UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

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

 

For the quarterly period ended August 15, 2015

 

OR

 

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

 

For the transition period from       to

 

Commission file number 1-303

 


 

(Exact name of registrant as specified in its charter)

 


 

Ohio 

 

31-0345740 

(State or other jurisdiction of 

 

(I.R.S. Employer 

incorporation or organization) 

 

Identification No.) 

 

1014 Vine Street, Cincinnati, OH 45202

(Address of principal executive offices)

(Zip Code)

 

(513) 762-4000

(Registrant’s telephone number, including area code)

 

Unchanged

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

 


 

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

 

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

 

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

 

Large accelerated filer  x

 

Accelerated filer  o

 

 

 

Non-accelerated filer  o

 

Smaller reporting company  o

(do not check if a 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 o No x .

 

There were 973,434,417 shares of Common Stock ($1 par value) outstanding as of September 18, 2015.

 

 

 



 

PART I — FINANCIAL INFORMATION

 

Item 1.         Financial Statements.

 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share amounts)

(unaudited)

 

 

 

Second Quarter Ended

 

Two Quarters Ended 

 

 

 

August 15,

 

August 16,

 

August 15,

 

August 16,

 

 

 

2015

 

2014

 

2015

 

2014 

 

Sales

 

$

  25,539

 

$

  25,310

 

$

  58,590

 

$

  58,271

 

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

 

20,065

 

20,136

 

45,825

 

46,201

 

Operating, general and administrative

 

4,068

 

3,920

 

9,422

 

9,088

 

Rent

 

155

 

166

 

370

 

383

 

Depreciation and amortization

 

477

 

444

 

1,097

 

1,025

 

 

 

 

 

 

 

 

 

 

 

Operating profit

 

774

 

644

 

1,876

 

1,574

 

Interest expense

 

114

 

112

 

262

 

259

 

 

 

 

 

 

 

 

 

 

 

Earnings before income tax expense

 

660

 

532

 

1,614

 

1,315

 

Income tax expense

 

227

 

182

 

557

 

456

 

 

 

 

 

 

 

 

 

 

 

Net earnings including noncontrolling interests

 

433

 

350

 

1,057

 

859

 

Net earnings attributable to noncontrolling interests

 

 

3

 

5

 

11

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co.

 

$

433

 

$

347

 

$

1,052

 

$

848

 

 

 

 

 

 

 

 

 

 

 

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

 

$

  0.44

 

$

  0.35

 

$

  1.08

 

$

  0.85

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in basic calculation

 

963

 

970

 

966

 

988

 

 

 

 

 

 

 

 

 

 

 

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

 

$

  0.44

 

$

  0.35

 

$

  1.06

 

$

  0.84

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in diluted calculation

 

977

 

982

 

981

 

1,000

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.105

 

$

0.083

 

$

0.198

 

$

0.165

 

 

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

 

2



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions and unaudited)

 

 

 

Second Quarter Ended 

 

Two Quarters Ended

 

 

 

August 15,
2015

 

August 16,
2014

 

August 15,
2015

 

August 16,
2014

 

Net earnings including noncontrolling interests

 

$

  433

 

$

  350

 

$

  1,057

 

$

  859

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

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

 

4

 

3

 

7

 

2

 

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

 

13

 

5

 

29

 

13

 

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

 

(3

)

 

17

 

 

 

 

 

 

 

 

 

 

 

 

Total other comprehensive income

 

14

 

8

 

53

 

15

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income

 

447

 

358

 

1,110

 

874

 

Comprehensive income attributable to noncontrolling interests

 

 

3

 

5

 

11

 

Comprehensive income attributable to The Kroger Co.

 

$

447

 

$

355

 

$

1,105

 

$

863

 

 


(1)         Amount is net of tax of $3 for the second quarter of 2015 and $1 for the second quarter of 2014.  Amount is net of tax of $4 for the first two quarters of 2015.

(2)         Amount is net of tax of $8 for the second quarter of 2015 and $4 for the second quarter of 2014.  Amount is net of tax of $17 for the first two quarters of 2015 and $8 for the first two quarters of 2014.

(3)         Amount is net of tax of $(2) for the second quarter of 2015 and $10 for the first two quarters of 2015.

 

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

 

3



 

THE KROGER CO.

CONSOLIDATED BALANCE SHEETS

(in millions, except per share amounts)

(unaudited)

 

 

 

August 15,

 

January 31,

 

 

 

2015

 

2015

 

ASSETS

 

 

 

 

 

Current assets

 

 

 

 

 

Cash and temporary cash investments

 

$

268

 

$

268

 

Store deposits in-transit

 

934

 

988

 

Receivables

 

1,319

 

1,266

 

FIFO inventory

 

6,841

 

6,933

 

LIFO reserve

 

(1,293

)

(1,245

)

Prepaid and other current assets

 

457

 

701

 

Total current assets

 

8,526

 

8,911

 

 

 

 

 

 

 

Property, plant and equipment, net

 

18,573

 

17,912

 

Intangibles, net

 

736

 

757

 

Goodwill

 

2,307

 

2,304

 

Other assets

 

639

 

613

 

 

 

 

 

 

 

Total Assets

 

$

30,781

 

$

30,497

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Current liabilities

 

 

 

 

 

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

 

$

1,527

 

$

1,885

 

Trade accounts payable

 

5,261

 

5,052

 

Accrued salaries and wages

 

1,221

 

1,291

 

Deferred income taxes

 

286

 

287

 

Other current liabilities

 

3,068

 

2,888

 

Total current liabilities

 

11,363

 

11,403

 

 

 

 

 

 

 

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

 

 

 

 

 

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

 

9,744

 

9,712

 

Adjustment to reflect fair-value interest rate hedges

 

(1

)

¾

 

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

 

9,743

 

9,712

 

 

 

 

 

 

 

Deferred income taxes

 

1,157

 

1,209

 

Pension and postretirement benefit obligations

 

1,460

 

1,463

 

Other long-term liabilities

 

1,176

 

1,268

 

 

 

 

 

 

 

Total Liabilities

 

24,899

 

25,055

 

 

 

 

 

 

 

Commitments and contingencies (see Note 9)

 

 

 

 

 

 

 

 

 

 

 

SHAREOWNERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

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

 

¾

 

¾

 

Common shares, $1 par per share, 2,000 shares authorized; 1,918 shares issued in 2015 and 2014

 

1,918

 

1,918

 

Additional paid-in capital

 

2,901

 

2,748

 

Accumulated other comprehensive loss

 

(759

)

(812

)

Accumulated earnings

 

13,228

 

12,367

 

Common shares in treasury, at cost, 953 shares in 2015 and 944 shares in 2014

 

(11,384

)

(10,809

)

 

 

 

 

 

 

Total Shareowners’ Equity - The Kroger Co.

 

5,904

 

5,412

 

Noncontrolling interests

 

(22

)

30

 

 

 

 

 

 

 

Total Equity

 

5,882

 

5,442

 

 

 

 

 

 

 

Total Liabilities and Equity

 

$

30,781

 

$

30,497

 

 

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

 

4



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in millions and unaudited)

 

 

 

Two Quarters Ended

 

 

 

August 15,
2015

 

August 16,
2014

 

Cash Flows from Operating Activities:

 

 

 

 

 

Net earnings including noncontrolling interests

 

$

1,057

 

$

859

 

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

 

 

 

 

 

Depreciation and amortization

 

1,097

 

1,025

 

LIFO charge

 

48

 

54

 

Stock-based employee compensation

 

95

 

76

 

Expense for Company-sponsored pension plans

 

56

 

21

 

Deferred income taxes

 

(82

)

(103

)

Other

 

54

 

53

 

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

 

 

 

 

 

Store deposits in-transit

 

54

 

2

 

Receivables

 

(26

)

(47

)

Inventories

 

92

 

102

 

Prepaid and other current assets

 

235

 

274

 

Trade accounts payable

 

210

 

194

 

Accrued expenses

 

(21

)

62

 

Income taxes receivable and payable

 

(32

)

(47

)

Other

 

(82

)

67

 

 

 

 

 

 

 

Net cash provided by operating activities

 

2,755

 

2,592

 

 

 

 

 

 

 

Cash Flows from Investing Activities:

 

 

 

 

 

Payments for property and equipment, including payments for lease buyouts

 

(1,696

)

(1,347

)

Proceeds from sale of assets

 

24

 

18

 

Other

 

(38

)

16

 

 

 

 

 

 

 

Net cash used by investing activities

 

(1,710

)

(1,313

)

 

 

 

 

 

 

Cash Flows from Financing Activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

24

 

48

 

Payments on long-term debt

 

(34

)

(26

)

Net payments on commercial paper

 

(347

)

(160

)

Dividends paid

 

(181

)

(166

)

Excess tax benefits on stock-based awards

 

73

 

32

 

Proceeds from issuance of capital stock

 

74

 

66

 

Treasury stock purchases

 

(628

)

(1,221

)

Investment in the remaining equity of a noncontrolling interest

 

(26

)

 

Other

 

 

(5

)

 

 

 

 

 

 

Net cash used by financing activities

 

(1,045

)

(1,432

)

 

 

 

 

 

 

Net decrease in cash and temporary cash investments

 

 

(153

)

 

 

 

 

 

 

Cash and temporary cash investments:

 

 

 

 

 

Beginning of year

 

268

 

401

 

End of quarter

 

$

268

 

$

248

 

 

 

 

 

 

 

Reconciliation of capital investments:

 

 

 

 

 

Payments for property and equipment, including payments for lease buyouts

 

$

(1,696

)

$

(1,347

)

Payments for lease buyouts

 

16

 

28

 

Changes in construction-in-progress payables

 

(47

)

(63

)

