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KR > SEC Filings for KR > Form 10-K on 1-Apr-2014All Recent SEC Filings

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Form 10-K for KROGER CO


1-Apr-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.

The following discussion and analysis of financial condition and results of operations of The Kroger Co. should be read in conjunction with the "Forward-looking Statements" section set forth in Part I, the "Risk Factors" section set forth in Item 1A of Part I and "Outlook" below.

OUR BUSINESS

The Kroger Co. was founded in 1883 and incorporated in 1902. It is one of the nation's largest retailers, as measured by revenue, operating 2,640 supermarket and multi-department stores under two dozen banners including Kroger, City Market, Dillons, Food 4 Less, Fred Meyer, Fry's, Harris Teeter, Jay C, King Soopers, QFC, Ralphs and Smith's. Of these stores, 1,240 have fuel centers. We also operate 786 convenience stores, either directly or through franchisees, and 320 fine jewelry stores.

Kroger operates 38 manufacturing plants, primarily bakeries and dairies, which supply approximately 40% of the corporate brand units sold in our retail outlets.

Our revenues are earned and cash is generated as consumer products are sold to customers in our stores. We earn income predominately by selling products at price levels that produce revenues in excess of the costs we incur to make these products available to our customers. Such costs include procurement and distribution costs, facility occupancy and operational costs, and overhead expenses. Our retail operations, which represent over 99% of Kroger's consolidated sales and EBITDA, are our only reportable segment.

On January 28, 2014, we closed our merger with Harris Teeter Supermarkets, Inc. ("Harris Teeter") by purchasing 100% of the Harris Teeter outstanding common stock for approximately $2.4 billion. The merger allows us to expand into the fast-growing southeastern and mid-Atlantic markets and into Washington, D.C. Harris Teeter is included in our ending Consolidated Balance Sheet, but because of the timing of the merger closing late in the year its results of operations were not material to our consolidated results of operations for 2013. See Note 2 to the Consolidated Financial Statements for more information related to our merger with Harris Teeter.

OUR 2013 PERFORMANCE

We achieved outstanding results in 2013. Our business strategy continues to resonate with a full range of customers and our results reflect the balance we seek to achieve across our business including positive identical sales growth, increases in loyal household count, and good cost control, as well as growth in net earnings and net earnings per diluted share. Our 2013 net earnings were $1.5 billion or $2.90 per diluted share, compared to $1.5 billion, or $2.77 per diluted share for the same period of 2012. The net earnings for 2013 include a net benefit of $23 million, which includes benefits from certain tax items of $40 million, offset partially by after-tax expense of $17 million ($7 million in interest and $10 million in operating, general and administrative expenses) in costs related to our merger with Harris Teeter ("2013 adjusted items"). See Note 5 to the Consolidated Financial Statements for more information relating to the benefits from certain tax items. For 2012, our net earnings include an estimated after-tax amount of $58 million or $0.11 per diluted share due to a 53rd week in fiscal year 2012 (the "extra week"). In addition, 2012 net earnings benefited by $74 million after-tax or $0.14 per diluted share from a settlement with Visa and MasterCard and from a reduction in our obligation to fund the UFCW consolidated pension fund created in January 2012. Excluding the 2013 adjusted items, net earnings for 2013 totaled $1.5 billion, or $2.85 per diluted share, compared to net earnings in 2012 of $1.4 billion, or $2.52 per diluted share, excluding the Visa and MasterCard settlement, the UFCW consolidated pension fund adjustment and the extra week in 2012. 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 adjusted items were not directly related to our day-to-day business. After accounting for these 2013 and 2012 adjusted items, our adjusted net earnings per diluted share for 2013 represents a 13% increase, compared to 2012. Please refer to the "Net Earnings" section for more information.

Our identical supermarket sales increased 3.6%, excluding fuel, in 2013, compared to 2012. We have achieved 41 consecutive quarters of positive identical supermarket sales growth, excluding fuel. As we continue to outpace many of our competitors on identical supermarket sales growth, we continue to gain market share. We focus on identical supermarket sales growth, excluding fuel, as it is a key performance target for our long-term growth strategy.


