Edgar Filing: KROGER CO

kr_Current_Folio_10Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended November 5, 2016

☐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 ☒ No ☐

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 ☒ No ☐

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	☒		Accelerated filer	☐
Non-accelerated filer (do not check if a smaller reporting company)	☐		Smaller reporting company	☐

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

There were 938,124,655 shares of Common Stock ($1 par value) outstanding as of December 7, 2016.

PART I – FINANCIAL INFORMATION

Item 1.Financial Statements.

THE KROGER CO.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share amounts)

(unaudited)


	Third Quarter Ended				Three Quarters Ended
	November 5,		November 7,		November 5,		November 7,
	2016		2015		2016		2015
Sales	$	26,557	$	25,075	$	87,726	$	83,665
Merchandise costs, including advertising, warehousing, and transportation, excluding items shown separately below		20,653		19,478		68,019		65,303
Operating, general and administrative		4,443		4,169		14,695		13,591
Rent		199		172		666		542
Depreciation and amortization		549		484		1,768		1,581

Operating profit		713		772		2,578		2,648
Interest expense		124		107		396		369

Earnings before income tax expense		589		665		2,182		2,279
Income tax expense		206		238		727		795

Net earnings including noncontrolling interests		383		427		1,455		1,484
Net earnings (loss) attributable to noncontrolling interests		(8)		(1)		(14)		4

Net earnings attributable to The Kroger Co.	$	391	$	428	$	1,469	$	1,480

Net earnings attributable to The Kroger Co. per basic common share	$	0.41	$	0.44	$	1.54	$	1.52

Average number of common shares used in basic calculation		940		965		946		966

Net earnings attributable to The Kroger Co. per diluted common share	$	0.41	$	0.43	$	1.52	$	1.50

Average number of common shares used in diluted calculation		953		979		962		980

Dividends declared per common share	$	0.120	$	0.105	$	0.345	$	0.303

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

THE KROGER CO.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions and unaudited)


	Third Quarter Ended				Three Quarters Ended
	November 5,		November 7,		November 5,		November 7,
	2016		2015		2016		2015
Net earnings including noncontrolling interests	$	383	$	427	$	1,455	$	1,484

Other comprehensive income (loss)
Realized and unrealized gains and losses on available for sale securities, net of income tax(1)		—		1		(20)		8
Amortization of amounts included in net periodic pension expense, net of income tax(2)		8		12		23		41
Unrealized gains and losses on cash flow hedging activities, net of income tax(3)		46		(3)		(52)		14
Amortization of unrealized gains and losses on cash flow hedging activities, net of income tax(4)		—		—		1		—

Total other comprehensive income (loss)		54		10		(48)		63

Comprehensive income		437		437		1,407		1,547
Comprehensive income (loss) attributable to noncontrolling interests		(8)		(1)		(14)		4
Comprehensive income attributable to The Kroger Co.	$	445	$	438	$	1,421	$	1,543

(1)

Amount is net of tax of $1 for the third quarter of 2015. Amount is net of tax of $(16) for the first three quarters of 2016 and $5 for the first three quarters of 2015.

(2)

Amount is net of tax of $4 for the third quarter of 2016 and $8 for the third quarter of 2015. Amount is net of tax of $14 for the first three quarters of 2016 and $25 for the first three quarters of 2015.

(3)

Amount is net of tax of $27 for the third quarter of 2016 and $(2) for the third quarter of 2015. Amount is net of tax of $(31) for the first three quarters of 2016 and $8 for the first three quarters of 2015.

(4)

Amount is net of tax of $1 for the third quarter of 2016 and the first three quarters of 2016.

