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 August 17, 2019
OR
◻
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-303
The Kroger Co.
(Exact name of registrant as specified in its charter)
Ohio
31-0345740
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
1014 Vine Street, Cincinnati, Ohio 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)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange on which registered
Common, $1.00 Par Value
KR
New York Stock Exchange
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 every Interactive Data File required to be submitted 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 such files). Yes ⌧ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻
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 801,621,398 shares of Common Stock ($1 par value) outstanding as of September 18, 2019.
PART I – FINANCIAL INFORMATION
Item 1.
Financial Statements.
THE KROGER CO.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Second Quarter Ended
Two Quarters Ended
August 17,
August 18,
(In millions, except per share amounts)
2019
2018
Sales
$
28,168
28,014
65,419
65,735
Operating expenses
Merchandise costs, including advertising, warehousing, and transportation, excluding items shown separately below
22,007
21,976
50,990
51,395
Operating, general and administrative
4,811
4,711
11,125
10,968
Rent
200
204
474
480
Depreciation and amortization
591
574
1,370
1,315
Operating profit
559
549
1,460
1,577
Other income (expense)
Interest expense
(130)
(144)
(327)
(336)
Non-service component of company-sponsored pension plan costs
(4)
(1)
(13)
Mark to market (loss) gain on Ocado securities
(45)
216
61
252
Gain on sale of businesses
—
11
176
1,782
Net earnings before income tax expense
380
628
1,369
3,262
Income tax expense
93
127
319
743
Net earnings including noncontrolling interests
287
501
1,050
2,519
Net loss attributable to noncontrolling interests
(10)
(7)
(19)
(15)
Net earnings attributable to The Kroger Co.
297
508
1,069
2,534
Net earnings attributable to The Kroger Co. per basic common share
0.37
0.63
1.32
3.05
Average number of common shares used in basic calculation
800
797
799
821
Net earnings attributable to The Kroger Co. per diluted common share
0.62
1.31
3.03
Average number of common shares used in diluted calculation
805
829
The accompanying notes are an integral part of the Consolidated Financial Statements.
2
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In millions)
Other comprehensive income (loss)
Realized gains and losses on available for sale securities, net of income tax(1)
Change in pension and other postretirement defined benefit plans, net of income tax(2)
9
8
16
23
Unrealized gains and losses on cash flow hedging activities, net of income tax(3)
(55)
(63)
Amortization of unrealized gains and losses on cash flow hedging activities, net of income tax(4)
1
Cumulative effect of accounting change(5)
(146)
Total other comprehensive (loss) income
5
(191)
21
Comprehensive income
242
506
859
2,540
Comprehensive loss attributable to noncontrolling interests
Comprehensive income attributable to The Kroger Co.
513
878
2,555
3
CONSOLIDATED BALANCE SHEETS
February 2,
(In millions, except par amounts)
ASSETS
Current assets
Cash and temporary cash investments
629
429
Store deposits in-transit
983
1,181
Receivables
1,567
1,589
FIFO inventory
7,847
8,123
LIFO reserve
(1,321)
(1,277)
Assets held for sale
166
Prepaid and other current assets
435
592
Total current assets
10,140
10,803
Property, plant and equipment, net
21,820
21,635
Operating lease assets
6,861
Intangibles, net
1,103
1,258
Goodwill
3,095
3,087
Other assets
1,443
1,335
Total Assets
44,462
38,118
LIABILITIES
Current liabilities
Current portion of long-term debt including obligations under finance leases
1,353
3,157
Current portion of operating lease liabilities
675
Trade accounts payable
6,268
6,059
Accrued salaries and wages
1,099
1,227
Liabilities held for sale
51
Other current liabilities
3,955
3,780
Total current liabilities
13,350
14,274
Long-term debt including obligations under finance leases
12,130
12,072
Noncurrent operating lease liabilities
6,463
Deferred income taxes
1,502
1,562
Pension and postretirement benefit obligations
482
494
Other long-term liabilities
1,882
1,881
Total Liabilities
35,809
30,283
Commitments and contingencies see Note 8
SHAREHOLDERS’ EQUITY
Preferred shares, $100 par per share, 5 shares authorized and unissued
Common shares, $1 par per share, 2,000 shares authorized; 1,918 shares issued in 2019 and 2018
1,918
Additional paid-in capital
3,270
3,245
Accumulated other comprehensive loss
(537)
(346)
Accumulated earnings
20,647
19,681
Common shares in treasury, at cost, 1,116 shares in 2019 and 1,120 shares in 2018
(16,587)
(16,612)
Total Shareholders’ Equity - The Kroger Co.
8,711
7,886
Noncontrolling interests
(58)
(51)
Total Equity
8,653
7,835
Total Liabilities and Equity
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities:
Adjustments to reconcile net earnings including noncontrolling interests to net cash provided by operating activities:
Non-cash operating lease cost
346
LIFO charge
46
27
Stock-based employee compensation
89
81
Expense for company-sponsored pension plans
22
38
(49)
92
(176)
(1,782)
Gain on the sale of assets
(157)
Mark to market gain on Ocado securities
(61)
(252)
Other
(23)
32
Changes in operating assets and liabilities net of effects from mergers and disposals of businesses:
198
144
44
(73)
Inventories
274
68
365
209
94
Accrued expenses
104
Income taxes receivable and payable
(34)
397
Operating lease liabilities
(313)
Proceeds from contract associated with sale of business
295
(25)
(189)
Net cash provided by operating activities
3,277
3,260
Cash Flows from Investing Activities:
Payments for property and equipment
(1,581)
(1,487)
Proceeds from sale of assets
247
67
Payments for acquisitions, net of cash acquired
(197)
Purchases of stores
(44)
Net proceeds from sale of businesses
327
2,169
Purchases of Ocado securities
(392)
(32)
12
Net cash (used) provided by investing activities
(1,039)
128
Cash Flows from Financing Activities:
Proceeds from issuance of long-term debt
53
1,016
Payments on long-term debt including obligations under finance leases
(1,025)
(249)
Net payments on commercial paper
(800)
(1,946)
Dividends paid
(226)
(211)
Proceeds from issuance of capital stock
18
40
Treasury stock purchases
(1,979)
(35)
Net cash used by financing activities
(2,038)
(3,374)
Net increase in cash and temporary cash investments
14
Cash and temporary cash investments:
Beginning of year
347
End of period
361
Reconciliation of capital investments:
Changes in construction-in-progress payables
29
(43)
Total capital investments
(1,552)
(1,530)
Disclosure of cash flow information:
Cash paid during the year for interest
306
312
Cash paid during the year for income taxes
454
263
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY
Accumulated
Additional
Common Stock
Paid-In
Treasury Stock
Comprehensive
Noncontrolling
Shares
Amount
Capital
Loss
Earnings
Interest
Total
Balances at February 3, 2018
3,161
1,048
(14,684)
(471)
17,007
(26)
6,905
Issuance of common stock:
Stock options exercised
10
Restricted stock issued
(6)
Treasury stock activity:
Treasury stock purchases, at cost
(134)
74
(1,792)
(1,926)
Stock options exchanged
(17)
Share-based employee compensation
45
Other comprehensive income net of income tax of $5
Cash dividends declared ($0.125 per common share)
(109)
2,026
(8)
2,018
Balances at May 26, 2018
3,059
1,122
(16,476)
(455)
18,924
(29)
6,941
(2)
30
(104)
64
(40)
134
(135)
36
Other comprehensive income net of income tax of $2
55
(53)
Cash dividends declared ($0.14 per common share)
(101)
Balances at August 18, 2018
3,180
1,121
(16,605)
(450)
19,331
(36)
7,338
15
34
Other comprehensive income net of income tax of $15
48
(113)
317
(9)
308
Balances at November 10, 2018
3,209
1,120
(16,608)
(402)
19,535
(42)
7,610
(5)
(3)
(14)
39
Other comprehensive income net of income tax of $17
56
259
251
Balances at February 2, 2019
6
Other comprehensive loss net of income tax of ($5)
Cumulative effect of accounting change
146
772
763
Balances at May 25, 2019
3,287
1,119
(16,613)
(492)
20,481
8,532
79
(30)
41
Other comprehensive loss net of income tax of ($14)
Cash dividends declared ($0.16 per common share)
(131)
Balances at August 17, 2019
1,116
7
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 other consolidated entities. The February 2, 2019 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 adjustments, all of which are of a normal, recurring nature that are necessary for a fair statement 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 February 2, 2019.