Total capital investments, excluding lease buyouts

 

$

(1,727

)

$

(1,382

)

 

 

 

 

 

 

Disclosure of cash flow information:

 

 

 

 

 

Cash paid during the year for interest

 

$

279

 

$

282

 

Cash paid during the year for income taxes

 

$

651

 

$

582

 

 

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

 

5



 

THE KROGER CO.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS’ EQUITY

(in millions, except per share amounts)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

Common Stock

 

Paid-In

 

Treasury Stock

 

Comprehensive

 

Accumulated

 

Noncontrolling

 

 

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Gain (Loss)

 

Earnings

 

Interest

 

Total

 

Balances at February 1, 2014

 

1,918

 

$

1,918

 

$

2,590

 

902

 

$

(9,641

)

$

(464

)

$

10,981

 

$

11

 

$

5,395

 

Issuance of common stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock options exercised

 

 

 

 

(6

)

66

 

 

 

 

66

 

Restricted stock issued

 

 

 

(83

)

(4

)

37

 

 

 

 

(46

)

Treasury stock activity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Treasury stock purchases, at cost

 

 

 

 

50

 

(1,129

)

 

 

 

(1,129

)

Stock options exchanged

 

 

 

 

4

 

(92

)

 

 

 

(92

)

Share-based employee compensation

 

 

 

76

 

 

 

 

 

 

76

 

Other comprehensive gain net of income tax of $8

 

 

 

 

 

 

15

 

 

 

15

 

Other

 

 

 

63

 

 

(26

)

 

 

3

 

40

 

Cash dividends declared ($0.165 per common share)

 

 

 

 

 

 

 

(162

)

 

(162

)

Net earnings including noncontrolling interests

 

 

 

 

 

 

 

848

 

11

 

859

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at August 16, 2014

 

1,918

 

$

1,918

 

$

2,646

 

946

 

$

(10,785

)

$

(449

)

$

11,667

 

$

25

 

$

5,022

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

(6

)

74

 

 

 

 

74

 

Restricted stock issued

 

 

 

(110

)

(3

)

33

 

 

 

 

(77

)

Treasury stock activity:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Treasury stock purchases, at cost

 

 

 

 

14

 

(500

)

 

 

 

(500

)

Stock options exchanged

 

 

 

 

4

 

(128

)

 

 

 

(128

)

Share-based employee compensation

 

 

 

95

 

 

 

 

 

 

95

 

Other comprehensive gain net of income tax of $31

 

 

 

 

 

 

53

 

 

 

53

 

Investment in the remaining equity of a noncontrolling interest

 

 

 

40

 

 

 

 

 

(57

)

(17

)

Other

 

 

 

128

 

 

(54

)

 

 

 

74

 

Cash dividends declared ($0.198 per common share)

 

 

 

 

 

 

 

(191

)

 

(191

)

Net earnings including noncontrolling interests

 

 

 

 

 

 

 

1,052

 

5

 

1,057

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at August 15, 2015

 

1,918

 

$

1,918

 

$

2,901

 

953

 

$

(11,384

)

$

(759

)

$

13,228

 

$

(22

)

$

5,882

 

 

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

 

6



 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

All amounts in the Notes to 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 31, 2015 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 31, 2015.

 

The unaudited information in the Consolidated Financial Statements for the second quarter and two quarters ended August 15, 2015 and August 16, 2014, includes the results of operations of the Company for the 12 and 28-week periods then ended.

 

The net increase (decrease) in book overdrafts previously reported in financing activities in the Consolidated Statements of Cash Flows is now reported within operating activities.  Prior year amounts have been revised to the current year presentation.  These revisions were not material to the prior years.

 

Refer to Note 7 for an additional change to the Consolidated Balance Sheets for a recently adopted accounting standard regarding the presentation of debt issuance costs.

 

On June 25, 2015, the Company’s Board of Directors approved a two-for-one stock split of The Kroger Co.’s common shares in the form of a 100% stock dividend, which was effective July 13, 2015.  All share and per share amounts in our Consolidated Financial Statements and related notes have been retroactively adjusted to reflect the stock split for all periods presented.

 

2.              MERGER

 

On August 18, 2014, the Company closed its merger with Vitacost.com, Inc. (“Vitacost.com”).  The Company’s purchase price allocation was finalized in the second quarter of 2015 and the changes in the fair values assumed from the preliminary amounts were not material.

 

Pro forma results of operations, assuming the transaction had taken place at the beginning of 2013, are included in the following table.  The pro forma information includes historical results of operations of Vitacost.com and adjustments for interest expense that would have been incurred due to financing the merger, depreciation and amortization of the assets acquired and excludes the pre-merger transaction related expenses incurred by Vitacost.com and the Company.  The pro forma information does not include efficiencies, cost reductions or synergies expected to result from the merger.  The unaudited pro forma financial information is not necessarily indicative of the results that actually would have occurred had the merger been completed at the beginning of the 2013.

 

 

 

Second Quarter Ended
August 16, 2014

 

Two Quarters Ended
August 16, 2014

 

Sales

 

$

25,402

 

$

58,494

 

Net earnings including noncontrolling interests

 

346

 

848

 

Net earnings attributable to noncontrolling interests

 

3

 

11

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co.

 

$

343

 

$

837

 

 

7



 

3.  STOCK OPTION PLANS

 

The Company recognized total share-based compensation of $44 and $36 in the second quarters ended August 15, 2015 and August 16, 2014, respectively.  The Company recognized total share-based compensation of $95 and $76 in the first two quarters of 2015 and 2014, respectively.  These costs were recognized as operating, general and administrative costs in the Company’s Consolidated Statements of Operations.

 

The Company grants options for common shares (“stock options”) to employees under various plans at an option price equal to the fair market value of a common share on the date of grant.  In addition to stock options, the Company awards restricted stock to employees and its non-employee directors under various plans.  Equity awards may be made once each quarter on a predetermined date.  It has been the Company’s practice to make an annual grant to employees, which occurred in the second quarter of 2015.  Special grants may be made in the other three quarters.  Grants to non-employee directors occur on the same date that the annual grant to employees occurs.

 

Stock options granted in the first two quarters of 2015 expire 10 years from the date of grant and vest between one year and five years from the date of grant. Restricted stock awards granted in the first two quarters of 2015 have restrictions that lapse between one year and five years from the date of the awards.  All grants and awards become immediately exercisable, in the case of options, and restrictions lapse, in the case of restricted stock, upon certain changes in control of the Company.

 

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

 

Stock Options

 

 

 

Shares subject
to option

 

Weighted-average
exercise price

 

Outstanding, January 31, 2015 

 

40.8

 

$

15.56

 

Granted 

 

3.3

 

$

38.33

 

Exercised 

 

(5.7

)

$

12.99

 

Canceled or Expired 

 

(0.2

)

$

17.05

 

 

 

 

 

 

 

Outstanding, August 15, 2015 

 

38.2

 

$

17.90

 

 

Restricted Stock

 

 

 

Restricted shares
outstanding

 

Weighted-average
grant-date fair value

 

Outstanding, January 31, 2015 

 

10.2

 

$

21.04

 

Granted 

 

3.1

 

$

  38.32

 

Vested 

 

(4.9

)

$

  21.43

 

Forfeited

 

(0.2

)

$

21.68

 

 

 

 

 

 

 

Outstanding, August 15, 2015

 

8.2

 

$

  27.38

 

 

The weighted-average grant date fair value of stock options granted during the first two quarters of 2015 and 2014, was $9.76 and $5.98, respectively.  The fair value of each stock option grant was estimated on the date of grant using the Black-Scholes option-pricing model, based on the assumptions shown in the table below.  The Black-Scholes model utilizes accounting judgment and financial estimates, including the term option holders are expected to retain their stock options before exercising them, the volatility of the Company’s share price over that expected term, the dividend yield over the term, and the number of awards expected to be forfeited before they vest.  Using alternative assumptions in the calculation of fair value would produce fair values for stock option grants that could be different than those used to record stock-based compensation expense in the Consolidated Statements of Operations.  The increase in the fair value of the stock options granted during the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily from an increase in the Company’s share price, which decreased the expected dividend yield.

 

8



 

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

 

 

 

2015

 

2014

 

Risk-free interest rate 

 

2.12%

 

2.06%

 

Expected dividend yield 

 

1.20%

 

1.51%

 

Expected volatility 

 

24.07%

 

25.29%

 

Expected term 

 

7.2 Years

 

6.6 Years

 

 

4.              DEBT OBLIGATIONS

 

Long-term debt consists of:

 

 

 

August 15,

 

January 31,

 

 

 

2015

 

2015

 

0.76% to 8.00% Senior Notes due through 2043 

 

$

  9,231

 

$

  9,224

 

5.00% to 12.75% Mortgages due in varying amounts through 2027

 

69

 

73

 

0.37% to 0.38% Commercial paper borrowings due through October 2015

 

928

 

1,275

 

Other 

 

467

 

454

 

 

 

 

 

 

 

Total debt, excluding capital leases and financing obligations 

 

10,695

 

11,026

 

 

 

 

 

 

 

Less current portion 

 

(1,484

)

(1,844

)

 

 

 

 

 

 

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

 

$

  9,211

 

$

  9,182

 

 

5.              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 2015 and 2014.

 

 

 

Second Quarter Ended

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

August 15,
2015

 

August 16,
2014

 

August 15,
2015

 

August 16,
2014

 

Components of net periodic benefit cost: 

 

 

 

 

 

 

 

 

 

Service cost

 

$

16

 

$

10

 

$

3

 

$

2

 

Interest cost

 

39

 

42

 

2

 

3

 

Expected return on plan assets

 

(53

)

(56

)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

 

(3

)

(2

)

Actuarial loss (gain)

 

24

 

12

 

(1

)

(1

)

 

 

 

 

 

 

 

 

 

 

Net periodic benefit cost 

 

$

26

 

$

8

 

$

1

 

$

2

 

 

9



 

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 2015 and 2014.