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

THE KROGER CO.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

(unaudited)


	November 5,		January 30,
	2016		2016
ASSETS
Current assets
Cash and temporary cash investments	$	374	$	277
Store deposits in-transit		1,043		923
Receivables		1,488		1,734
FIFO inventory		8,268		7,440
LIFO reserve		(1,292)		(1,272)
Prepaid and other current assets		522		790
Total current assets		10,403		9,892

Property, plant and equipment, net		20,966		19,619
Intangibles, net		1,164		1,053
Goodwill		3,035		2,724
Other assets		939		609

Total Assets	$	36,507	$	33,897

LIABILITIES
Current liabilities
Current portion of long-term debt including obligations under capital leases and financing obligations	$	3,019	$	2,370
Trade accounts payable		6,310		5,728
Accrued salaries and wages		1,153		1,426
Deferred income taxes		221		221
Other current liabilities		3,421		3,226
Total current liabilities		14,124		12,971

Long-term debt including obligations under capital leases and financing obligations		10,817		9,709
Deferred income taxes		1,759		1,752
Pension and postretirement benefit obligations		1,381		1,380
Other long-term liabilities		1,796		1,287

Total Liabilities		29,877		27,099

Commitments and contingencies (see Note 8)

SHAREOWNERS’ EQUITY

Preferred shares, $100 per share, 5 shares authorized and unissued		—		—
Common shares, $1 par per share, 2,000 shares authorized; 1,918 shares issued in 2016 and 2015		1,918		1,918
Additional paid-in capital		3,039		2,980
Accumulated other comprehensive loss		(728)		(680)
Accumulated earnings		15,150		14,011
Common shares in treasury, at cost, 984 shares in 2016 and 951 shares in 2015		(12,767)		(11,409)

Total Shareowners’ Equity - The Kroger Co.		6,612		6,820
Noncontrolling interests		18		(22)

Total Equity		6,630		6,798

Total Liabilities and Equity	$	36,507	$	33,897

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

THE KROGER CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions and unaudited)


	Three Quarters Ended
	November 5,		November 7,
	2016		2015
Cash Flows from Operating Activities:
Net earnings including noncontrolling interests	$	1,455	$	1,484
Adjustments to reconcile net earnings including noncontrolling interests to net cash provided by operating activities:
Depreciation and amortization		1,768		1,581
LIFO charge		19		58
Stock-based employee compensation		110		130
Expense for Company-sponsored pension plans		62		79
Deferred income taxes		5		(149)
Other		(27)		67
Changes in operating assets and liabilities net of effects from mergers of businesses:
Store deposits in-transit		(120)		26
Receivables		48		1
Inventories		(798)		(693)
Prepaid and other current assets		219		242
Trade accounts payable		509		814
Accrued expenses		(144)		240
Income taxes receivable and payable		267		45
Other		83		(80)

Net cash provided by operating activities		3,456		3,845

Cash Flows from Investing Activities:
Payments for property and equipment, including payments for lease buyouts		(3,025)		(2,532)
Proceeds from sale of assets		114		34
Payments for mergers		(401)		—
Other		39		(82)

Net cash used by investing activities		(3,273)		(2,580)

Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt		1,785		58
Payments on long-term debt		(1,332)		(547)
Net borrowings on commercial paper		1,200		100
Dividends paid		(316)		(283)
Excess tax benefits on stock-based awards		—		83
Proceeds from issuance of capital stock		51		94
Treasury stock purchases		(1,401)		(659)
Investment in the remaining equity of a noncontrolling interest		—		(26)
Other		(73)		(79)

Net cash used by financing activities		(86)		(1,259)

Net increase in cash and temporary cash investments		97		6

Cash and temporary cash investments:
Beginning of year		277		268
End of quarter	$	374	$	274

Reconciliation of capital investments:
Payments for property and equipment, including payments for lease buyouts	$	(3,025)	$	(2,532)
Payments for lease buyouts		5		16
Changes in construction-in-progress payables		14		(42)
Total capital investments, excluding lease buyouts	$	(3,006)	$	(2,558)

Disclosure of cash flow information:
Cash paid during the year for interest	$	410	$	397
Cash paid during the year for income taxes	$	450	$	864

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

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 31, 2015	1,918	$	1,918	$	2,748	944	$	(10,809)	$	(812)	$	12,367	$	30	$	5,442
Issuance of common stock:
Stock options exercised	—		—		—	(7)		94		—		—		—		94
Restricted stock issued	—		—		(113)	(3)		34		—		—		—		(79)
Treasury stock activity:
Treasury stock purchases, at cost	—		—		—	14		(500)		—		—		—		(500)
Stock options exchanged	—		—		—	4		(159)		—		—		—		(159)
Share-based employee compensation	—		—		130	—		—		—		—		—		130
Other comprehensive gain net of income tax of $38	—		—		—	—		—		63		—		—		63
Investment in the remaining equity of a noncontrolling interest	—		—		40	—		—		—		—		(57)		(17)
Other	—		—		143	—		(60)		—		—		(3)		80
Cash dividends declared ($0.303 per common share)	—		—		—	—		—		—		(293)		—		(293)
Net earnings including noncontrolling interests	—		—		—	—		—		—		1,480		4		1,484