The unaudited information in the Consolidated Financial Statements for the second quarters and two quarters ended August 17, 2019 and August 18, 2018, includes the results of operations of the Company for the 12 and 28-week periods then ended.
Products and services related primarily to Kroger Personal Finance and Media, which were historically accounted for as an offset to operating, general and administrative expenses (“OG&A”), are classified as a component of sales as of the beginning of fiscal year 2019, except for certain amounts in Media, which are netted against merchandise costs. These prior-year amounts have been reclassified to conform to current-year presentation.
Refer to Note 5 for a description of changes to the Consolidated Balance Sheet for recently adopted accounting standards regarding the recognition of lease agreements and reclassification of stranded tax effects.
Fair Value Measurements
Fair value measurements are classified and disclosed in one of the following three categories:
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.
The Company records cash and temporary cash investments, store deposits in-transit, receivables, prepaid and other current assets, trade accounts payable, accrued salaries and wages and other current liabilities at approximated fair value. Certain other investments and derivatives are recorded as Level 1, 2 or 3 instruments. Refer to Note 2 for the disclosure of debt instrument fair values.
2.
DEBT OBLIGATIONS
Long-term debt consists of:
1.50% to 8.00% Senior Notes due through 2048
12,104
12,097
5.63% to 12.75% Mortgages due in varying amounts through 2027
13
2.63% Commercial paper borrowings
3.37% Term Loan
1,000
488
440
Total debt, excluding obligations under finance leases
12,605
14,351
Less current portion
(1,305)
(3,103)
Total long-term debt, excluding obligations under finance leases
11,300
11,248
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 upon the net present value of the future cash flow using the forward interest rate yield curve in effect at August 17, 2019 and February 2, 2019. At August 17, 2019, the fair value of total debt was $13,422 compared to a carrying value of $12,605. At February 2, 2019, the fair value of total debt was $14,190 compared to a carrying value of $14,351.
During the first two quarters of 2019, the Company repaid a $1,000 term loan bearing an interest rate of 3.37%.
In anticipation of future debt refinancing, the Company, in the first two quarters of 2019, entered into six forward-starting interest rate swap agreements with a maturity date of January 2021 with an aggregate notional amount totaling $300 and one forward-starting interest rate swap agreement with a maturity date of January 2020 with a notional amount of $50. As of the end of the second quarter of 2019, the Company had a total of $600 notional amount of forward-starting interest rate swaps outstanding. The forward-starting interest rate swaps entered into in the first two quarters of 2019 were designated as cash-flow hedges.
3.
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 second quarters of 2019 and 2018.
Pension Benefits
Other Benefits
Components of net periodic benefit cost:
Service cost
Interest cost
31
Expected return on plan assets
(41)
Amortization of:
Prior service cost
Actuarial loss (gain)
Net periodic benefit cost
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 first two quarters of 2019 and 2018.
17
73
(97)
(94)
24
The Company is not required to make any contributions to its company-sponsored pension plans in 2019, but may make contributions to the extent such contributions are beneficial to the Company. The Company did not make any contributions to its company-sponsored pension plans in the first two quarters of 2019 or 2018.
The Company contributed $173 and $159 to employee 401(k) retirement savings accounts in the first two quarters of 2019 and 2018, 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.
During the first two quarters of 2019, the Company incurred charges totaling $86, $66 net of tax, due to obligations related to withdrawal liabilities for certain multi-employer pension funds. The charges were recorded in the OG&A caption in the Consolidated Statements of Operations.
Additionally, during the second quarter of 2019, the Company sold an unused warehouse. The gain on the sale was used to contribute a similar amount into the UFCW Consolidated Pension Plan.
4.
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:
August 17, 2019
August 18, 2018
Per
Share
(Numerator)
(Denominator)
294
502
Dilutive effect of stock options
1,057
2,507
The Company had combined undistributed and distributed earnings to participating securities totaling $3 and $6 in the second quarter of 2019 and 2018, respectively. For the first two quarters of 2019 and 2018, the Company had combined undistributed and distributed earnings to participating securities of $12 and $27, respectively.
The Company had options outstanding for approximately 27 million and 10 million shares during the second quarter of 2019 and 2018, respectively, that were excluded from the computations of net earnings per diluted common share because their inclusion would have had an anti-dilutive effect on net earnings per share. The Company had options outstanding for approximately 24 million shares during the first two quarters of 2019 and 17 million shares in the first two quarters of 2018 that were excluded from the computations of net earnings per diluted common share because their inclusion would have had an anti-dilutive effect on net earnings per share.
5.
RECENTLY ADOPTED ACCOUNTING STANDARDS
On February 3, 2019, the Company adopted ASU 2016-02, “Leases,” which provides guidance for the recognition of lease agreements. The Company adopted the standard using the modified retrospective approach, which provides a method for recording existing leases at adoption that approximates the results of a full retrospective approach. In addition, the Company elected the transition package of practical expedients permitted within the standard, which allowed it to carry forward the historical lease classification, and applied the transition option which does not require application of the guidance to comparative periods in the year of adoption.
The adoption of the standard resulted in the recognition of operating lease assets and operating lease liabilities of approximately $6,800 and $7,000, respectively, as of February 3, 2019. Included in the measurement of the new lease assets is the reclassification of certain balances including those historically recorded as prepaid or deferred rent and favorable and unfavorable leasehold interests. Several other asset and liability line items in the Consolidated Balance Sheets were also impacted by immaterial amounts. The adoption of this standard also resulted in a change in naming convention for leases classified historically as capital leases. These leases are now referred to as finance leases. The adoption of this standard did not materially affect the Company’s consolidated net earnings or cash flows.
