Business Context and Reporting Period
Company: The Kroger Co.
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Second quarter and first two quarters ended August 14, 1999.
Key Event: The financial statements reflect the merger with Fred Meyer, Inc., completed on May 27, 1999, accounted for as a pooling of interests. The 1998 comparative periods include results from Dillon Companies, Inc. and Fred Meyer, Inc., but differ in length (12-13 weeks vs. 12 weeks), making direct period-over-period comparisons difficult.
Key Financial Metrics
| Metric (in millions) | 2nd Qtr 1999 | 2nd Qtr 1998 | 2 Qtrs 1999 | 2 Qtrs 1998 |
|---|---|---|---|---|
| Sales | $10,289 | $9,947 | $23,782 | $20,376 |
| Gross Profit | $2,699 | $2,553 | $6,229 | $5,143 |
| Operating Profit | $254 | $340 | $800 | $497 |
| Net Earnings | $46 | $99 | $253 | $(141) |
| Diluted EPS (Net) | $0.05 | $0.12 | $0.29 | $(0.16) |
| Operating Cash Flow (YTD) | $1,215 (1999) vs $1,006 (1998) | |||
| Total Debt (Long-term + Current) | $7,993 (Aug 14, 1999) vs $8,159 (Jan 2, 1999) | |||
| Cash & Equivalents | $304 (Aug 14, 1999) |
Margins (YTD 1999): Gross margin was approximately 26.2%. Operating margin was approximately 3.4%.
Material Changes and Unusual Items
- Merger Related Costs: Significant expenses were incurred to integrate Fred Meyer. Total merger-related costs were $200 million for the second quarter and $235 million year-to-date. These include transaction costs ($85M Q2), administration integration ($12M Q2), and store closures.
- Extraordinary Loss: A $10 million extraordinary loss (net of tax) was recorded in the second quarter of 1999, primarily related to the termination of interest rate swap contracts ($17 million pre-tax) due to the merger restructuring.
- One-Time Expenses: The 1998 period included $41 million in one-time logistics expenses and $12 million in Texas consolidation costs, which are not present in the 1999 period.
- EBITDA: Adjusted EBITDA (excluding one-time items, LIFO, and extraordinary losses) was $705 million for the second quarter of 1999, compared to $652 million in the second quarter of 1998.
Guidance, Outlook, and Risks
- Synergy Targets: Management expects to achieve $225 million in synergy savings over the next three years from the Fred Meyer merger ($40M in 1999, $115M in 2000, $190M in 2001).
- Earnings Growth: The company targets a 16%-18% average annual increase in earnings per share over the next three years, effective with the year 2000.
- Capital Expenditures: Expected to total $1.5-$1.6 billion for the full year 1999, focused on technology, logistics, and store expansion.
- Year 2000 Readiness: The company is actively remediating IT and non-IT systems. Estimated total cost is $48 million, with $38 million incurred to date. Risks include potential system disruptions if remediation is not timely.
- Contingencies: The company is attempting to dispose of its 50% interest in Santee Dairies, which may result in a loss. Additionally, there are ongoing lease obligations for closed stores.
Investor Verification Checklist
- Merger Integration Progress: Verify the realization of projected $225 million in synergy savings against actual merger-related costs incurred.
- Debt Covenants: Confirm continued compliance with EBITDA-based covenants in the Credit Agreement and Senior Credit Facility, given the restructuring of debt.
- Year 2000 Costs: Monitor the remaining $10 million budget for Y2K remediation and potential operational disruptions.
- Comparable Sales: Distinguish between total sales growth (driven by acquisitions) and identical store sales growth (reported as 2.6% for the quarter).
- Asset Write-downs: Review future potential write-downs related to the Santee Dairies interest and closed/duplicate facilities.