Balances at November 7, 2015	1,918	$	1,918	$	2,948	952	$	(11,400)	$	(749)	$	13,554	$	(26)	$	6,245

Balances at January 30, 2016	1,918	$	1,918	$	2,980	951	$	(11,409)	$	(680)	$	14,011	$	(22)	$	6,798
Issuance of common stock:
Stock options exercised	—		—		—	(4)		51		—		—		—		51
Restricted stock issued	—		—		(111)	(2)		55		—		—		—		(56)
Treasury stock activity:
Treasury stock purchases, at cost	—		—		—	37		(1,319)		—		—		—		(1,319)
Stock options exchanged	—		—		—	2		(82)		—		—		—		(82)
Share-based employee compensation	—		—		110	—		—		—		—		—		110
Other comprehensive loss net of income tax of $(32)	—		—		—	—		—		(48)		—		—		(48)
Other	—		—		60	—		(63)		—		—		54		51
Cash dividends declared ($0.345 per common share)	—		—		—	—		—		—		(330)		—		(330)
Net earnings including noncontrolling interests	—		—		—	—		—		—		1,469		(14)		1,455

Balances at November 5, 2016	1,918	$	1,918	$	3,039	984	$	(12,767)	$	(728)	$	15,150	$	18	$	6,630

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

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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

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 in which the Company is the primary beneficiary. The January 30, 2016 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 Company’s Annual Report on Form 10-K for the fiscal year ended January 30, 2016.

The unaudited information in the Consolidated Financial Statements for the third quarters and three quarters ended November 5, 2016 and November 7, 2015, includes the results of operations of the Company for the 12 and 40-week periods then ended.

Refer to Note 6 for a description of changes to the Consolidated Statements of Operations and Consolidated Statements of Cash Flows for a recently adopted accounting standard regarding the presentation of employee share-based compensation payments.

Revenue Recognition

The Company changed from the remote method to the proportional method of recognizing gift card and gift certificate revenue, which had an immaterial effect on earnings.

2.MERGER

On September 2, 2016, the Company closed its merger with Modern HC Holdings, Inc. (“ModernHEALTH”) by purchasing 100% of the outstanding shares of ModernHEALTH for $407. This merger allows the Company to expand its specialty pharmacy services by significantly increasing geographic reach and patient therapies. The merger was accounted for under the purchase method of accounting and was financed through the issuance of commercial paper. In a business combination, the purchase price is allocated to assets acquired and liabilities assumed based on their fair values, with any excess of purchase price over fair value recognized as goodwill. In addition to recognizing the assets and liabilities on the acquired company’s balance sheet, the Company reviews supply contracts, leases, financial instruments, employment agreements and other significant agreements to identify potential assets or liabilities that require recognition in connection with the application of acquisition accounting under Accounting Standards Codification (“ASC”) 805. Intangible assets are recognized apart from goodwill when the asset arises from contractual or other legal rights, or are separable from the acquired entity such that they may be sold, transferred, licensed, rented or exchanged either on a standalone basis or in combination with a related contract, asset or liability.

Pending finalization of the Company’s valuation and other items, the following table summarizes the preliminary fair values of the assets acquired and liabilities assumed as part of the merger with ModernHEALTH:


	September 2,
	2016
ASSETS
Total current assets	$	82

Property, plant and equipment		8
Intangibles		136

Total Assets, excluding Goodwill		226

LIABILITIES
Total current liabilities		(70)

Fair-value of long-term debt including obligations under capital leases and financing obligations		(1)
Deferred income taxes		(33)

Total Liabilities		(104)

Total Identifiable Net Assets		122
Goodwill		285
Total Purchase Price	$	407

Of the $136 allocated to intangible assets, the Company recorded $131 and $5 related to pharmacy prescription files and distribution agreements, respectively. The Company will amortize the pharmacy prescription files and distribution agreements, using the straight line method, over 10 years. The goodwill recorded as part of the merger was attributable to the assembled workforce of ModernHEALTH and operational synergies expected from the merger, as well as any intangible assets that did not qualify for separate recognition. The merger was treated as a stock purchase for income tax purposes. The assets acquired and liabilities assumed as part of the merger did not result in a step up of tax basis and goodwill is not expected to be deductible for tax purposes.