 

 

 

Two Quarters Ended

 

 

 

Pension Benefits

 

Other Benefits

 

 

 

August 15,
2015

 

August 16,
2014

 

August 15,
2015

 

August 16,
2014

 

Components of net periodic benefit cost: 

 

 

 

 

 

 

 

 

 

Service cost

 

$

  35

 

$

  24

 

$

  6

 

$

  6

 

Interest cost

 

90

 

98

 

6

 

7

 

Expected return on plan assets

 

(124

)

(130

)

 

 

Amortization of:

 

 

 

 

 

 

 

 

 

Prior service cost

 

 

 

(6

)

(4

)

Actuarial loss (gain)

 

55

 

28

 

(3

)

(3

)

 

 

 

 

 

 

 

 

 

 

Net periodic benefit cost 

 

$

56

 

$

  20

 

$

  3

 

$

  6

 

 

The Company contributed $5 to its Company-sponsored defined benefit pension plans in the first two quarters of 2015.  The Company is not required and does not expect to make any additional contributions in 2015.

 

The Company contributed $107 and $98 to employee 401(k) retirement savings accounts in the first two quarters of 2015 and 2014, respectively.

 

During the first quarter of 2014, the Company incurred a charge of $56 (after-tax) due to commitments and withdrawal liabilities arising from the restructuring of certain multi-employer pension plan obligations.

 

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.

 

10



 

6.              EARNINGS PER COMMON SHARE

 

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

 

 

 

Second Quarter Ended

 

Second Quarter Ended

 

 

 

August 15, 2015

 

August 16, 2014

 

 

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

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

 

$

429

 

963

 

$

0.44

 

$

  343

 

970

 

$

0.35

 

Dilutive effect of stock options

 

 

 

14

 

 

 

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

429

 

977

 

$

0.44

 

$

  343

 

982

 

$

0.35

 

 

 

 

Two Quarters Ended

 

Two Quarters Ended

 

 

 

August 15, 2015

 

August 16, 2014

 

 

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

Earnings
(Numerator)

 

Shares
(Denominator)

 

Per Share
Amount

 

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

 

$

1,042

 

966

 

$

1.08

 

$

  840

 

988

 

$

0.85

 

Dilutive effect of stock options

 

 

 

15

 

 

 

 

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

$

1,042

 

981

 

$

1.06

 

$

  840

 

1,000

 

$

0.84

 

 

The Company had combined undistributed and distributed earnings to participating securities totaling $4 in the second quarters of 2015 and 2014.  For the first two quarters of 2015 and 2014, the Company had combined undistributed and distributed earnings to participating securities of $10 and $8, respectively.

 

The Company had options outstanding for approximately 2 million and 3 million shares during the second quarters of 2015 and 2014, 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 1 million shares in the first two quarters of 2015 and 3 million shares in the first two quarters of 2014 that were excluded from the computations of net earnings per diluted common share because their inclusion would have had an anti-dilutive effect on earnings per share.

 

7.              RECENTLY ADOPTED ACCOUNTING STANDARDS

 

In 2015, the Financial Accounting Standards Board (“FASB”) amended Accounting Standards Codification 835, “Interest-Imputation of Interest.” The amendment simplifies the presentation of debt issuance costs related to a recognized debt liability by requiring it be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  This amendment became effective for the Company beginning February 1, 2015, and was adopted retrospectively in accordance with the standard. The adoption of this amendment resulted in amounts previously reported in other assets to now be reported within long-term debt including obligations under capital leases and financing obligations in the Consolidated Balance Sheets.  These amounts were not material to the prior year.  The adoption of this amendment did not have an effect on the Company’s Consolidated Statements of Operations.

 

11



 

8.              RECENTLY ISSUED ACCOUNTING STANDARDS

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Per ASU 2015-14, “Deferral of Effective Date,” this guidance will be effective for the Company in the first quarter of its fiscal year ending February 2, 2019.  Early adoption is permitted as of the first quarter of the Company’s fiscal year ending February 3, 2018.  The Company is currently in the process of evaluating the effect of adoption of this ASU on the Company’s Consolidated Financial Statements.

 

In April 2015, the FASB issued ASU 2015-04, “Retirement Benefits (Topic 715): Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation and Plan Assets.” This amendment permits an entity to measure defined benefit plan assets and obligations using the month end that is closest to the entity’s fiscal year end for all plans. This guidance will be effective for the Company in its fiscal year ending January 28, 2017.  The implementation of this amendment will not have an effect on the Company’s Consolidated Statements of Operations and will not have a significant effect on the Company’s Consolidated Balance Sheets.

 

In April 2015, the FASB issued ASU 2015-07, “Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” This amendment removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share. This guidance will be effective for the Company in its fiscal year ending January 28, 2017.  The implementation of this amendment will have an effect on the Company’s Notes to the Consolidated Financial Statements and will not have an effect on the Company’s Consolidated Statements of Operations or Consolidated Balance Sheets.

 

9.              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.

 

12



 

10.       FAIR VALUE MEASUREMENTS

 

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

 

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

 

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

 

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

 

For items carried at (or adjusted to) fair value in the Consolidated Financial Statements, the following tables summarize the fair value of these instruments at August 15, 2015 and January 31, 2015:

 

August 15, 2015 Fair Value Measurements Using

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Total

 

Trading Securities

 

$

49

 

$

 

$

 

$

49

 

Available-for-Sale Securities

 

47

 

 

 

47

 

Warrants

 

 

37

 

 

37

 

Long-Lived Assets

 

 

 

4

 

4

 

Interest Rate Hedges

 

 

(1

)

 

(1

)

Total

 

$

96

 

$

36

 

$

4

 

$

136

 

 

January 31, 2015 Fair Value Measurements Using

 

 

 

Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Total

 

Trading Securities

 

$

47

 

$

 

$

 

$

47

 

Available-for-Sale Securities

 

36

 

 

 

36

 

Warrants

 

 

26

 

 

26

 

Long-Lived Assets

 

 

 

22

 

22

 

Interest Rate Hedges

 

 

(39

)

 

(39

)

Total

 

$

83

 

$

(13

)

$

22

 

$

92

 

 

In the first two quarters of 2015, unrealized gains on the Level 1 available-for-sale securities totaled $11.

 

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

 

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

 

13



 

Fair value measurements of non-financial assets and non-financial liabilities are primarily used in the impairment analysis of goodwill, other intangible assets, and long-lived assets, and in the valuation of store lease exit costs.  The Company reviews goodwill and other intangible assets for impairment annually, during the fourth quarter of each fiscal year, and as circumstances indicate the possibility of impairment.  See Note 3 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended January 31, 2015 for further discussion related to the Company’s carrying value of goodwill.  Long-lived assets and store lease exit costs were measured at fair value on a nonrecurring basis using Level 3 inputs as defined in the fair value hierarchy.  See Note 1 to the Consolidated Financial Statements in the Annual Report on Form 10-K for the fiscal year ended January 31, 2015 for further discussion of the Company’s policies regarding the valuation of long-lived assets and store lease exit costs.  For the first two quarters of 2015, long-lived assets with a carrying amount of $30 were written down to their fair value of $4 resulting in an impairment charge of $26.  For the first two quarters of 2014, long-lived assets with a carrying amount of $27 were written down to their fair value of $10 resulting in an impairment charge of $17.  In fiscal year 2014, long-lived assets with a carrying amount of $59 were written down to their fair value of $22, resulting in an impairment charge of $37.

 

Fair Value of Other Financial Instruments

 

Current and Long-term Debt

 

The fair value of the Company’s long-term debt, including current maturities, was estimated based on the quoted market prices for the same or similar issues adjusted for illiquidity based on available market evidence.  If quoted market prices were not available, the fair value was based upon the net present value of the future cash flow using the forward interest rate yield curve in effect at August 15, 2015 and January 31, 2015.  At August 15, 2015, the fair value of total debt was $11,509 compared to a carrying value of $10,695.  At January 31, 2015, the fair value of total debt was $12,319 compared to a carrying value of $11,026.  The reduction in the fair value of total debt from January 31, 2015, compared to August 15, 2015, is primarily due to a decrease in the forward interest rate yield curve and a reduction in the amount of outstanding commercial paper.

 

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

 

The carrying amounts of these items approximated fair value.

 

Other Assets

 

The fair values of these investments were estimated based on quoted market prices for those or similar investments, or estimated cash flows, if appropriate.  At August 15, 2015 and January 31, 2015, the carrying and fair value of long-term investments for which fair value is determinable was $137 and $133, respectively.  At August 15, 2015 and January 31, 2015, the carrying value of notes receivable for which fair value is determinable was $112 and $98, respectively.

 

14



 

11.       ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The following table represents the changes in AOCI by component for the first two quarters of 2014 and 2015:

 

 

 

Cash Flow
Hedging
Activities(1)

 

Available for sale
Securities(1)

 

Pension and
Postretirement
Defined Benefit
Plans(1)

 

Total(1)

 

Balance at February 1, 2014

 

$

(25

)

$

12

 

$

(451

)

$

(464

)

OCI before reclassifications

 

 

2

 

 

2

 

Amounts reclassified out of AOCI(3)

 

 

 

13

 

13

 

Net current-period OCI

 

 

2

 

13

 

15

 

Balance at August 16, 2014

 

$

(25

)

$

14

 

$

(438

)

$

(449

)

 

 

 

 

 

 

 

 

 

 

Balance at January 31, 2015

 

$

(49

)

$

17

 

$

(780

)

$

(812

)

OCI before reclassifications(2)

 

17

 

7

 

 

24

 

Amounts reclassified out of AOCI(3)

 

 

 

29

 

29

 

Net current-period OCI

 

17

 

7

 

29

 

53

 

Balance at August 15, 2015

 

$

(32

)

$

24

 

$

(751

)

$

(759

)

 


(1)         All amounts are net of tax.