Increasing market share is an important part of our long-term strategy as it best reflects how our products and services resonate with customers. Market share growth allows us to spread the fixed costs in our business over a wider revenue base. Our fundamental operating philosophy is to maintain and increase market share by offering customers good prices and superior products and service. Based on Nielsen POS+ data, our estimated market share increased in total by approximately 50 basis points in 2013 across our 18 marketing areas outlined by the Nielsen report. This information also indicates that our market share increased in 16 of the marketing areas and declined in two. Wal-Mart supercenters are one of our top two competitors in 13 of these 18 marketing areas. In these 13 marketing areas, our market share increased in 12 and slightly declined in one. These market share results reflect our long-term strategy of market share growth.

RESULTS OF OPERATIONS

The following discussion summarizes our operating results for 2013 compared to 2012 and for 2012 compared to 2011. Comparability is affected by income and expense items that fluctuated significantly between and among the periods and an extra week in 2012.

Net Earnings

Net earnings totaled $1.5 billion in 2013, $1.5 billion in 2012 and $602 million in 2011. The net earnings for 2013 include a net benefit of $23 million, after tax, related to the 2013 adjusted items. The net earnings for 2012 include a benefit from net earnings of approximately $58 million, after-tax, for the extra week and a net $74 million, after-tax, benefit for the settlement with Visa and MasterCard and a reduction in our obligation to fund the UFCW consolidated pension fund created in January 2012 ("2012 adjusted items"). The net earnings for 2011 include a UFCW consolidated pension plan charge totaling $591 million, after-tax ("2011 adjusted item"). Excluding these benefits and charges for adjusted items in 2013, 2012 and 2011, adjusted net earnings were $1.5 billion in 2013, $1.4 billion in 2012 and $1.2 billion in 2011. 2013 adjusted net earnings improved, compared to adjusted net earnings in 2012, due to an increase in first-in, first-out ("FIFO") non-fuel operating profit and decreased interest expense, partially offset by increased income tax expense. 2012 adjusted net earnings improved, compared to adjusted net earnings in 2011, due to an increase in FIFO non-fuel operating profit, increased net earnings from our fuel operations and a last-in, first-out ("LIFO") charge of $55 million (pre-tax), compared to a LIFO charge of $216 million (pre-tax) in 2011, partially offset by increased interest expense and income tax expense.

2013 net earnings per diluted share totaled $2.90, and adjusted net earnings per diluted share totaled $2.85, which excludes the 2013 adjusted items. 2012 net earnings per diluted share totaled $2.77, and adjusted net earnings per diluted share totaled $2.52, which excludes the 2012 adjusted items. 2011 net earnings per diluted share totaled $1.01, and adjusted net earnings per diluted share in 2011 totaled $2.00, which excludes the 2011 adjusted item. Adjusted net earnings per diluted share in 2013, compared to adjusted net earnings per diluted share in 2012, increased primarily due to fewer shares outstanding as a result of the repurchase of Kroger common shares, increased FIFO non-fuel operating profit and decreased interest expense, partially offset by increased income tax expense. Adjusted net earnings per diluted share in 2012, compared to adjusted net earnings per diluted share in 2011, increased primarily due to fewer shares outstanding as a result of the repurchase of Kroger common shares, increased FIFO non-fuel operating profit, increased net earnings from our fuel operations and a decrease in the LIFO charge to $55 million (pre-tax), compared to a LIFO charge of $216 million (pre-tax) in 2011, partially offset by increased interest expense and income tax expense.

Management believes adjusted net earnings (and adjusted net earnings per diluted share) are useful metrics to investors and analysts because the adjusted items referenced above in net earnings and net earnings per diluted share are not directly related to our day-to-day business. 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 generally accepted accounting principle ("GAAP") measure of performance. Adjusted net earnings (and adjusted net earnings per diluted share) should not be reviewed 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) as it believes these measures are more meaningful indicators of ongoing 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) to measure our progress against internal budgets and targets. In addition, management takes into account adjusted net earnings when calculating management incentive programs.