On December 18, 2015, the Company closed its merger with Roundy’s, Inc. (“Roundy’s”). In the second quarter of 2016, there was a purchase price allocation adjustment to reduce goodwill and other current liabilities by $8.

Pro forma results of operations, assuming the Roundy’s merger had taken place at the beginning of 2014 and the ModernHEALTH merger had taken place at the beginning of 2015, are included in the following table. The pro forma information includes historical results of operations of Roundy’s and ModernHEALTH, as well as adjustments for interest expense that would have been incurred due to financing the mergers, depreciation and amortization of the assets acquired and excludes the pre-merger transaction related expenses incurred by Roundy’s, ModernHEALTH and the Company. The pro forma information does not include efficiencies, cost reductions, synergies or investments in our Customer 1st Strategy expected to result from the mergers. The unaudited pro forma financial information is not necessarily indicative of the results that actually would have occurred had the Roundy’s merger been completed at the beginning of 2014 or the ModernHEALTH merger been completed at the beginning of 2015. The sales and net earnings of ModernHEALTH are not material to the Company’s 2016 results.


	Third Quarter Ended		Three Quarters Ended
	November 7, 2015		November 7, 2015
Sales	$	25,989	$	87,406
Net earnings including noncontrolling interests		426		1,487
Net earnings (loss) attributable to noncontrolling interests		(1)		4

Net earnings attributable to The Kroger Co.	$	427	$	1,483

3.DEBT OBLIGATIONS

Long-term debt consists of:


	November 5,		January 30,
	2016		2016
1.14% to 8.00% Senior Notes due through 2046	$	10,319	$	9,826
5.00% to 12.75% Mortgages due in varying amounts through 2027		49		58
0.63% to 0.67% Commercial paper borrowings due through November 2016		2,190		990
Other		527		522

Total debt, excluding capital leases and financing obligations		13,085		11,396
Less current portion		(2,964)		(2,318)

Total long-term debt, excluding capital leases and financing obligations	$	10,121	$	9,078

In the third quarter of 2016, the Company issued $500 of senior notes due in fiscal year 2019 bearing an interest rate of 1.50%, $750 of senior notes due in fiscal year 2026 bearing an interest rate of 2.65% and $500 of senior notes due in fiscal year 2046 bearing an interest rate of 3.88%. The Company also repaid $450 of senior notes bearing an interest rate of 2.20%, $500 of senior notes bearing an interest rate of 3-month London Inter-Bank Offering Rate plus 53 basis points and $300 of senior notes bearing an interest rate of 1.20%. In connection with the senior note issuances, the Company also terminated forward-starting interest rate swaps with an aggregate notional amount totaling $300. 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 issued during the third quarter of 2016. Since these forward-starting interest rate swap agreements were classified as cash flow hedges, the unamortized loss of $13, $8 net of tax, has been deferred in AOCI and will be amortized to earnings as the interest payments are made.

In anticipation of future debt refinancing in fiscal years 2016 through 2019, the Company, in the first and second quarters of 2016, entered into additional forward-starting interest rate swap agreements with an aggregate notional amount totaling $1,500. As of the end of the third quarter of 2016, the Company has a total of $1,600 notional amount of forward-starting interest rate swaps outstanding. The forward-starting interest rate swaps entered into in the first three quarters of 2016 were designated as cash-flow hedges as defined by GAAP.

4.BENEFIT PLANS

The following table provides the components of net periodic benefit cost for the Company-sponsored defined benefit pension plans and other post-retirement benefit plans for the third quarters of 2016 and 2015.

Third Quarter Ended

Pension Benefits

Other Benefits

November 5,

November 7,

November 5,

November 7,

2016

2015

2016