(2)         Net of tax of $10 and $4 for cash flow hedging activities and available for sale securities, respectively, for the first two quarters of 2015.

(3)         Net of tax of $8 for pension and postretirement defined benefit plans for the first two quarters of 2014 and $17 for pension and postretirement defined benefit plans for the first two quarters of 2015.

 

The following table represents the items reclassified out of AOCI and the related tax effects for the second quarter and first two quarters of 2015 and 2014:

 

 

 

Second Quarter Ended

 

Two Quarters Ended

 

 

 

August 15,
2015

 

August 16,
2014

 

August 15,
2015

 

August 16,
2014

 

Pension and postretirement defined benefit plan items

 

 

 

 

 

 

 

 

 

Amortization of amounts included in net periodic pension expense(1)

 

21

 

9

 

46

 

21

 

Tax expense

 

(8

)

(4

)

(17

)

(8

)

Net of tax

 

13

 

5

 

29

 

13

 

Total reclassifications, net of tax

 

$

13

 

$

5

 

$

29

 

$

13

 

 


(1)         Reclassified from AOCI into merchandise costs and operating, general and administrative expense.  These components are included in the computation of net periodic pension expense (see Note 5 to the Company’s Consolidated Financial Statements for additional details).

 

12.       INCOME TAXES

 

The effective income tax rate was 34.4% in the second quarter of 2015, compared to 34.2% for the second quarter of 2014. The effective income tax rate was 34.5% for the first two quarters of 2015, compared to 34.7% for the first two quarters of 2014. The effective income tax rate for the second quarter of 2015 and the first two quarters of 2015 differed from the federal statutory rate primarily due to the benefit from the favorable conclusion of certain tax audits and utilization of tax credits and deductions, partially offset by the effect of state income taxes. The effective income tax rate for the second quarter of 2014 and the first two quarters of 2014 differed from the federal statutory rate primarily due to the utilization of tax credits and deductions, partially offset by the effect of state income taxes.

 

15



 

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

 

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

 

OVERVIEW

 

Second quarter 2015 total sales were $25.5 billion compared with $25.3 billion for the same period of 2014.  This increase was attributable to identical supermarket sales increases and increased fuel gallon sales, partially offset by a decrease in the average retail fuel price.  Identical supermarket sales, excluding fuel, increased 5.3% in the second quarter of 2015, compared to the second quarter of 2014, primarily due to an increase in the number of households shopping with us, an increase in visits per household, changes in product mix and product cost inflation.  All geographies and all supermarket store departments had positive identical sales.  This continues our trend of positive identical supermarket sales growth for 47 consecutive quarters.  Total sales for the first two quarters of 2015 were $58.6 billion compared to $58.3 billion for the same period of 2014.  This increase was attributable to identical supermarket sales increases and increased fuel gallon sales, offset partially by a decrease in the average retail fuel price.  Identical supermarket sales, excluding fuel, increased 5.5% in the first two quarters of 2015, compared to the same period in 2014, primarily due to an increase in the number of households shopping with us, an increase in visits per household, changes in product mix and product cost inflation.  Our Customer 1st strategy continues to deliver solid results.

 

On June 25, 2015, the Board of Directors approved a two-for-one stock split of The Kroger Co.’s common shares in the form of a 100% stock dividend, which was effective July 13, 2015.  All share and per share amounts in our Management’s Discussion and Analysis of Financial Condition and Results of Operation have been retroactively adjusted to reflect the stock split for all periods presented.

 

For the second quarter of 2015, net earnings totaled $433 million, or $0.44 per diluted share, compared to $347 million, or $0.35 per diluted share for the same period of 2014.  The increase in net earnings for the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from an increase in non-fuel First-In, First Out (“FIFO”) operating profit and an increase in earnings from our fuel operations, offset partially by increased tax expense.  For the first two quarters of 2015, net earnings totaled $1.1 billion, or $1.06 per diluted share, compared to $848 million, or $0.84 per diluted share for the same period of 2014.  Net earnings for the first two quarters of 2014 included a $0.06 per diluted share charge due to the commitments and withdrawal liabilities arising from the restructuring of certain multiemployer pension plan obligations to help stabilize associates’ future benefits (“pension plan agreements”).  Excluding the pension plan agreements, net earnings totaled $904 million, or $0.90 per diluted share, for the first two quarters of 2014.  The pension plan agreements resulted in an increase in operating, general and administrative (“OG&A”) expense of $87 million ($56 million after-tax) in the first two quarters of 2014.  We believe adjusted net earnings and adjusted net earnings per diluted share present a more accurate year-over-year comparison of our financial results because the pension plan agreements were not the result of our normal operations.  The increase in net earnings for the first two quarters of 2015, compared to adjusted net earnings for the first two quarters of 2014, resulted primarily from an increase in non-fuel FIFO operating profit and an increase in earnings from our fuel operations, offset partially by increased tax expense.

 

Based on the strength of our results for the first two quarters of 2015, we have increased both the lower and upper ranges of our guidance for net earnings per diluted share and identical supermarket sales, without fuel, for fiscal year 2015.  Please refer to the “Outlook” section for more information on our expectations.

 

RESULTS OF OPERATIONS

 

Net Earnings

 

Net earnings totaled $433 million for the second quarter of 2015, an increase of 24.8% from net earnings of $347 million for the second quarter of 2014.  The increase in net earnings for the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from an increase in non-fuel FIFO operating profit and an increase in earnings from our fuel operations, offset partially by increased tax expense.  The increase in non-fuel FIFO operating profit for the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from the benefit of increased supermarket sales, productivity improvements, effective cost controls and decreased workers’ compensation and general liability expenses, partially offset by continued investments in lower prices for our customers and increases in company sponsored pension, credit card, incentive plan and shrink costs.  Included in continued investments in lower prices for our customers is the cost of our pharmacy programs, which experienced high levels of inflation that were not fully passed on to the customer in the second quarter of 2015.  The increase in net earnings from our fuel operations for the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from an increase in the average margin per gallon of fuel sold and an increase in fuel gallons sold.

 

16



 

Net earnings totaled $1.1 billion for the first two quarters of 2015, an increase of 24.1% from net earnings of $848 million for the first two quarters of 2014.  Net earnings for the first two quarters of 2015 increased 16.4% from adjusted net earnings of $904 million for the first two quarters of 2014, excluding the pension plan agreements.  The increase in net earnings for the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily from an increase in non-fuel FIFO operating profit and an increase in earnings from our fuel operations, offset partially by increased tax expense.  The increase in non-fuel FIFO operating profit for the first two quarters of 2015, compared to the same period in 2014, resulted primarily from the benefit of increased supermarket sales, the 2014 charge due to the pension plan agreements, productivity improvements, effective cost controls and decreased workers’ compensation and general liability expenses, partially offset by continued investments in lower prices for our customers and increases in company sponsored pension, credit card, incentive plan and shrink costs.  The increase in net earnings from our fuel operations for the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily from an increase fuel gallons sold, partially offset by a decrease in the average margin per gallon of fuel sold.

 

Net earnings of $0.44 per diluted share for the second quarter of 2015 represented an increase of 25.7% over net earnings of $0.35 per diluted share for the second quarter of 2014.  Net earnings per diluted share increased in the second quarter of 2015, compared to the second quarter of 2014, due to increased net earnings.

 

Net earnings of $1.06 per diluted share for the first two quarters of 2015 represented an increase of 26.2% over net earnings of $0.84 per diluted share for the first two quarters of 2014.  Net earnings per diluted share for the first two quarters of 2015 increased 17.8% from adjusted net earnings per diluted share of $0.90 for the first two quarters of 2014, excluding the pension plan agreements.  Net earnings per diluted share increased in the first two quarters of 2015, compared to the first two quarters of 2014, due to increased net earnings and the repurchase of common shares resulting in a lower weighted average shares outstanding.

 

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

 

17



 

The following table provides a reconciliation of net earnings attributable to The Kroger Co. to net earnings attributable to The Kroger Co. excluding the pension plan agreements and a reconciliation of net earnings attributable to The Kroger Co. per diluted common share to net earnings attributable to The Kroger Co. per diluted common share excluding the pension plan agreements, for the second quarters and the first two quarters of 2015 and 2014 ($ in millions):

 

 

 

Second Quarter Ended

 

Two Quarters Ended

 

 

 

August 15, 2015

 

August 16, 2014

 

August 15, 2015

 

August 16, 2014

 

Net earnings attributable to The Kroger Co.

 

$

  433

 

$

  347

 

$

  1,052

 

$

  848

 

Adjustment for pension plan agreements(1)(2)

 

 

 

 

56

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. excluding the adjustment item above

 

$

  433

 

$

  347

 

$

  1,052

 

$

  904

 

 

 

 

 

 

 

 

 

 

 

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

 

$

0.44

 

$

0.35

 

$

1.06

 

$

0.84

 

Adjustment for pension plan agreements(3)

 

 

 

 

0.06

 

 

 

 

 

 

 

 

 

 

 

Net earnings attributable to The Kroger Co. per diluted common share excluding the adjustment item above

 

$

0.44

 

$

0.35

 

$

1.06

 

$

0.90

 

 

 

 

 

 

 

 

 

 

 

Average number of common shares used in diluted calculation

 

977

 

982

 

981

 

1,000

 

 


(1)         The amount presented represents the after-tax effect of the adjustment.