In February 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018-02, "Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This amendment allows companies to reclassify stranded tax effects resulting from the Tax Act from accumulated other comprehensive income (AOCI) to retained earnings. The Company adopted ASU 2018-02 on February 3, 2019, which resulted in a decrease to AOCI and an increase to accumulated earnings of $146, primarily related to deferred taxes previously recorded for pension and other postretirement benefits and cash flow hedges. The adoption of this standard did not have an effect on the Company’s consolidated results of operations or cash flows.
6.
RECENTLY ISSUED ACCOUNTING STANDARDS
In August 2018, the FASB issued ASU 2018-15, “Intangibles – Goodwill and Other – Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” Under the new standard, implementation costs related to a cloud computing arrangement will be deferred or expensed as incurred, in accordance with the existing internal-use software guidance for similar costs. The new standard also prescribes the balance sheet, income statement, and cash flow classification of the capitalized implementation costs and related amortization expense. This guidance will be effective for the Company in the first quarter of the Company’s fiscal year ending January 30, 2021. The amendments may be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company is currently assessing the impact that adoption of this guidance will have on its Consolidated Financial Statements and related disclosures.
7.
LEASES AND LEASE-FINANCED TRANSACTIONS
The Company leases certain store real estate, warehouses, distribution centers, office space and equipment. While the Company’s current strategy emphasizes ownership of store real estate, the Company operates in leased facilities in approximately half of its store locations. Lease terms generally range from 10 to 20 years with options to renew for varying terms at the Company’s sole discretion. Certain leases also include options to purchase the leased property. Leases with an initial term of 12 months or less are not recorded on the balance sheet. Certain leases include escalation clauses or payment of executory costs such as property taxes, utilities or insurance and maintenance. Rent expense for leases with escalation clauses or other lease concessions are accounted for on a straight-line basis over the lease term. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants. Certain properties or portions thereof are subleased to others for periods generally ranging from one to 20 years.
The following table provides supplemental balance sheet classification information related to leases:
Classification
Assets
Operating
Finance
Property, plant and equipment, net(1)
716
721
Total leased assets
7,577
Liabilities
Current
54
Noncurrent
830
824
Total lease liabilities
8,016
The following table provides the components of lease cost:
Lease Cost
Operating lease cost(1)
Rent Expense
228
539
Sublease income
(28)
(65)
Finance lease cost
Amortization of leased assets
Depreciation and Amortization
28
Interest on lease liabilities
Interest Expense
25
Net lease cost
224
527
Maturities of operating and finance lease liabilities are listed below. Amounts in the table include options to extend lease terms that are reasonably certain of being exercised.
Leases
Remainder of 2019
451
492
2020
932
90
1,022
2021
861
950
2022
734
86
820
2023
663
85
748
Thereafter
6,824
895
7,719
Total lease payments
10,465
1,286
11,751
Less amount representing interest
3,327
408
Present value of lease liabilities(1)
7,138
Total future minimum rentals under non-cancellable subleases at August 17, 2019 were $276.
The following table provides the weighted-average lease term and discount rate for operating and finance leases:
Weighted-average remaining lease term (years)
Operating leases
16.2
Finance leases
15.5
Weighted-average discount rate
4.3
%
The following table provides supplemental cash flow information related to leases:
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases
476
Operating cash flows from finance leases
Financing cash flows from finance leases
Leased assets obtained in exchange for new operating lease liabilities
473
Leased assets obtained in exchange for new finance lease liabilities
101
Net gain recognized from sale and leaseback transactions(1)
The Company adopted new lease accounting guidance in the first quarter of 2019 as discussed in Note 1 and Note 5, and as required, the following disclosure is provided for periods prior to adoption. Minimum annual rentals and payments under capital leases and lease-financed transactions for the five years subsequent to February 2, 2019 and in the aggregate are listed below. Amounts in the table below only include payments through the noncancelable lease term.
Lease-
Financed
Transactions
103
948
880
773
82
649
556
766
3,197
1,207
7,003
43
Less estimated executory costs included in capital leases
Net minimum lease payments under capital leases
372
Present value of net minimum lease payments under capital leases
835
8.
COMMITMENTS AND CONTINGENCIES
The Company continuously evaluates contingencies based upon the best available evidence.
The Company believes that allowances for loss have been provided to the extent necessary and that its assessment of contingencies is reasonable. To the extent that resolution of contingencies results in amounts that vary from the Company’s estimates, future earnings will be charged or credited.
Litigation — Various claims and lawsuits arising in the normal course of business, including suits charging violations of certain antitrust, wage and hour, or civil rights laws, as well as product liability cases, 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 effect on the Company’s financial position, results of operations, or cash flows.
The Company continually evaluates its exposure to loss contingencies arising from pending or threatened litigation and believes it has made provisions where it is reasonably possible to estimate and where an adverse outcome is probable. Nonetheless, assessing and predicting the outcomes of these matters involve substantial uncertainties. Management currently believes that the aggregate range of loss for the Company’s exposure is not material to the Company. It remains possible that despite management’s current belief, material differences in actual outcomes or changes in management’s evaluation or predictions could arise that could have a material adverse effect on the Company’s financial condition, results of operations, or cash flows.
9.
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following table represents the changes in AOCI by component for the first two quarters of 2019 and 2018:
Pension and
Cash Flow
Postretirement
Hedging
Available for sale
Defined Benefit
Activities(1)
Securities(1)
Plans(1)
Total(1)
Balance at February 3, 2018
(499)
OCI before reclassifications(2)
Amounts reclassified out of AOCI(3)
Net current-period OCI
Balance at August 18, 2018
26
(476)
Balance at February 2, 2019
(352)
Cumulative effect of accounting change(4)
(141)
(66)
(125)
Balance at August 17, 2019
(60)
(477)
The following table represents the items reclassified out of AOCI and the related tax effects for the second quarter and first two quarters of 2019 and 2018:
Cash flow hedging activity items
Amortization of gains and losses on cash flow hedging activities(1)
Tax expense
Net of tax
Pension and postretirement defined benefit plan items
Amortization of amounts included in net periodic pension cost(2)
Total reclassifications, net of tax
10.
INCOME TAXES
The effective income tax rate was 24.5% in the second quarter of 2019, compared to 20.2% in the second quarter of 2018. The effective income tax rate was 23.3% for the first two quarters of 2019, compared to 22.8% for the first two quarters of 2018. The effective income tax rate for the second quarter of 2019 and the first two quarters of 2019 differed from federal statutory rate due to the effect of state income taxes and tax expense related to share-based payments, partially offset by the utilization of tax credits and deductions. The effective income tax rate for the second quarter of 2018 differed from the federal statutory rate due to the utilization of tax credits and deductions and the benefit from favorable settlements of certain state tax items, partially offset by the effect of state income taxes. The effective income tax rate for the first two quarters of 2018 differed from the federal statutory rate due to the effect of state income taxes, partially offset by utilization of tax credits and deductions and the benefit from favorable settlements of certain state tax items.