The following table provides a reconciliation of net earnings attributable to The Kroger Co. to net earnings attributable to The Kroger Co. excluding the adjusted items and a reconciliation of net earnings attributable to The Kroger Co. per diluted common share to the net earnings attributable to The Kroger Co. per diluted common share excluding the adjusted items, for 2013, 2012 and 2011:

Net Earnings per Diluted Share excluding the Adjustment Items

(in millions, except per share amounts)

                                                   2013          2012          2011
Net earnings attributable to The Kroger Co.     $    1,519    $    1,497    $      602
Benefit from certain tax items offset by
Harris Teeter merger costs(1)                          (23 )           -             -
53rd week adjustment (1)                                 -           (58 )           -
Adjustment for the UFCW consolidated pension
plan liability and credit card settlement
(1)                                                      -           (74 )           -
UFCW pension plan consolidation charge (1)               -             -           591

Net earnings attributable to The Kroger Co.
excluding the adjustment items above            $    1,496    $    1,365    $    1,193

Net Earnings attributable to The Kroger Co.
per diluted common share                        $     2.90    $     2.77    $     1.01
Benefit from certain tax items offset by
Harris Teeter merger costs (2)                       (0.05 )           -             -
53rd week adjustment (2)                                 -         (0.11 )           -
Adjustments for the UFCW consolidated
pension plan liability and credit card
settlement (2)                                           -         (0.14 )           -
UFCW pension plan consolidation charge (2)               -             -          0.99

Net earnings attributable to The Kroger Co.
per diluted common share excluding the
adjustment items above                          $     2.85    $     2.52    $     2.00

Average numbers of common shares used in
diluted calculation                                    520           537           593



(1) The amounts presented represent the after-tax effect of each adjustment. Pre-tax amounts were $27 for Harris Teeter merger costs in 2013, $91 for the 53rd week adjustment in 2012, $115 for the adjustment for the UFCW consolidated pension plan liability and credit card settlement in 2012 and $953 for the UFCW pension plan consolidation charge in 2011.
(2) The amounts presented represent the net earnings per diluted common share effect of each adjustment.

Sales



                                  Total Sales

                                 (in millions)



                                        Percentage                    2012         Percentage
                               2013     Increase(2)     2012      Adjusted (3)     Increase(4)     2011
Total supermarket sales
without fuel                 $ 76,666           4.0 % $ 75,179   $       73,733            3.8 % $ 71,004
Fuel sales                     18,962           3.0 %   18,896           18,413            8.9 %   16,901
Other sales(1)                  2,747           9.2 %    2,544            2,515            6.4 %    2,364

Total sales                  $ 98,375           3.9 % $ 96,619   $       94,661            4.9 % $ 90,269



(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; and in-store health clinics.
(2) This column represents the percentage increase in 2013, compared to adjusted sales in 2012.
(3) The 2012 adjusted column represents the items presented in the 2012 column as adjusted to remove the extra week.
(4) This column represents the percentage increase in adjusted sales in 2012, compared to 2011.


Total sales increased in 2013, compared to 2012, by 1.82%. The increase in 2013 total sales, compared to 2012, was primarily due to our identical supermarket sales increase, excluding fuel, of 3.6%, partially offset by the extra week in fiscal 2012. Total sales increased in 2013, compared to 2012 adjusted total sales, by 3.9%. The increase in 2013 total sales, compared to 2012 adjusted total sales, was primarily due to our identical supermarket sales increase, excluding fuel, of 3.6%. Identical supermarket sales, excluding fuel, increased in 2013, compared to 2012, primarily due to an increase in average sale per customer, partially due to inflation, and an increase in the transaction count.