(2)         The pre-tax adjustment for the pension plan agreements was $87.

(3)         The amount presented represents the net earnings per diluted common share effect of the adjustment.

 

Sales

 

Total Sales

($ in millions)

 

 

 

Second Quarter Ended

 

Two Quarters Ended

 

 

 

August 15,
2015

 

Percentage
Increase

 

August 16,
2014

 

Percentage
Increase(2)

 

August 15,
2015

 

Percentage
Increase

 

August 16,
2014

 

Percentage
Increase(3)

 

Total supermarket sales without fuel 

 

$

  20,657

 

5.2

%

$

  19,629

 

12.4

%

$

  48,013

 

5.6

%

$

  45,487

 

11.8

%

Fuel sales

 

4,009

 

(18.8

)%

4,936

 

8.1

%

8,582

 

(22.8

)%

11,119

 

5.6

%

Other sales(1) 

 

873

 

17.2

%

745

 

14.1

%

1,995

 

19.8

%

1,665

 

14.3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total sales 

 

$

  25,539

 

0.9

%

$

  25,310

 

11.6

%

$

  58,590

 

0.5

%

$

  58,271

 

10.6

%

 


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

(2)                   This column represents the percentage increase in the second quarter of 2014, compared to the second quarter of 2013.

(3)                   This column represents the percentage increase in the first two quarters of 2014, compared to the first two quarters of 2013.

 

Total sales increased in the second quarter of 2015, compared to the second quarter of 2014, by 0.9%.  The increase in total sales for the second quarter of 2015, compared to the second quarter of 2014, was primarily due to our increase in total supermarket sales without fuel, partially offset by a decrease in fuel sales due to a decrease in the average retail fuel price of 24.5%.  The increase in total supermarket sales without fuel for the second quarter of 2015, compared to the second quarter of 2014, was primarily due to our identical supermarket sales increase, excluding fuel, of 5.3%.  Identical supermarket sales, excluding fuel, for the second quarter of 2015, compared to the second quarter of 2014, increased primarily due to an increase in the number of households shopping with us, an increase in visits per household, changes in product mix and product cost inflation.  Total fuel sales decreased 18.8% in the second quarter of 2015, compared to the second quarter of 2014, primarily due to a decrease in the average retail fuel price of 24.5%, partially offset by an increase in fuel gallons sold of 7.6%.  The decrease in the average retail fuel price was caused by a decrease in the product cost of fuel.

 

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Total sales increased in the first two quarters of 2015, compared to the first two quarters of 2014, by 0.5%.  The increase in total sales for the first two quarters of 2015, compared to the first two quarters of 2014, was primarily due to our increase in total supermarket sales without fuel, partially offset by a decrease in fuel sales due to a decrease in the average retail fuel price of 28.4%.  The increase in total supermarket sales without fuel for the first two quarters of 2015, compared to the first two quarters of 2014, was primarily due to our identical supermarket sales increase, excluding fuel, of 5.5%.  Identical supermarket sales, excluding fuel, for the first two quarters of 2015, compared to the first two quarters of 2014, increased primarily due to an increase in the number of households shopping with us, an increase in visits per household, changes in product mix and product cost inflation.  Total fuel sales decreased 22.8% in the first two quarters of 2015, compared to the first two quarters of 2014, primarily due to a decrease in the average retail fuel price of 28.4%, partially offset by an increase in fuel gallons sold of 7.7%.  The decrease in the average retail fuel price was caused by a decrease in the product cost of fuel.

 

We define a supermarket as identical when it has been in operation without expansion or relocation for five full quarters.  Although identical supermarket sales is a relatively standard term, numerous methods exist for calculating identical supermarket sales growth.  As a result, the method used by our management to calculate identical supermarket sales may differ from methods other companies use to calculate identical supermarket sales.  We urge you to understand the methods used by other companies to calculate identical supermarket sales before comparing our identical supermarket sales to those of other such companies.  Fuel discounts received at our fuel centers and earned based on in-store purchases are included in all of the identical supermarket sales results calculations illustrated below and reduce our identical supermarket sales results.  Differences between total supermarket sales and identical supermarket sales primarily relate to changes in supermarket square footage.  Identical supermarket sales include sales from all departments at identical Fred Meyer multi-department stores.  Our identical supermarket sales results are summarized in the table below.  We used the identical supermarket dollar figures presented below to calculate percentage changes for the second quarter and the first two quarters of 2015.

 

Identical Supermarket Sales

($ in millions)

 

 

 

Second Quarter

 

 

 

August 15,
2015

 

Percentage
Increase

 

August 16,
2014

 

Percentage
Increase(1)

 

Including fuel centers

 

$

22,951

 

1.3

%

$

22,659

 

5.3

%

Excluding fuel centers

 

$

19,865

 

5.3

%

$

18,870

 

4.8

%

 


(1)         This column represents the percentage increase in identical supermarket sales in the second quarter of 2014, compared to the second quarter of 2013.

 

Identical Supermarket Sales

($ in millions)

 

 

 

Two Quarters Ended

 

 

 

August 15,
2015

 

Percentage
Increase

 

August 16,
2014

 

Percentage
Increase(1)

 

Including fuel centers

 

$

52,652

 

0.9

%

$

52,180

 

4.7

%

Excluding fuel centers

 

$

46,065

 

5.5

%

$

43,656

 

4.7

%

 


(1)         This column represents the percentage increase in identical supermarket sales in the first two quarters of 2014, compared to the first two quarters of 2013.

 

Gross Margin and FIFO Gross Margin

 

Our gross margin rate, as a percentage of sales, was 21.44% for the second quarter of 2015, as compared to 20.44% for the second quarter of 2014.  The increase in the gross margin rate, as a percentage of sales, in the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from a decrease in retail fuel sales and reductions in transportation and advertising costs, as a percentage of sales, partially offset by continued investments in lower prices for our customers and increased shrink costs, as a percentage of sales.

 

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Our gross margin rate, as a percentage of sales, was 21.79% for the first two quarters of 2015, as compared to 20.71% for the first two quarters of 2014.  The increase in the gross margin rate, as a percentage of sales, in the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily from a decrease in retail fuel sales and reductions in transportation and advertising costs, as a percentage of sales, partially offset by continued investments in lower prices for our customers and increased shrink costs, as a percentage of sales.

 

We calculate FIFO gross margin 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.  Our LIFO charge was $21 million for the second quarter of 2015 and $26 million for the second quarter of 2014.  Our LIFO charge was $48 million for the first two quarters of 2015 and $54 million for the first two quarters of 2014.  FIFO gross margin is a non-GAAP financial measure and should not be considered as an alternative to gross margin or any other GAAP measure of performance.  FIFO gross margin should not be reviewed in isolation or considered as a substitute for our financial results as reported in accordance with GAAP.  FIFO gross margin is an important measure used by management to evaluate merchandising and operational effectiveness.  Management believes FIFO gross margin is a useful metric to investors and analysts because it measures our day-to-day merchandising and operational effectiveness.

 

Our FIFO gross margin rate was 21.52% for the second quarter of 2015, as compared to 20.54% for the second quarter of 2014.  Our fuel operations lower our FIFO gross margin rate, as a percentage of sales, due to the very low FIFO gross margin rate on retail fuel sales as compared to non-fuel sales.  Excluding the effect of retail fuel operations, our FIFO gross margin rate decreased seven basis points in the second quarter of 2015, compared to the second quarter of 2014.  The decrease in FIFO gross margin rate, excluding fuel, in the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from continued investments in lower prices for our customers and increased shrink costs, as a percentage of sales, partially offset by reductions in transportation and advertising costs, as a percentage of sales.

 

Our FIFO gross margin rate was 21.87% for the first two quarters of 2015, as compared to 20.81% for the first two quarters of 2014.  Excluding the effect of retail fuel operations, our FIFO gross margin rate decreased seven basis points for the first two quarters of 2015, compared to the first two quarters of 2014.  This decrease in FIFO gross margin rate, excluding fuel, in the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily from continued investments in lower prices for our customers and increased shrink costs, as a percentage of sales, partially offset by reductions in transportation and advertising costs, as a percentage of sales.

 

LIFO Charge

 

The LIFO charge was $21 million in the second quarter of 2015 and $26 million in the second quarter of 2014.  The LIFO charge decreased in the second quarter of 2015, compared to the second quarter of 2014, due to our lower expected year-end product cost of inflation in most major categories for fiscal 2015 compared to fiscal 2014.

 

The LIFO charge was $48 million in the first two quarters of 2015 and $54 million in the first two quarters of 2014.  The LIFO charge decreased in the first two quarters of 2015, compared to the first two quarters of 2014, due to our lower expected year-end product cost of inflation in most major categories for 2015 compared to 2014.

 

Operating, General and Administrative Expenses

 

OG&A expenses consist primarily of employee-related costs such as wages, healthcare benefit costs, retirement plan costs, utilities, and credit card fees.  Rent expense, depreciation and amortization expense, and interest expense are not included in OG&A.

 

OG&A expenses, as a percentage of sales, increased 44 basis points to 15.93% for the second quarter of 2015 from 15.49% for the second quarter of 2014.  The increase in OG&A rate, as a percentage of sales, in the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from a decrease in retail fuel sales and increases in company sponsored pension, credit card and incentive plan costs, as a percentage of sales, partially offset by increased supermarket sales, productivity improvements, effective cost controls and decreased workers’ compensation and general liability expenses.  Our retail fuel operations lower our OG&A rate, as a percentage of sales, due to the very low OG&A rate, as a percentage of sales, of retail fuel sales compared to non-fuel sales.  Excluding the effect of retail fuel, our OG&A rate, as a percentage of sales, decreased 31 basis points in the second quarter of 2015, compared to the second quarter of 2014.  The decrease in the OG&A rate, excluding fuel, in the second quarter of 2015, compared to the second quarter of 2014, resulted primarily from increased supermarket sales, productivity improvements, effective cost controls and decreased workers’ compensation and general liability expenses, partially offset by increases in company sponsored pension, credit card and incentive plan costs, as a percentage of sales.