11.
HELD FOR SALE AND DISPOSAL OF BUSINESSES
Certain assets and liabilities related to the Company’s Turkey Hill Dairy and You Technology businesses were classified as held for sale in the Consolidated Balance Sheet as of February 2, 2019.
On March 13, 2019, the Company completed the sale of its You Technology business to Inmar for total consideration of $565, including $396 of cash and $64 of preferred equity received upon closing. The Company is also entitled to receive other cash payments of $105 over five years. The transaction includes a long-term service agreement for Inmar to provide the Company digital coupon services. The sale resulted in a gain of $70, $52 net of tax, which is included in “Gain on sale of businesses” in the Consolidated Statement of Operations. The Company recorded the fair value of the long-term service agreement of $358 in “Other current liabilities” and “Other long-term liabilities” in the Consolidated Balance Sheets and such amount is being recorded as sales over the 10-year agreement.
On April 26, 2019, the Company completed the sale of its Turkey Hill Dairy business to an affiliate of Peak Rock Capital for total proceeds of $225. The sale resulted in a gain of $106, $80 net of tax, which is included in “Gain on sale of businesses” in the Consolidated Statements of Operations.
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.
USE OF NON-GAAP FINANCIAL MEASURES
The accompanying Consolidated Financial Statements, including the related notes, are presented in accordance with generally accepted accounting principles (“GAAP”). We provide non-GAAP measures, including First-In, First-Out (“FIFO”) gross margin, FIFO operating profit, adjusted net earnings and adjusted net earnings per diluted share because management believes these metrics are useful to investors and analysts. These non-GAAP financial measures should not be considered as an alternative to gross margin, operating profit, net earnings and net earnings per diluted share or any other GAAP measure of performance. These measures should not be reviewed in isolation or considered as a substitute for our financial results as reported in accordance with GAAP.
We calculate FIFO gross margin as FIFO gross profit divided by sales. FIFO gross profit is calculated as sales less merchandise costs, including advertising, warehousing, and transportation expenses, but excluding the Last-In, First-Out (“LIFO”) charge. Merchandise costs exclude depreciation and rent expenses. FIFO gross margin is an important measure used by management as management believes FIFO gross margin is a useful metric to investors and analysts because it measures our day-to-day merchandising and operational effectiveness.
We calculate FIFO operating profit as operating profit excluding the LIFO charge. FIFO operating profit is an important measure used by management as management believes FIFO operating profit is a useful metric to investors and analysts because it measures our day-to-day operational effectiveness.
The adjusted net earnings and adjusted net earnings per diluted share metrics are important measures used by management to compare the performance of core operating results between periods. We believe adjusted net earnings and adjusted net earnings per diluted share are useful metrics to investors and analysts because they present more accurate year-over-year comparisons for our net earnings and net earnings per diluted share because adjusted items are not the result of our normal operations. Net earnings for the first two quarters of 2019 include the following, which we define as the “2019 Adjusted Items”:
Net earnings for the second quarter of 2019 include the following, which we define as the “2019 Second Quarter Adjusted Items”:
Net earnings for the first two quarters of 2018 include the following, which we define as the “2018 Adjusted Items”:
Net earnings for the second quarter of 2018 include the following, which we define as the “2018 Second Quarter Other Income (Expense) Adjusted Items”:
Please refer to the “Net Earnings per Diluted Share excluding the Adjusted Items” table below for reconciliations of certain non-GAAP financial measures reported in this Quarterly Report on Form 10-Q to the most comparable GAAP financial measure and related disclosure. We are unable to provide a full reconciliation of the non-GAAP measures used in our guidance (see “Outlook” below) without unreasonable effort as certain information necessary to calculate such measures on a GAAP basis is unavailable, dependent on future events outside of our control and cannot be determined without unreasonable effort.
OVERVIEW
Notable items for the second quarter and first two quarters of 2019 are:
19
The following table provides a reconciliation of net earnings attributable to The Kroger Co. to adjusted net earnings attributable to The Kroger Co. and a reconciliation of net earnings attributable to The Kroger Co. per diluted common share to adjusted net earnings attributable to The Kroger Co. per diluted common share, excluding the 2019 and 2018 Adjusted Items.
Net Earnings per Diluted Share excluding the Adjusted Items
($ in millions, except per share amounts)
Percentage
Change
(Income) expense adjustments
Adjustments for pension plan withdrawal liabilities(1)(2)
66
Adjustment for gain on sale of convenience store business(1)(3)
(1,360)
Adjustment for gain on sale of Turkey Hill Dairy(1)(4)
(80)
Adjustment for gain on sale of You Technology(1)(5)
(52)
Adjustment for mark to market loss (gain) on Ocado securities(1)(6)
(164)
Adjustment for depreciation related to held for sale assets(1)(7)
(11)
Adjustment for contingent consideration(1)(8)
(16)
2019 and 2018 Adjusted Items
60
(172)
(126)
(1,572)
Net earnings attributable to The Kroger Co. excluding the Adjusted Items
357
336
6.3
943
962
(2.0)
Adjustments for pension plan withdrawal liabilities(9)
0.03
0.08
(0.01)
Adjustment for gain on sale of convenience store business(9)
(1.63)
Adjustment for gain on sale of Turkey Hill Dairy(9)
(0.10)
Adjustment for gain on sale of You Technology(9)
(0.06)
Adjustment for mark to market loss (gain) on Ocado securities(9)
0.04
(0.20)
(0.05)
(0.23)
Adjustment for depreciation related to held for sale assets(9)
Adjustment for contingent consideration(9)
(0.02)
0.07
(0.21)
(0.15)
(1.88)
Adjusted net earnings attributable to The Kroger Co. per diluted common share
0.44
0.41
7.3
1.16
1.15
0.9
20
RESULTS OF OPERATIONS
Total Sales
($ in millions)
Change(1)
Change(2)
Change(3)
Change(4)
Total sales to retail customers without fuel(5)
24,598
2.4
24,016
1.9
57,191
2.2
55,981
Supermarket fuel sales
3,405
(9.9)
3,781
29.2
7,801
(6.5)
8,341
23.7
Convenience stores(6)
(100.0)
944
(60.0)
Other sales(7)
165
(24.0)
217
13.6
427
(9.0)
469
14.4
Total sales
0.5
1.0
(0.5)
Total sales were $28.2 billion in the second quarter of 2019, compared to $28.0 billion in the second quarter of 2018. This increase was due to an increase in total sales to retail customers without fuel, partially offset by a reduction in supermarket fuel sales and decreased sales due to the disposal of Turkey Hill Dairy and You Technology in the first quarter of 2019. Total sales excluding fuel, dispositions and the merger with Home Chef increased 2.5% in the second quarter of 2019, compared to the second quarter of 2018. The increase in total sales to retail customers without fuel for the second quarter of 2019, compared to the second quarter of 2018, was primarily due to our merger with Home Chef and our identical sales increase, excluding fuel, of 2.2%. Identical sales, excluding fuel, for the second quarter of 2019, compared to the second quarter of 2018, increased primarily due to growth of loyal households, a higher customer basket value, retail inflation and Kroger Specialty Pharmacy sales growth, partially offset by our continued investments in lower prices for our customers. Total supermarket fuel sales decreased 9.9% in the second quarter of 2019, compared to the second quarter of 2018, primarily due to a decrease in fuel gallons sold of 5.6% and a decrease in the average retail fuel price of 4.7%. The decrease in the average retail fuel price was caused by a decrease in the product cost of fuel.
