compared to the same period of 2011.

 

Depreciation expense was $884 million, or 1.74% of total sales, for the first two quarters of 2012 compared to $873 million, or 1.80% of total sales, for the first two quarters of 2011.  The increase in depreciation expense, in total dollars, was the result of additional depreciation on capital expenditures, including acquisitions and lease buyouts of $2.0 billion, during the rolling four quarter period ending with the second quarter of 2012.  The decrease in depreciation expense for the first two quarters of 2012, compared to the first two quarters of 2011, as a percentage of sales, was primarily due to the benefit of increased supermarket sales.  Excluding the effect of retail fuel operations, depreciation, as a percentage of sales, decreased seven basis points in the first two quarters of 2012, compared to the same period of 2011.

 

21



 

Operating Profit and FIFO Operating Profit

 

Operating profit was $535 million, or 2.46% of sales, for the second quarter of 2012, compared to $488 million, or 2.33% of sales, for the second quarter of 2011.  Operating profit was $1.3 billion, or 2.65% of sales, for the first two quarters of 2012, compared to $1.3 billion, or 2.69% of sales, for the first two quarters of 2011.  Operating profit, as a percentage of sales, increased 13 basis points in the second quarter of 2012, compared to the second quarter of 2011, primarily due to improvements in operating, general and administrative expenses, rent and depreciation, offset partially by continued investments in lower prices for our customers, increased shrink and warehouse costs and increased fuel sales.  Operating profit, as a percentage of sales, decreased four basis points in the first two quarters of 2012, compared to the first two quarters of 2011, primarily due to continued investments in lower prices for our customers, increased shrink costs and increased fuel sales, offset by improvements in operating, general and administrative expenses, rent and depreciation.

 

We calculate FIFO operating profit as operating profit excluding the LIFO charge.  FIFO operating profit is a non-GAAP financial measure and should not be considered as an alternative to operating profit or any other GAAP measure of performance.  FIFO operating profit should not be reviewed in isolation or considered as a substitute for our financial results as reported in accordance with GAAP.  FIFO operating profit is an important measure used by management to evaluate operational effectiveness.  Management believes FIFO operating profit is a useful metric to investors and analysts because it measures our day-to-day operational effectiveness.

 

FIFO operating profit was $570 million, or 2.62% of sales, for the second quarter of 2012, compared to $523 million, or 2.50% of sales, for the second quarter of 2011.  Retail fuel sales lower our FIFO operating profit rate due to the very low FIFO operating profit rate, as a percentage of sales, of retail fuel sales compared to non-fuel sales.  FIFO operating profit, excluding fuel, was $490 million, or 2.80% of sales, for the second quarter of 2012, compared to $442 million, or 2.63% of sales, for the second quarter of 2011.  FIFO operating profit, as a percentage of sales excluding fuel, increased 17 basis points in the second quarter of 2012, compared to the second quarter of 2011 primarily due to improvements in operating, general and administrative expenses, rent and depreciation, offset partially by continued investments in lower prices for our customers and increased shrink and warehouse costs.

 

FIFO operating profit was $1.4 billion, or 2.81% of sales, for the first two quarters of 2012, compared to $1.4 billion, or 2.85% of sales, for the first two quarters of 2011.  FIFO operating profit, excluding fuel, was $1.3 billion, or 3.23% of sales, for the first two quarters of both 2012 and 2011.  FIFO operating profit, as a percentage of sales excluding fuel, remained unchanged in the first two quarters of 2012, compared to the first two quarters of 2011, primarily due to improvements in operating, general and administrative expenses, rent and depreciation, offset by continued investments in lower prices for our customers and increased shrink costs.

 

22



 

The following table provides a reconciliation of operating profit to FIFO operating profit and FIFO operating profit, excluding fuel, for the second quarters and first two quarters of 2012 and 2011:

 

 

 

Second Quarter Ended

 

Two Quarters Ended

 

 

 

August 11,
2012

 

2012
Percentage
of Sales

 

August 13,
2011

 

2011
Percentage

of Sales

 

August 11,
2012

 

2012
Percentage
of Sales

 

August 13,
2011

 

2011
Percentage
of Sales

 

Sales

 

$

21,726

 

 

 

$

20,913

 

 

 

$

50,791

 

 

 

$

48,374

 

 

 

Fuel sales

 

4,249

 

 

 

4,076

 

 

 

10,122

 

 

 

9,309

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales excluding fuel

 

$

17,477

 

 

 

$

16,837

 

 

 

$

40,669

 

 

 

$

39,065

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating profit

 

$

535

 

2.46

%

$

488

 

2.33

%

$

1,348

 

2.65

%

$

1,299

 

2.69

%

LIFO charge

 

35

 

0.16

%

35

 

0.17

%

81

 

0.16

%

81

 

0.17

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FIFO operating profit

 

570

 

2.62

%

523

 

2.50

%

1,429

 

2.81

%

1,380

 

2.85

%

Fuel operating profit

 

80

 

1.88

%

81

 

1.99

%

115

 

1.14

%

119

 

1.28

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

FIFO operating profit excluding fuel

 

$

490

 

2.80

%

$

442

 

2.63

%

$

1,314

 

3.23

%

$

1,261

 

3.23

%

 

Percentages may not sum due to rounding.

 

Interest Expense

 

Net interest expense was $106 million, or 0.49% of total sales, in the second quarter of 2012 and $97 million, or 0.47% of total sales, in the second quarter of 2011.  For the first two quarters of 2012, net interest expense was $247 million, or 0.49% of total sales, in 2012 and $235 million, or 0.49% of total sales, in the first two quarters of 2011.  The incr