 

20



 

OG&A expenses, as a percentage of sales, increased 48 basis points to 16.08% for the first two quarters of 2015 from 15.60% for the first two quarters of 2014.  The increase in OG&A rate, as a percentage of sales, in the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily from a decrease in retail fuel sales and increases in company sponsored pension, credit card and incentive plan costs, as a percentage of sales, partially offset by increased supermarket sales, the 2014 charge due to the pension plan agreements, productivity improvements, effective cost controls and decreased workers’ compensation and general liability expenses.  Excluding the effect of retail fuel and the pension plan agreements, our adjusted OG&A rate, as a percentage of sales, decreased 20 basis points in the first two quarters of 2015, compared to the first two quarters of 2014.  The decrease in the adjusted OG&A rate, as a percentage of sales, excluding fuel and the pension plan agreements, in the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily from increased supermarket sales, productivity improvements, effective cost controls and decreased workers’ compensation and general liability expenses, partially offset by increases in company sponsored pension, credit card and incentive plan costs, as a percentage of sales.

 

Rent Expense

 

Rent expense was $155 million, or 0.61% of sales, for the second quarter of 2015, compared to $166 million, or 0.65% of sales, for the second quarter of 2014.  For the first two quarters of 2015, rent expense was $370 million, or 0.63% of sales, compared to $383 million, or 0.66% of sales, in the first two quarters of 2014.  The decrease in rent expense in both the second quarter and the first two quarters of 2015, compared to the second quarter and the first two quarters of 2014, was primarily due to our continued emphasis on owning rather than leasing, whenever possible.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expense was $477 million, or 1.87% of total sales, for the second quarter of 2015 compared to $444 million, or 1.76% of total sales, for the second quarter of 2014.  The increase in our depreciation and amortization expense for the second quarter of 2015, compared to the second quarter of 2014, in total dollars, was the result of additional depreciation on capital investments, including acquisitions and lease buyouts, of $3.3 billion, during the rolling four quarter period ending with the second quarter of 2015.

 

Depreciation and amortization expense was $1.1 billion, or 1.87% of total sales, for the first two quarters of 2015 compared to $1.0 billion, or 1.76% of total sales, for the first two quarters of 2014.  The increase in our depreciation and amortization expense for the first two quarters of 2015, compared to the first two quarters of 2014, in total dollars, was the result of additional depreciation on capital investments, including acquisitions and lease buyouts, of $3.3 billion, during the rolling four quarter period ending with the second quarter of 2015.

 

Operating Profit and FIFO Operating Profit

 

Operating profit was $774 million, or 3.03% of sales, for the second quarter of 2015, compared to $644 million, or 2.54% of sales, for the second quarter of 2014.  Operating profit, as a percentage of sales, increased 49 basis points in the second quarter of 2015, compared to the second quarter of 2014, primarily due to increased supermarket sales, the effect of our retail fuel operations, productivity improvements, effective cost controls, decreased workers’ compensation and general liability expenses, and reductions in transportation and advertising costs, as a percentage of sales, partially offset by continued investments in lower prices for our customers and increases in company sponsored pension, credit card, incentive plan and shrink costs, as a percentage of sales.

 

Operating profit was $1.9 billion, or 3.20% of sales, for the first two quarters of 2015, compared to $1.6 billion, or 2.70% of sales, for the first two quarters of 2014.  Operating profit, as a percentage of sales, increased 50 basis points in the first two quarters of 2015, compared to the first two quarters of 2014, primarily due to increased supermarket sales, the effect of our fuel operations, the 2014 charge due to pension plan agreements, productivity improvements, effective cost controls, decreased workers’ compensation and general liability expenses, and reductions in transportation and advertising costs, as a percentage of sales, partially offset by continued investments in lower prices for our customers and increases in company sponsored pension, credit card, incentive plan and shrink costs, as a percentage of sales.

 

21



 

We calculate FIFO operating profit as operating profit excluding the LIFO charge.  FIFO operating profit is a non-GAAP financial measure and should not be considered as an alternative to operating profit or any other GAAP measure of performance.  FIFO operating profit should not be reviewed in isolation or considered as a substitute for our financial results as reported in accordance with GAAP.  FIFO operating profit is an important measure used by management to evaluate operational effectiveness.  Management believes FIFO operating profit is a useful metric to investors and analysts because it measures our day-to-day operational effectiveness. Since fuel discounts are earned based on in-store purchases, fuel operating profit does not include fuel discounts, which are allocated to our in-store supermarket location departments.  We also derive OG&A expenses, rent and depreciation and amortization through the use of estimated allocations in the calculation of fuel operating profit.

 

FIFO operating profit was $795 million, or 3.11% of sales, for the second quarter of 2015, compared to $670 million, or 2.65% of sales, for the second quarter of 2014.  Retail fuel sales lower our FIFO operating profit rate due to the very low FIFO operating profit rate, as a percentage of sales, of retail fuel sales compared to non-fuel sales.  FIFO operating profit, as a percentage of sales excluding fuel, increased 28 basis points in the second quarter of 2015, compared to the second quarter of 2014.  The increase in our FIFO operating profit, excluding fuel, rate in the second quarter of 2015, compared to the second quarter of 2014, was primarily due to increased supermarket sales, productivity improvements, effective cost controls, decreased workers’ compensation and general liability expenses, and reductions in transportation and advertising costs, as a percentage of sales, partially offset by continued investments in lower prices in our customers and increases in company sponsored pension, credit card, incentive plan and shrink costs, as a percentage of sales.

 

FIFO operating profit was $1.9 billion, or 3.28% of sales, for the first two quarters of 2015, compared to $1.6 billion, or 2.79% of sales, for the first two quarters of 2014.  FIFO operating profit, as a percentage of sales excluding fuel and the pension plan agreements, increased 18 basis points in the first two quarters of 2015, compared to the first two quarters of 2014.  The increase in our FIFO operating profit rate, excluding fuel, in the first two quarters of 2015, compared to the first two quarters of 2014, was primarily due to increased supermarket sales, productivity improvements, effective cost controls, decreased workers’ compensation and general liability expenses, and reductions in transportation and advertising costs, as a percentage of sales, partially offset by continued investments in lower prices for our customers and increases in company sponsored pension, credit card, incentive plan and shrink costs, as a percentage of sales.

 

Income Taxes

 

Our effective income tax rate was 34.4% in the second quarter of 2015, compared to 34.2% for the second quarter of 2014. Our effective income tax rate was 34.5% for the first two quarters of 2015, compared to 34.7% for the first two quarters of 2014. Our effective income tax rate for the second quarter of 2015 and the first two quarters of 2015 differed from the federal statutory rate primarily due to the benefit from the favorable conclusion of certain tax audits and utilization of tax credits and deductions, partially offset by the effect of state income taxes. Our effective income tax rate for the second quarter of 2014 and the first two quarters of 2014 differed from the federal statutory rate primarily due to the utilization of tax credits and deductions, partially offset by the effect of state income taxes.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash Flow Information

 

Net cash provided by operating activities

 

We generated $2.8 billion of cash from operating activities during the first two quarters of 2015, compared to $2.6 billion in the first two quarters of 2014.  The cash provided by operating activities came from net earnings including noncontrolling interests, adjusted for non-cash expenses, and changes in working capital.  Changes in working capital provided cash from operating activities of $512 million in the first two quarters of 2015 and $540 million in the first two quarters of 2014.  The decrease in cash provided by changes in working capital for the first two quarters of 2015, compared to the first two quarters of 2014, was primarily due to an increase in cash used for accrued expenses.  Prepaid expenses decreased significantly from year-end in 2015 and 2014 reflecting prepayments of certain employee benefits at year-end in each prior year.

 

Net cash used by investing activities

 

We used $1.7 billion of cash for investing activities during the first two quarters of 2015, compared to $1.3 billion during the first two quarters of 2014.  The amount of cash used for investing activities increased in the first two quarters of 2015 versus the first two quarters of 2014, primarily due to increased cash payments for capital investments.

 

22



 

Net cash used by financing activities

 

We used $1.0 billion of cash for financing activities in the first two quarters of 2015 compared to $1.4 billion in the first two quarters of 2014.  The decrease in the amount of cash used for financing activities for the first two quarters of 2015, compared to the first two quarters of 2014, resulted primarily due to a decrease in repurchases of our outstanding common shares, offset partially by an increase in payments on commercial paper.  Proceeds from the issuance of capital stock resulted from exercises of employee stock options.

 

Debt Management

 

As of August 15, 2015, we maintained a $2.75 billion (with the ability to increase by $750 million), unsecured revolving credit facility that, unless extended, terminates on June 30, 2019.  Outstanding borrowings under the credit facility and commercial paper borrowings, and some outstanding letters of credit, reduce funds available under the credit facility.  As of August 15, 2015, we had $928 million of outstanding commercial paper and no borrowings under our credit facility.  The outstanding letters of credit that reduce funds available under our credit facility totaled $9 million as of August 15, 2015.