Total sales were $65.4 billion in the first two quarters of 2019, compared to $65.7 billion for the first two quarters of 2018. This decrease was due to the sale of our convenience store business unit in the first quarter of 2018, Turkey Hill Dairy and You Technology in the first quarter of 2019 and a decrease in supermarket fuel sales, partially offset by our increase in total sales to retail customers without fuel. Total sales, excluding fuel, dispositions and the merger with Home Chef increased 2.1% in the first two quarters of 2019, compared to the first two quarters of 2018. The increase in total sales to retail customers without fuel for the first two quarters of 2019, compared to the first two quarters of 2018, was primarily due to our merger with Home Chef and our identical sales increase, excluding fuel, of 1.8%. Identical sales, excluding fuel, for the first two quarters of 2019, compared to the first two quarters of 2018, increased primarily due to growth of loyal households, a higher customer basket value, retail inflation and Kroger Specialty Pharmacy sales growth, partially offset by our continued investments in lower prices for our customers. Total supermarket fuel sales decreased 6.5% in the first two quarters of 2019, compared to the first two quarters of 2018, primarily due to a decrease in fuel gallons sold of 4.3% and a decrease in the average retail fuel price of 2.3%. The decrease in the average retail fuel price was caused by a decrease in the product cost of fuel.
We calculate identical sales, excluding fuel, as sales to retail customers, including sales from all departments at identical supermarket locations, Kroger Specialty Pharmacy businesses and ship-to-home solutions. We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters. Additionally, sales from all acquired businesses are treated as identical as if they were part of the Company in the prior year. Products and services related primarily to Kroger Personal Finance, which were historically accounted for as an offset to OG&A, are classified as a component of sales as of the beginning of fiscal year 2019. These prior-year amounts have been reclassified to conform to current-year presentation, which is consistent with our Restock Kroger initiative and our view of the products and services as part of our core business strategy. This is also more consistent with industry practice. These Kroger Personal Finance transactions represent sales to retail customers and, as such, are included in identical sales in 2019 and 2018. This change increased identical sales by 2 basis points in the second quarter of 2019 and 5 basis points in the second quarter of 2018. This change increased identical sales by 2 basis points in the first two quarters of 2019 and 6 basis points in the first two quarters of 2018. See “Supplemental Information” section below for more detail on the changes and the impact of the reclassification. Although identical sales is a relatively standard term, numerous methods exist for calculating identical sales growth. As a result, the method used by our management to calculate identical sales may differ from methods other companies use to calculate identical sales. We urge you to understand the methods used by other companies to calculate identical sales before comparing our identical sales to those of other such companies. Our identical sales results are summarized in the following table. We used the identical sales dollar figures presented below to calculate percentage changes for the second quarter and first two quarters of 2019.
Identical Sales
Excluding fuel centers
24,299
23,768
1.6
56,432
1.8
55,439
Gross Margin, LIFO and FIFO Gross Margin
We define gross margin as sales minus merchandise costs, including advertising, warehousing, and transportation. Rent expense, depreciation and amortization expense, and interest expense are not included in gross margin.
Our gross margin rate, as a percentage of sales, was 21.87% for the second quarter of 2019, compared to 21.55% for the second quarter of 2018. The increase in the second quarter of 2019, compared to the second quarter of 2018, resulted primarily from a higher gross margin rate on fuel sales, decreased shrink, as a percentage of sales, growth in our alternative profit stream portfolio and effective negotiations to achieve savings on the cost of products sold, partially offset by industry-wide lower gross margin rates in pharmacy, continued investments in lower prices for our customers, a higher LIFO charge, continued growth in the specialty pharmacy business and increased warehouse costs, as a percentage of sales, due to cycling of costs associated with new warehouses and new warehouse capabilities.
Our gross margin rate, as a percentage of sales, was 22.06% for the first two quarters of 2019, compared to 21.82% for the first two quarters of 2018. The increase in the first two quarters of 2019, compared to the first two quarters of 2018, resulted primarily from a higher gross margin rate on fuel sales, decreased shrink, as a percentage of sales, growth in our alternative profit stream portfolio and effective negotiations to achieve savings on the cost of products sold, partially offset by industry-wide lower gross margin rates in pharmacy, continued investments in lower prices for our customers, a higher LIFO charge, continued growth in the specialty pharmacy business and increased warehouse costs, as a percentage of sales, due to cycling of costs associated with new warehouses and new warehouse capabilities.
Our LIFO charge was $30 million for the second quarter of 2019 compared to $12 million for the second quarter of 2018. Our LIFO charge was $46 million for the first two quarters of 2019 compared to $27 million for the first two quarters of 2018. Our LIFO charge reflects an increase in our expected annualized product cost inflation for 2019, driven by dry grocery, pharmacy and dairy.
Our FIFO gross margin rate, which excludes the second quarter LIFO charge, was 21.98% for the second quarter of 2019, compared to 21.59% for the second quarter of 2018. Our fuel sales lower our FIFO gross margin rate due to the very low FIFO gross margin rate, as a percentage of sales, of fuel sales compared to non-fuel sales. Excluding the effect of fuel, our FIFO gross margin rate decreased 29 basis points in the second quarter of 2019, compared to the second quarter of 2018. This decrease resulted primarily from industry-wide lower gross margin rates in pharmacy, continued investments in lower prices for our customers, continued growth in the specialty pharmacy business and increased warehouse costs, as a percentage of sales, due to cycling of costs associated with new warehouses and new warehouse capabilities, partially offset by decreased shrink, as a percentage of sales, growth in our alternative profit stream portfolio and effective negotiations to achieve savings on the cost of products sold. Excluding fuel and retail pharmacy, our FIFO gross margin decreased 12 basis points in the second quarter of 2019, compared to the second quarter of 2018. Our FIFO gross margin investment, excluding fuel and retail pharmacy, that occurred in the second quarter of 2019 has decelerated compared to the prior three quarters.