Total sales increased in 2012, compared to 2011, by 7.0%. The increase in 2012 total sales, compared to 2011, was primarily due to our identical supermarket sales increase, excluding fuel, of 3.5%, increased fuel sales of 8.9% and the extra week in fiscal 2012. Adjusted total sales increased in 2012, compared to 2011, by 4.9%. The increase in 2012 adjusted total sales, compared to 2011 total sales, was primarily due to our identical supermarket sales increase, excluding fuel, of 3.5% and an increase in fuel sales of 8.9%. Identical supermarket sales, excluding fuel, increased in 2012, adjusted for the extra week, compared to 2011, primarily due to an increase in the average sale per customer, partially due to inflation, and an increase in the transaction count. Total fuel sales increased in 2012, adjusted for the extra week, compared to 2011, primarily due to an increase in fuel gallons sold of 7.8% and an increase in the average retail fuel price of 1.7%. The increase in the average retail fuel price was caused by an increase 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 supermarket identical 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. We calculate annualized identical supermarket sales by adding together four quarters of identical supermarket sales. Our identical supermarket sales results are summarized in the table below, based on the 52-week period of 2013, compared to the previous year results adjusted to a comparable 52 week period.

                          Identical Supermarket Sales

                             (dollars in millions)



                                       2013     2012(1)
Including supermarket fuel centers   $ 88,482   $ 85,661
Excluding supermarket fuel centers   $ 74,095   $ 71,541

Including supermarket fuel centers        3.3 %      4.5 %
Excluding supermarket fuel centers        3.6 %      3.5 %



(1) Identical supermarket sales for 2013 were calculated on a 52 week basis by excluding week 1 of fiscal 2012 in our 2012 identical supermarket sales base. Identical supermarket sales for 2012 were calculated on a 53 week basis by including week 1 of fiscal 2012 in our 2011 identical supermarket sales base.

Gross Margin and FIFO Gross Margin

Our gross margin rates, as a percentage of sales, were 20.57% in 2013, 20.59% in 2012 and 20.92% in 2011. The decrease in 2013, compared to 2012, resulted primarily from continued investments in lower prices for our customers and increased shrink and advertising costs, as a percentage of sales, offset partially by a growth rate in retail fuel sales that was lower than the total Company sales growth rate. Our retail fuel operations lower our gross margin rate, as a percentage of sales, due to the very low gross margin on retail fuel sales as compared to non-fuel sales. A lower growth rate in retail fuel sales, as compared to the growth rate for the total Company, increases the gross margin rates, as a percentage of sales, when compared to the prior year. The decrease in gross margin rates in 2012, compared to 2011, resulted primarily from a higher growth rate in fuel sales, as compared to the growth rate for the total Company, continued investments in lower prices for our customers and increased shrink and warehousing costs, as a percentage of sales, offset partially by a decrease in the LIFO charge as a percentage of sales.


We calculate FIFO gross margin as sales minus merchandise costs, including advertising, warehousing, and transportation expenses, but excluding the LIFO charge. Merchandise costs exclude depreciation and rent expenses. Our LIFO charge was $52 million in 2013, $55 million in 2012 and $216 million in 2011. 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 rates, as a percentage of sales, were 20.62% in 2013, 20.65% in 2012 and 21.15% in 2011. Our retail fuel operations lower our FIFO gross margin rate, as a percentage of sales, due to the very low FIFO gross margin on retail fuel sales as compared to non-fuel sales. Excluding the effect of retail fuel operations, our FIFO gross margin rate decreased 14 basis points in 2013, as a percentage of sales, compared to 2012. This decrease in 2013, compared to 2012, resulted primarily from continued investments in lower prices for our customers and increased shrink and advertising costs as a percentage of sales. Excluding the effect of retail fuel operations, our FIFO gross margin rate decreased 40 basis points in 2012, as a percentage of sales, compared to 2011. This decrease in 2012, compared to 2011, resulted primarily from continued investments in lower prices for our customers and increased shrink and warehousing costs as a percentage of sales.

LIFO Charge

The LIFO charge was $52 million in 2013, $55 million in 2012 and $216 million in 2011. We experienced relatively consistent levels of product cost inflation in 2013, compared to 2012. In 2013, our LIFO charge resulted primarily from an annualized product cost inflation related to meat, seafood and pharmacy. In 2012, our LIFO charge resulted primarily from an annualized product cost inflation related to grocery, natural foods, meat, deli and bakery, general merchandise and grocery, partially offset by deflation in seafood and manufactured product. In 2012, we experienced lower levels of product cost inflation, compared to 2011. In 2011, our LIFO charge primarily resulted from an annualized product cost inflation related to grocery, meat and seafood, deli and bakery, and pharmacy.