 

Our bank credit facility and the indentures underlying our publicly issued debt contain various restrictive covenants.  As of August 15, 2015, we were in compliance with these 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 capital leases and lease-financing obligations, increased $130 million to $11.3 billion as of the end of the second quarter of 2015, from $11.1 billion as of the end of the second quarter of 2014.  Total debt decreased $328 million as of the end of the second quarter of 2015, from $11.6 billion as of year-end 2014.  The increase as of the end of the second quarter of 2015, compared to the end of the second quarter of 2014, resulted from the issuance of $500 million of senior notes bearing an interest rate of 2.95%, partially offset by payments at maturity of $300 million of senior notes bearing an interest rate of 4.95% and a decrease in outstanding commercial paper of $162 million.

 

We anticipate refinancing approximately $500 million of debt maturing in the third quarter of 2015.

 

Common Share Repurchase Program

 

During the second quarter of 2015, we invested $43 million to repurchase 1.1 million Kroger common shares at an average price of $38.23 per share.  For the first two quarters of 2015, we invested $628 million to repurchase 17.0 million Kroger common shares at an average price of $36.84 per share.  These shares were reacquired under two separate share repurchase programs.  The first is a $500 million repurchase program that was authorized by our Board of Directors on June 26, 2014.  The second is a program that uses the cash proceeds from the exercises of stock options by participants in our stock option and long-term incentive plans as well as the associated tax benefits.

 

On June 25, 2015, our Board of Directors approved a new $500 million share repurchase program to replace our prior authorization, which had been exhausted.  As of August 15, 2015, we have not made any repurchases under this program.

 

Liquidity Needs

 

We estimate our liquidity needs over the next twelve-month period to be approximately $4.9 billion, which includes anticipated requirements for working capital, capital expenditures, 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 2015.  We generally operate with a working capital deficit due to our efficient use of cash in funding operations and 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 $928 million of commercial paper and $500 million of senior notes maturing in the next twelve months, which is included in the $4.9 billion in estimated liquidity needs.  The commercial paper and the $500 million of senior notes mature in the third quarter of 2015.  Based on the current market environment, we expect to refinance this debt on favorable terms.  We believe we have adequate coverage of our debt covenants to continue to maintain our current debt ratings and to respond effectively to competitive conditions.

 

23



 

CAPITAL INVESTMENTS

 

Capital investments, excluding mergers, acquisitions and the purchase of leased facilities, totaled $812 million for the second quarter of 2015 compared to $672 million for the second quarter of 2014.  Capital investments, excluding mergers, acquisitions and the purchase of leased facilities, totaled $1.7 billion in the first two quarters of 2015 and $1.4 billion in the first two quarters of 2014.  During the first two quarters of 2015, capital expenditures for the purchase of leased facilities totaled $16 million compared to $28 million for the first two quarters of 2014.  During the second quarter of 2015, we opened, acquired, expanded or relocated 15 food stores and also completed 34 major within-the-wall remodels.  During the first two quarters of 2015, we opened, acquired, expanded or relocated 32 food stores and also completed 54 major within-the-wall remodels.  Total food store square footage at the end of the second quarter of 2015 increased 0.5% from the end of the second quarter of 2014.  Excluding mergers, acquisitions and operational closings, total food store square footage at the end of the second quarter of 2015 increased 1.7% over the end of the second quarter of 2014.

 

RETURN ON INVESTED CAPITAL

 

We calculate return on invested capital (“ROIC”) by dividing adjusted operating profit for the prior four quarters by the average invested capital.  Adjusted operating profit is calculated by excluding certain items included in operating profit, and adding back our LIFO charge, depreciation and amortization and rent.  Average invested capital is calculated as the sum of (i) the average of our total assets, (ii) the average LIFO reserve, (iii) the average accumulated depreciation and amortization and (iv) a rent factor equal to total rent for the last four quarters multiplied by a factor of eight; minus (i) the average taxes receivable, (ii) the average trade accounts payable, (iii) the average accrued salaries and wages and (iv) the average other current liabilities.  Averages are calculated for return on invested capital by adding the beginning balance of the first quarter and the ending balance of the fourth quarter, of the last four quarters, and dividing by two.  We use a factor of eight for our total rent as we believe this is a common factor used by our investors, analysts and rating agencies.  ROIC is a non-GAAP financial measure of performance.  ROIC should not be reviewed in isolation or considered as a substitute for our financial results as reported in accordance with GAAP.  ROIC is an important measure used by management to evaluate our investment returns on capital.  Management believes ROIC is a useful metric to investors and analysts because it measures how effectively we are deploying our assets.  All items included in the calculation of ROIC are GAAP measures, excluding certain adjustments to operating income.

 

Although ROIC is a relatively standard financial term, numerous methods exist for calculating a company’s ROIC.  As a result, the method used by our management to calculate ROIC may differ from methods other companies use to calculate their ROIC.  We urge you to understand the methods used by other companies to calculate their ROIC before comparing our ROIC to that of such other companies.

 

24



 

The following table provides a reconciliation of ROIC for the rolling four quarters basis ended August 15, 2015 ($ in millions).  There is no prior year comparative number as the prior year calculation does not include a full year of Harris Teeter assets and results.

 

 

 

Rolling Four Quarters
Ended

 

 

 

August 15, 2015

 

Return on Invested Capital

 

 

 

Numerator

 

 

 

Operating profit

 

$

3,439

 

LIFO charge

 

141

 

Depreciation and amortization

 

2,020

 

Rent

 

694

 

Adjusted operating profit on a rolling four quarters basis

 

$

6,294

 

 

 

 

 

Denominator

 

 

 

Average total assets

 

$

29,900

 

Average taxes receivable(1)

 

(36

)

Average LIFO reserve

 

1,222

 

Average accumulated depreciation and amortization(2)

 

16,884

 

Average trade accounts payable

 

(5,169

)

Average accrued salaries and wages

 

(1,175

)

Average other current liabilities(3)

 

(2,966

)

Rent x 8

 

5,552

 

Average invested capital

 

$

44,212

 

Return on Invested Capital

 

14.24

%

 


(1)         As of August 15, 2015 and August 16, 2014, taxes receivable were $48 and $23, respectively.

(2)         As of August 15, 2015 and August 16, 2014, accumulated depreciation and amortization was $17,493 and $16,274, respectively.

(3)         As of August 16, 2014, other current liabilities included accrued income taxes of $30.  Accrued income taxes are removed from other current liabilities in the calculation of average invested capital.

 

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 January 31, 2015.

 

The preparation of financial statements in conformity with generally accepted accounting principles 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.

 

The net increase (decrease) in book overdrafts previously reported in financing activities in the Consolidated Statements of Cash Flows are now reported within operating activities.  See Recently Adopted Accounting Standards for an additional change to the Consolidated Balance Sheets for a recently adopted accounting standard.  Prior year amounts have been revised to the current year presentation.  These revisions were not material to the prior years.

 

25



 

RECENTLY ADOPTED ACCOUNTING STANDARDS

 

In 2015, the Financial Accounting Standards Board (“FASB”) amended Accounting Standards Codification 835, “Interest-Imputation of Interest.” The amendment simplifies the presentation of debt issuance costs related to a recognized debt liability by requiring it be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This amendment became effective beginning February 1, 2015, and was adopted retrospectively in accordance with the standard.  The adoption of this amendment resulted in amounts previously reported in other assets to now be reported within long-term debt including obligations under capital leases and financing obligations in the Consolidated Balance Sheets.  These amounts were not material to the prior year.  The adoption of this amendment did not have an effect on our Consolidated Statements of Operations.

 

RECENTLY ISSUED ACCOUNTING STANDARDS

 

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services.  Per ASU 2015-14, “Deferral of Effective Date,” this guidance will be effective for the Company in the first quarter of its fiscal year ending February 2, 2019.  Early adoption is permitted as of the first quarter of our fiscal year ending February 3, 2018.  We are currently in the process of evaluating the effect of adoption of this ASU on the Consolidated Financial Statements.

 

In April 2015, the FASB issued ASU 2015-04, “Retirement Benefits (Topic 715): Practical Expedient for the Measurement Date of an Employer’s Defined Benefit Obligation and Plan Assets.” This amendment permits an entity to measure defined benefit plan assets and obligations using the month end that is closest to the entity’s fiscal year end for all plans. This guidance will be effective for us in the fiscal year ending January 28, 2017.  The implementation of this amendment will not have an effect on the Consolidated Statements of Operations and will not have a significant effect on the Consolidated Balance Sheets.

 

In April 2015, the FASB issued ASU 2015-07, “Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” This amendment removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share. This guidance will be effective for us in the fiscal year ending January 28, 2017.  The implementation of this amendment will have an effect on the Company’s Notes to the Consolidated Financial Statements and will not have an effect on the Consolidated Statements of Operations or Consolidated Balance Sheets.

 

26



 

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 “comfortable,” “committed,” “will,” “expect,” “goal,” “should,” “intend,” “target,” “believe,” “anticipate,” “plan,” 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.

 

·

 

We expect net earnings to be $1.92 to $1.98 per diluted share for 2015, which exceeds our long-term net earnings per diluted share growth rate guidance of 8-11%. We expect the third quarter to be at the high end of the 8-11% range and the fourth quarter to be below the range.

 

 

 

·

 

We expect identical supermarket sales growth, excluding fuel, of 4.0%-5.0% in 2015.

 

 

 

·

 

We expect full-year non-fuel FIFO operating margin to exceed our goal to slightly expand on a rolling four quarters basis.

 

 

 

·

 

We expect our 2015 year-end ROIC to increase slightly compared to the fiscal 2014 result.

 

 

 

·

 

For 2015, we expect product cost inflation of 1.0% - 2.0%, excluding fuel, and an annualized LIFO charge of approximately $90 million.

 

 

 

·

 

For 2015, we expect interest expense to be approximately $480 million.

 

 

 

·

 

We plan to use cash flow primarily to repurchase common shares, fund our cash dividend, fund capital investments and maintain our current investment grade debt rating.