Our FIFO gross margin rate, which excludes the first two quarters LIFO charge, was 22.13% for the first two quarters of 2019, compared to 21.86% for the first two quarters of 2018. Excluding the effect of fuel, our FIFO gross margin rate decreased 36 basis points in the first two quarters of 2019, compared to the first two quarters of 2018. This decrease resulted primarily from industry-wide lower gross margin rates in pharmacy, continued investments in lower prices for our customers, continued growth in the specialty pharmacy business and increased warehouse costs, as a percentage of sales, due to cycling of costs associated with new warehouses and new warehouse capabilities, partially offset by decreased shrink, as a percentage of sales, growth in our alternative profit stream portfolio and effective negotiations to achieve savings on the cost of products sold. Excluding fuel and retail pharmacy, our FIFO gross margin decreased 13 basis points in the first two quarters of 2019, compared to the first two quarters of 2018.
Operating, General and Administrative Expenses
OG&A expenses consist primarily of employee-related costs such as wages, healthcare benefit costs, retirement plan costs, utility, 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, were 17.08% for the second quarter of 2019, compared to 16.82% for the second quarter of 2018. The increase in the second quarter of 2019, compared to the second quarter of 2018 resulted primarily from the 2019 Second Quarter OG&A Adjusted Items, investments in our digital strategy, increases in hourly associate labor costs attributed to investing in higher wages and other comprehensive benefits to improve employee retention, engagement and customer experience and the effect of decreased fuel sales, which increases our OG&A rate, as a percentage of sales, partially offset by the execution of Restock Kroger initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions and decreased incentive plan costs. Our fuel sales lower our OG&A rate, as a percentage of sales, due to the very low OG&A rate, as a percentage of sales, of fuel sales compared to non-fuel sales. Excluding the effect of fuel and the 2019 Second Quarter OG&A Adjusted Items, our OG&A rate decreased 14 basis points in the second quarter of 2019, compared to the second quarter of 2018. This decrease resulted primarily from the execution of Restock Kroger initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions and decreased incentive plan costs, partially offset by investments in our digital strategy and increases in hourly associate labor costs attributed to investing in higher wages and other comprehensive benefits to improve employee retention, engagement and customer experience.
OG&A expenses, as a percentage of sales, were 17.01% for the first two quarters of 2019, compared to 16.69% for the first two quarters of 2018. The increase in the first two quarters of 2019, compared to the first two quarters of 2018 resulted primarily from the 2019 OG&A Adjusted Items, the 2018 OG&A Adjusted Item, the effect of decreased supermarket fuel and convenience store sales, which increases our OG&A rate, as a percentage of sales, investments in our digital strategy and increases in hourly associate labor costs attributed to investing in higher wages and other comprehensive benefits to improve employee retention, engagement and customer experience, partially offset by the execution of Restock Kroger initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions, planned real estate transactions during the first quarter of 2019 and decreased incentive plan costs. Excluding the effect of fuel, the 2019 OG&A Adjusted Items and the 2018 OG&A Adjusted Item, our OG&A rate decreased 13 basis points in the first two quarters of 2019, compared to the first two quarters of 2018. This decrease resulted primarily from the execution of Restock Kroger initiatives that drive administrative efficiencies, store productivity and sourcing cost reductions, planned real estate transactions during the first quarter of 2019 and decreased incentive plan costs, partially offset by investments in our digital strategy and increases in hourly associate labor costs attributed to investing in higher wages and other comprehensive benefits to improve employee retention, engagement and customer experience.
During the second quarter of 2019, we accepted an offer to sell an unused warehouse that had been on the market for some time. We used this gain as an opportunity to contribute a similar amount into the UFCW Consolidated Pension Plan, helping stabilize associates’ future benefits. The net impact of these transactions had no effect to OG&A for the second quarter and first two quarters of 2019.
Rent expense, as a percentage of sales, remained relatively consistent in both the second quarter and first two quarters of 2019, compared to the same periods in 2018.
Depreciation and Amortization Expense
Depreciation and amortization expense increased, as a percentage of sales, in the second quarter of 2019, compared to the second quarter of 2018. This increase is primarily due to lower fuel sales, which increases our depreciation expense as a percentage of sales, and additional depreciation on capital investments, excluding mergers and lease buyouts, of $3.0 billion, during the rolling four quarter period ending with the second quarter of 2019.
Depreciation and amortization expense increased, as a percentage of sales, in the first two quarters of 2019, compared to the first two quarters of 2018. This increase is primarily due to lower fuel sales, which increases our depreciation expense as a percentage of sales, the 2018 Depreciation Adjusted Item and additional depreciation on capital investments, excluding mergers and lease buyouts, of $3.0 billion, during the rolling four quarter period ending with the second quarter of 2019.
Operating Profit and FIFO Operating Profit
Operating profit was $559 million, or 1.98% of sales, for the second quarter of 2019, compared to $549 million, or 1.96% of sales, for the second quarter of 2018. Operating profit, as a percentage of sales, increased 2 basis points in the second quarter of 2019, compared to the second quarter of 2018, due to a higher gross margin rate, partially offset by increased OG&A and depreciation and amortization expenses, as a percentage of sales.
Operating profit was $1.5 billion, or 2.23% of sales, for the first two quarters of 2019, compared to $1.6 billion, or 2.40% of sales, for the first two quarters of 2018. Operating profit, as a percentage of sales, decreased 17 basis points in the first two quarters of 2019, compared to the first two quarters of 2018, due to increased OG&A and depreciation and amortization expenses, as a percentage of sales, partially offset by a higher gross margin rate.
FIFO operating profit was $589 million, or 2.09% of sales, for the second quarter of 2019, compared to $561 million, or 2.00% of sales, for the second quarter of 2018. FIFO operating profit excluding the 2019 Second Quarter Adjusted Items increased 10.6% in the second quarter of 2019, compared to the second quarter of 2018, due to increased fuel earnings, partially offset by decreased pharmacy gross profit, increased depreciation and amortization and OG&A expenses, as a percentage of sales. Fuel sales lower our operating profit rate due to the very low operating profit rate, as a percentage of sales, of fuel sales compared to non-fuel sales. FIFO operating profit, as a percentage of sales excluding fuel and the 2019 and 2018 Second Quarter Adjusted Items decreased 14 basis points in the second quarter of 2019, compared to the second quarter of 2018, due to a lower gross margin rate and increased depreciation and amortization expenses, as a percentage of sales, partially offset by decreased OG&A expenses, as a percentage of sales.
FIFO operating profit was $1.5 billion, or 2.30% of sales, for the first two quarters of 2019, compared to $1.6 billion, or 2.44% of sales, for the first two quarters of 2018. FIFO operating profit excluding the 2019 and 2018 Adjusted Items remained relatively consistent in the first two quarters of 2019, compared to the first two quarters of 2018. FIFO operating profit, as a percentage of sales excluding fuel and the 2019 and 2018 Adjusted Items decreased 25 basis points in the first two quarters of 2019, compared to the first two quarters of 2018, due to a lower gross margin rate and increased depreciation and amortization expense, as a percentage of sales, partially offset by lower OG&A expense, as a percentage of sales.
Specific factors of the above operating trends under operating profit and FIFO operating profit are discussed earlier in this section.