Operating, General and Administrative Expenses

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

OG&A expenses, as a percentage of sales, were 15.45% in 2013, 15.37% in 2012 and 17.00% in 2011. Excluding the 2013, 2012 and 2011 adjusted items, OG&A expenses, as a percentage of sales, were 15.43% in 2013, 15.52% in 2012 and 15.94% in 2011. Our retail fuel operations reduce our overall OG&A rate, as a percentage of sales, due to the very low OG&A rate on retail fuel sales as compared to non-fuel sales. OG&A expenses, as a percentage of sales excluding fuel and the 2013 adjusted items, decreased 17 basis points in 2013, compared to 2012, adjusted for the 2012 adjusted items. This decrease resulted primarily from increased identical supermarket sales growth, productivity improvements and effective cost controls at the store level, offset partially by increased incentive compensation. OG&A expenses, as a percentage of sales excluding fuel and the 2012 adjusted items, decreased 36 basis points in 2012, compared to 2011, adjusted for the 2011 adjusted items. This decrease resulted primarily from increased identical supermarket sales growth, productivity improvements, effective cost controls at the store level, the benefit received in lower operating expenses from the consolidation of four UFCW multi-employer pension plans in the prior year and decreased incentive compensation, offset partially by increased healthcare costs.

Rent Expense

Rent expense was $613 million in 2013, as compared to $628 million in 2012 and $619 million in 2011. Rent expense, as a percentage of sales, was 0.62% in 2013, as compared to 0.65% in 2012 and 0.69% in 2011. Rent expense, as a percentage of sales excluding fuel, decreased four basis points in 2013, compared to 2012 and four basis points in 2012, compared to 2011. These continual decreases in rent expense, as a percentage of sales both including and excluding fuel, reflects our continued emphasis on owning rather than leasing, whenever possible, and the benefit of increased sales.


Depreciation and Amortization Expense

Depreciation and amortization expense was $1.7 billion in both 2013 and 2012 and $1.6 billion in 2011. Depreciation and amortization expense, as a percentage of sales, was 1.73% in 2013, 1.71% in 2012 and 1.81% in 2011. Excluding the extra week in 2012, depreciation and amortization expense, as a percentage of sales, was 1.74% in 2012. Depreciation and amortization expense, as a percentage of sales excluding fuel and the extra week in 2012, decreased three basis points in 2013, compared to 2012 and seven basis points in 2012, compared to 2011. These continual decreases in depreciation and amortization expense, excluding the extra week in 2012, as a percentage of sales both including and excluding fuel, are primarily the result of increasing sales, offset partially by our increased spending in capital investments.

Operating Profit and FIFO Operating Profit

Operating profit was $2.7 billion in 2013, $2.8 billion in 2012 and $1.3 billion in 2011. Excluding the extra week, operating profit was $2.7 billion in 2012. Operating profit, as a percentage of sales, was 2.77% in 2013, 2.86% in 2012 and 1.42% in 2011. Operating profit, as a percentage of sales excluding the extra week in 2012, was 2.81%. Operating profit, excluding the 2013, 2012 and 2011 adjusted items, was $2.7 billion in 2013, $2.6 billion in 2012 and $2.2 billion in 2011. Operating profit, as a percentage of sales excluding the 2013, 2012 and 2011 adjusted items, was 2.79% in 2013, 2.69% in 2012 and 2.47% in 2011.

Operating profit, as a percentage of sales excluding the 2013 and 2012 adjusted items, increased 10 basis points in 2013, compared to 2012, primarily due to improvements in operating, general and administrative expenses, rent and depreciation, as a percentage of sales, offset partially by continued investments in lower prices for our customers and increased shrink and advertising costs, as a percentage of sales. Operating profit, as a percentage of sales excluding the 2012 and 2011 adjusted items, increased 22 basis points in 2012, compared to 2011, primarily due to improvements in operating, general and administrative expenses, rent, depreciation and the LIFO charge, as a percentage of sales, offset partially by continued investments in lower prices for our customers and increased shrink and warehousing costs, as a percentage of sales.

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 . . .

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