 

 

 

·

 

We expect to obtain sales growth from new square footage, as well as from increased productivity from existing locations.

 

 

 

·

 

We expect capital investments, excluding mergers, acquisitions and purchases of leased facilities, to be at the high end of the $3.0 - $3.3 billion range. We expect total supermarket square footage for 2015 to grow approximately 2.0 — 2.5% before mergers, acquisitions and operational closings.

 

 

 

·

 

For 2015, we expect our effective tax rate to be approximately 35%, excluding the resolution of certain tax items and potential changes to tax legislation.

 

 

 

·

 

We do not anticipate goodwill impairments in 2015.

 

 

 

·

 

For 2015, we expect to contribute approximately $5 million to company-sponsored pension plans and $315 million to multi-employer pension funds, $60 million of which was accrued for at the end of 2014. We continue to evaluate and address our potential exposure to under-funded multi-employer pension plans. Although these liabilities are not a direct obligation or liability of Kroger, any new agreements that would commit us to fund certain multi-employer plans will be expensed when our commitment is probable and an estimate can be made.

 

 

 

·

 

In 2015, we will negotiate agreements with UFCW for store associates in Denver and Portland. We will also negotiate an agreement with the Teamsters covering our Southern California distribution centers. Negotiations this year will be challenging as we must have competitive cost structures in each market while meeting our associates’ needs for solid wages and good quality, affordable health care and retirement benefits.

 

27



 

Various uncertainties and other factors could cause actual results to differ materially from those contained in the forward-looking statements.  These include:

 

·

 

The extent to which our sources of liquidity are sufficient to meet our requirements may be affected by the state of the financial markets and the effect that such condition has on our ability to issue commercial paper at acceptable rates.  Our ability to borrow under our committed lines of credit, including our bank credit facilities, could be impaired if one or more of our lenders under those lines is unwilling or unable to honor its contractual obligation to lend to us, or in the event that natural disasters or weather conditions interfere with the ability of our lenders to lend to us.  Our ability to refinance maturing debt may be affected by the state of the financial markets.

 

 

 

·

 

Our ability to use cash flow to continue to repurchase shares, fund dividends, increase capital investments and maintain our investment grade debt rating, could be affected by unanticipated increases in net total debt, our inability to generate cash flow at the levels anticipated, and our failure to generate expected earnings.

 

 

 

·

 

Our ability to achieve sales, earnings and cash flow goals may be affected by: labor negotiations or disputes; changes in the types and numbers of businesses that compete with us; pricing and promotional activities of existing and new competitors, including non-traditional competitors, and the aggressiveness of that competition; our response to these actions; the state of the economy, including interest rates, the inflationary and deflationary trends in certain commodities, and the unemployment rate; the effect that fuel costs have on consumer spending; volatility of fuel margins; changes in government-funded benefit programs; manufacturing commodity costs; diesel fuel costs related to our logistics operations; trends in consumer spending; the extent to which our customers exercise caution in their purchasing in response to economic conditions; the inconsistent pace of the economic recovery; changes in inflation or deflation in product and operating costs; stock repurchases; our ability to retain pharmacy sales from third party payors; consolidation in the healthcare industry, including pharmacy benefit managers; our ability to negotiate modifications to multi-employer pension plans; natural disasters or adverse weather conditions; the potential costs and risks associated with potential cyber-attacks or data security breaches; the success of our future growth plans; and the successful integration of Harris Teeter.  Our ability to achieve sales and earnings goals may also be affected by our ability to manage the factors identified above.

 

 

 

·

 

During the first three quarters of each fiscal year, our LIFO charge and the recognition of LIFO expense is affected primarily by estimated year-end changes in product costs.  Our fiscal year LIFO charge is affected primarily by changes in product costs at year-end.

 

 

 

·

 

If actual results differ significantly from anticipated future results for certain reporting units including variable interest entities, an impairment loss for any excess of the carrying value of the reporting units’ goodwill over the implied fair value would have to be recognized.

 

 

 

·

 

Our effective tax rate may differ from the expected rate due to changes in laws, the status of pending items with various taxing authorities, and the deductibility of certain expenses.

 

 

 

·

 

Changes in our product mix may negatively affect certain financial indicators. For example, we continue to add supermarket fuel centers to our store base. Since gasoline generates low profit margins, we expect to see our FIFO gross margins decline as gasoline sales increase.

 

We cannot fully foresee the effects of changes in economic conditions on Kroger’s business. We have assumed economic and competitive situations will not change significantly in 2015.

 

Other factors and assumptions not identified above could also cause actual results to differ materially from those set forth in the forward-looking information. Accordingly, actual events and results may vary significantly from those included in, 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.

 

28



 

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 January 31, 2015.

 

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 15, 2015, 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 15, 2015, that has materially affected, or is reasonably likely to materially affect, Kroger’s internal control over financial reporting.

 

29



 

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.

 

30



 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

(c)

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period(1)

 

Total Number
of Shares
Purchased(2)

 

Average
Price Paid Per
Share

 

Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs(3)

 

Maximum
Dollar Value of
Shares that May
Yet Be
Purchased
Under the Plans
or Programs(4)
(in millions)

 

First four weeks

 

 

 

 

 

 

 

 

 

May 24, 2015 to June 20, 2015

 

130,540

 

$

36.62

 

130,540

 

$

 

Second four weeks

 

 

 

 

 

 

 

 

 

June 21, 2015 to July 18, 2015

 

1,941,006

 

$

38.03

 

218,779

 

$

500

 

Third four weeks

 

 

 

 

 

 

 

 

 

July 19, 2015 to August 15, 2015

 

771,406

 

$

38.84

 

771,406

 

$

500

 

Total 

 

2,842,952

 

$

  38.19

 

1,120,725

 

$

  500

 

 


(1)         The reported periods conform to our fiscal calendar composed of thirteen 28-day periods. The second quarter of 2015 contained three 28-day periods.

 

(2)         Includes (i) shares repurchased under a $500 million share repurchase program authorized by the Board of Directors and announced on June 26, 2014 (“2014 Repurchase Program”), (ii) shares repurchased under a program announced on December 6, 1999 to repurchase common shares to reduce dilution resulting from our employee stock option and long-term incentive plans, under which repurchases are limited to proceeds received from exercises of stock options and the tax benefits associated therewith (“the 1999 Repurchase Program”), and (iii) 1,722,227 shares that were surrendered to the Company by participants under our long-term incentive plans to pay for taxes on restricted stock awards.

 

(3)         Represents shares repurchased under the 2014 Repurchase Program and the 1999 Repurchase Program.

 

(4)         The amount shown in this column for the first four weeks reflects the amount remaining under the 2014 Repurchase Program.  On June 25, 2015, our Board of Directors approved a new $500 million share repurchase program (the “2015 Repurchase Program”) to replace the 2014 Repurchase Program, which has been exhausted.  Amounts available under the 1999 Repurchase Program are dependent upon option exercise activity.  The 2015 Repurchase Program and the 1999 Repurchase Program do not have an expiration date but may be terminated by the Board of Directors at any time.

 

31



 

Item 6. Exhibits.

 

EXHIBIT 3.1

 

-

 

Amended Articles of Incorporation. Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended May 22, 2010.

 

 

 

 

 

EXHIBIT 3.2

 

-

 

Amendment to Amended Articles of Incorporation. 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 3.3

 

-

 

The Company’s regulations are hereby incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended May 26, 2007.

 

 

 

 

 

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*

 

-

 

Form of Performance Unit Agreement Under Long-Term Incentive Plans.

 

 

 

 

 

EXHIBIT 10.2*

 

-

 

Retirement Agreement, between the Company and Michael Ellis, dated as of June 29, 2015.

 

 

 

 

 

EXHIBIT 10.3*

 

-

 

Amendment to Stock Option Agreements, between the Company and Michael Ellis, dated as of June 29, 2015.

 

 

 

 

 

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 99.1

 

-

 

Additional Exhibit – Statement of Computation of Ratio of Earnings to Fixed Charges.

 

 

 

 

 

EXHIBIT 101.INS

 

-

 

XBRL Instance 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.

 


*Management contract or compensatory plan or arrangement

 

32



 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

THE KROGER CO.

 

 

Dated:  September 22, 2015

By:

/s/ W. Rodney McMullen

 

 

W. Rodney McMullen

 

 

Chairman of the Board and Chief Executive Officer

 

 

 

Dated:  September 22, 2015

By:

/s/ J. Michael Schlotman

 

 

J. Michael Schlotman

 

 

Executive Vice President and Chief Financial Officer

 

33



 

Exhibit Index

 

Exhibit 3.1 -

 

Amended Articles of Incorporation. Incorporated by reference to Exhibit 3.1 of the Company’s Quarterly Report on Form 10-Q for the quarter ended May 22, 2010.

 

 

 

Exhibit 3.2 -

 

Amendment to Amended Articles of Incorporation. 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 3.3 -

 

The Company’s regulations are hereby incorporated by reference to Exhibit 3.2 of the Company’s Quarterly Report on Form 10-Q for the quarter ended May 26, 2007.

 

 

 

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* -

 

Form of Performance Unit Agreement Under Long-Term Incentive Plans.

 

 

 

EXHIBIT 10.2* -

 

Retirement Agreement, between the Company and Michael Ellis, dated as of June 29, 2015.

 

 

 

EXHIBIT 10.3* -

 

Amendment to Stock Option Agreements, between the Company and Michael Ellis, dated as of June 29, 2015.

 

 

 

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 99.1 -

 

Additional Exhibit - Statement of Computation of Ratio of Earnings to Fixed Charges.

 

 

 

EXHIBIT 101.INS -

 

XBRL Instance 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.

 


*Management contract or compensatory plan or arrangement

 

34