Income Taxes
The effective income tax rate was 24.5% in the second quarter of 2019, compared to 20.2% in the second quarter of 2018. The effective income tax rate was 23.3% for the first two quarters of 2019, compared to 22.8% for the first two quarters of 2018. The effective income tax rate for the second quarter of 2019 and the first two quarters of 2019 differed from the federal statutory rate due to the effect of state income taxes and tax expense related to share-based payments, partially offset by the utilization of tax credits and deductions. The effective income tax rate for the second quarter of 2018 differed from the federal statutory rate due to the utilization of tax credits and deductions and the benefit from favorable settlements of certain state tax items, partially offset by the effect of state income taxes. The effective income tax rate for the first two quarters of 2018 differed from the federal statutory rate due the effect of state income taxes, partially offset by the utilization of tax credits and deductions and the benefit from favorable settlements of certain state tax items.
Net Earnings and Net Earnings Per Diluted Share
Our net earnings are based on the factors discussed in the Results of Operations section.
Net earnings of $0.37 per diluted share for the second quarter of 2019 represented a decrease of 40.3% from net earnings of $0.62 per diluted share for the second quarter of 2018. Adjusted net earnings of $0.44 per diluted share for the second quarter of 2019 represented an increase of 7.3% from adjusted net earnings of $0.41 per diluted share for the second quarter of 2018. The increase in adjusted net earnings per diluted share resulted primarily from increased fuel earnings and decreased interest expense, partially offset by decreased pharmacy gross profit, higher income tax expense and a higher LIFO charge.
Net earnings of $1.31 per diluted share for the first two quarters of 2019 represented a decrease of 56.8% from net earnings of $3.03 per diluted share for the first two quarters of 2018. Adjusted net earnings of $1.16 per diluted share for the first two quarters of 2019 represented an increase of 0.9% from adjusted net earnings of $1.15 per diluted share for the first two quarters of 2018. The increase in adjusted net earnings per diluted share resulted primarily from increased fuel earnings, decreased interest expense and lower weighted average common shares outstanding due to common share repurchases, partially offset by decreased pharmacy gross profit, higher income tax expense and a higher LIFO charge.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Information
We generated $3.3 billion of cash from operations during both the first two quarters of 2019 and 2018. Net earnings including noncontrolling interests, adjusted for non-cash items and other impacts, generated approximately $2.5 billion of operating cash flow in the first two quarters of 2019 compared to $1.9 billion in the first two quarters of 2018. Cash provided by operating activities for changes in working capital was $845 million in the first two quarters of 2019 compared to $1.4 billion in the first two quarters of 2018. The decrease in cash provided by operating activities for changes in working capital in the first two quarters of 2019, compared to the first two quarters of 2018, was primarily due to the following:
Cash paid for taxes increased in the first two quarters of 2019, compared to the first two quarters of 2018, primarily due to the payment of estimated taxes on the gain on sale of the You Technology and Turkey Hill Dairy businesses in the first two quarters of 2019 and an overpayment of our fourth quarter 2017 estimated taxes that resulted in lower tax payments in the first two quarters of 2018.
Investing activities used cash of $1.0 billion in the first two quarters of 2019 compared to cash provided by investing activities of $128 million in the first two quarters of 2018. We used cash in investing activities in the first two quarters of 2019 compared to cash provided by investing activities in the first two quarters of 2018, primarily due to the following:
We used $2.0 billion of cash for financing activities in the first two quarters of 2019 compared to $3.4 billion during the first two quarters of 2018. The amount of cash used for financing activities for the first two quarters of 2019, compared to the first two quarters of 2018, decreased primarily due to decreased payments on commercial paper and share repurchases, partially offset by increased payments on long-term debt including obligations under finance leases and a reduction of proceeds from the issuance of long-term debt.
Debt Management
As of August 17, 2019, we maintained a $2.75 billion (with the ability to increase by $1 billion), unsecured revolving credit facility that, unless extended, terminates on August 29, 2022. Outstanding borrowings under the credit facility, commercial paper borrowings, and some outstanding letters of credit reduce funds available under the credit facility. As of August 17, 2019, we had no outstanding commercial paper and no borrowings under our revolving credit facility. The outstanding letters of credit that reduce funds available under our credit facility totaled $3 million as of August 17, 2019.
Our bank credit facility and the indentures underlying our publicly issued debt contain various financial covenants. As of August 17, 2019, we were in compliance with the financial covenants. Furthermore, management believes it is not reasonably likely that we will fail to comply with these financial covenants in the foreseeable future.
Total debt, including both the current and long-term portions of obligations under finance leases, decreased $1.7 billion as of August 17, 2019 compared to our fiscal year end 2018 debt of $15.2 billion. This decrease resulted primarily from net payments on commercial paper borrowings of $800 million and the repayment of our $1.0 billion term loan.
Common Share Repurchase Program
During the second quarter of 2019, we invested $8 million to repurchase 354 thousand Kroger common shares at an average price of $22.37 per share. For the first two quarters of 2019, we invested $23 million to repurchase 918 thousand Kroger common shares at an average price of $25.02 per share. The shares repurchased in the first two quarters of 2019 were reacquired under a program that uses the cash proceeds from the exercises of stock options by participants in Kroger’s stock option, long-term incentive plans and the associated tax benefits.
On March 15, 2018, our Board of Directors approved a $1.0 billion share repurchase program to reacquire shares via open market purchase or privately negotiated transactions, including accelerated stock repurchase transactions, block trades, or pursuant to trades intending to comply with rule 10b5-1 of the Securities Exchange Act of 1934 (the “March 2018 Repurchase Program”). As of August 17, 2019, $546 million remained under the March 2018 Repurchase Program.
Dividends
The following table provides dividend information ($ in millions, except per share amounts):
Cash dividends paid
113
Cash dividends paid per common share
0.140
0.125
226
211
0.280
0.250
Liquidity Needs
We estimate our liquidity needs over the next twelve-month period to approximate $4.5 billion, which includes anticipated requirements for working capital, capital investments, interest payments and scheduled principal payments of debt and commercial paper, offset by cash and temporary cash investments on hand at the end of the second quarter of 2019. We generally operate with a working capital deficit due to our efficient use of cash in funding operations and because we have consistent access to the capital markets. Based on current operating trends, we believe that cash flows from operating activities and other sources of liquidity, including borrowings under our commercial paper program and bank credit facility, will be adequate to meet our liquidity needs for the next twelve months and for the foreseeable future beyond the next twelve months. We have approximately $1.3 billion of senior notes maturing in the next twelve months, which are included in the $4.5 billion of estimated liquidity needs. We expect to satisfy these obligations using cash generated from operations and through issuing additional senior notes or commercial paper. We believe we have adequate coverage of our debt covenants to continue to maintain our current investment grade debt ratings and to respond effectively to competitive conditions.
CAPITAL INVESTMENTS
Capital investments, excluding mergers, acquisitions and the purchase of leased facilities, totaled $676 million for both the second quarter of 2019 and the second quarter of 2018. Capital investments, excluding mergers, acquisitions and the purchase of leased facilities, totaled $1.6 billion in the first two quarters of 2019 and $1.5 billion in the first two quarters of 2018. During the rolling four quarter period ended with the second quarter of 2019, we opened, expanded, relocated or acquired 27 supermarkets and also completed 174 major within-the-wall remodels. Total supermarket square footage at the end of the second quarter of 2019 increased 0.3% from the end of the second quarter of 2018. Excluding mergers, acquisitions and operational closings, total supermarket square footage at the end of the second quarter of 2019 increased 0.6% over the end of the second quarter of 2018.
CRITICAL ACCOUNTING POLICIES
We have chosen accounting policies that we believe are appropriate to report accurately and fairly our operating results and financial position, and we apply those accounting policies in a consistent manner. Our critical accounting policies are summarized in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019.
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our estimates on historical experience and other factors we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could vary from those estimates.
NEW ACCOUNTING STANDARDS
Refer to Note 5 and Note 6 to the Consolidated Financial Statements for recently adopted accounting standards and recently issued accounting standards not yet adopted as of August 17, 2019.
SUPPLEMENTAL INFORMATION
Sales Reclassification
Products and services related primarily to Kroger Personal Finance and Media, which were historically accounted for as an offset to OG&A, are classified as a component of sales as of the beginning of fiscal year 2019, except for certain amounts in Media, which are netted against merchandise costs. These prior-year amounts have been reclassified to conform to current-year presentation, which is consistent with our Restock Kroger initiative and our view of the products and services as part of our core business strategy. This is also more consistent with industry practice.
The following tables summarize the Company's second quarter and first two quarters of 2018 sales reclassifications ($ in millions):
Previously Stated
Reclassification
Reclassified
27,869
145
21,930
4,612
99
65,399
51,293
102
10,734
234
OUTLOOK
This discussion and analysis contains certain forward-looking statements about our future performance. These statements are based on management’s assumptions and beliefs in light of the information currently available to it. Such statements are indicated by words such as “achieve,” “affect,” “believe,” “could,” “effect,” “estimate,” “expect,” “future,” “goal,” “growth,” “guidance,” “incremental,” “likely,” “may,” “plan,” “range,” “result,” “strategy,” “success,” “target,” “trend,” and “will,” and similar words or phrases. These forward-looking statements are subject to uncertainties and other factors that could cause actual results to differ materially. These include the specific risk factors identified in “Risk Factors” and “Outlook” in our Annual Report on Form 10-K for our last fiscal year and any subsequent filings, as well as those identified below.
Statements elsewhere in this report and below regarding our expectations, projections, beliefs, intentions or strategies are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. While we believe that the statements are accurate, uncertainties about the general economy, our labor relations, our ability to execute our plans on a timely basis and other uncertainties described below could cause actual results to differ materially.
Various uncertainties and other factors could cause actual results to differ materially from those contained in the forward-looking statements. These include:
We cannot fully foresee the effects of changes in economic conditions on our business. We have assumed economic and competitive situations will not change significantly in 2019.
Other factors and assumptions not identified above, including those discussed in Item 1A of this Report, could also cause actual results to differ materially from those set forth in the forward-looking information. Accordingly, actual events and results may vary significantly from those included in, contemplated or implied by forward-looking statements made by us or our representatives. We undertake no obligation to update the forward-looking information contained in this filing.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
There have been no material changes in our exposure to market risk from the information provided in Item 7A. Quantitative and Qualitative Disclosures About Market Risk in our Annual Report on Form 10-K for the fiscal year ended February 2, 2019.
Item 4. Controls and Procedures.
The Chief Executive Officer and the Chief Financial Officer, together with a disclosure review committee appointed by the Chief Executive Officer, evaluated Kroger’s disclosure controls and procedures as of the quarter ended August 17, 2019, the end of the period covered by this report. Based on that evaluation, Kroger’s Chief Executive Officer and Chief Financial Officer concluded that Kroger’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) of the Exchange Act) were effective as of the end of the period covered by this report to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
In connection with the evaluation described above, there was no change in Kroger’s internal control over financial reporting during the quarter ended August 17, 2019, that has materially affected, or is reasonably likely to materially affect, Kroger’s internal control over financial reporting.
33
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
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, as well as product liability cases, 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.
The Company continually evaluates its exposure to loss contingencies arising from pending or threatened litigation and believes it has made provisions where it is possible to reasonably estimate and where an adverse outcome is probable. Nonetheless, assessing and predicting the outcomes of these matters involve substantial uncertainties. 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 impact on the Company’s financial condition, results of operations, or cash flows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(c)
ISSUER PURCHASES OF EQUITY SECURITIES
Maximum
Dollar Value of
Shares that May
Total Number of
Yet Be
Shares Purchased
Purchased
Total Number
Average
as Part of Publicly
Under the Plans
of Shares
Price Paid Per
Announced Plans
or Programs(4)
Period(1)
Purchased(2)
or Programs(3)
(in millions)
First four weeks
May 26, 2019 to June 22, 2019
93,917
24.04
92,602
546
Second four weeks
June 23, 2019 to July 20, 2019
1,554,249
21.89
221,048
Third four weeks
July 21, 2019 to August 17, 2019
40,863
22.55
40,745
1,689,029
22.03
354,395
35
Item 6. Exhibits.
EXHIBIT 3.1
-
Amended Articles of Incorporation are hereby incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended May 22, 2010, as amended by the Amendment to Amended Articles of Incorporation, which is hereby incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended May 23, 2015.
EXHIBIT 3.2
The Company’s regulations are hereby incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K filed with the SEC on June 27, 2019.
EXHIBIT 4.1
Instruments defining the rights of holders of long-term debt of the Company and its subsidiaries are not filed as Exhibits because the amount of debt under each instrument is less than 10% of the consolidated assets of the Company. The Company undertakes to file these instruments with the SEC upon request.
EXHIBIT 10.1
The Kroger Co. 2019 Long-Term Incentive Plan is hereby incorporated by reference to Exhibit 99.1 of the Company’s Form S-8 filed with the SEC on June 28, 2019.
EXHIBIT 31.1
Rule 13a—14(a) / 15d—14(a) Certifications — Chief Executive Officer.
EXHIBIT 31.2
Rule 13a—14(a) / 15d—14(a) Certifications — Chief Financial Officer.
EXHIBIT 32.1
Section 1350 Certifications.
EXHIBIT 101.INS
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
EXHIBIT 101.SCH
XBRL Taxonomy Extension Schema Document.
EXHIBIT 101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
EXHIBIT 101.DEF
XBRL Taxonomy Extension Definition Linkbase Document.
EXHIBIT 101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
EXHIBIT 101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
EXHIBIT 104
Cover Page Interactive Data File - The cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
Exhibit Index
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Dated: September 24, 2019
By:
/s/ W. Rodney McMullen
W. Rodney McMullen
Chairman of the Board and Chief Executive Officer
/s/ Gary Millerchip
Gary Millerchip
Senior Vice President and Chief Financial Officer