1. The CompanyFred Meyer, Inc., a Delaware corporation, and its subsidiaries (the "Company") operated at January 31, 1998 more than 260 retail stores in a variety of food and drug and multi-department one-stop-shopping formats located primarily in the Western region of the United States. In addition, the Company operates 258 fine jewelry stores across the United States, including 100 stores in the Company's multidepart-ment stores.2. Summary of Significant Accounting PoliciesPrinciples of ConsolidationThe accompanying financial statements include the consol-idated accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated.Fiscal YearThe Company's fiscal year ends on the Saturday closest to January 31. Fiscal years 1997, 1996, and 1995 ended on January 31, 1998, February 1, 1997, and February 3, 1996, respectively. Operating results for fiscal years 1997, 1996, and 1995 include 52, 52, and 53 weeks, respectively.Unless otherwise stated, references to years in this report relate to fiscal years rather than to calendar years. Business SegmentThe Company's operations consist of one segment, retail sales.Cash and Cash EquivalentsThe Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.InventoriesInventories consist principally of merchandise held for sale and substantially all inventories are stated at the lower of last-in, first-out (LIFO) cost or market. Inventories on a first-in, first-out method, which approximates replacement cost, would have been higher by $48.5 million at January 31, 1998 and $52.8 million at February 1, 1997. The pretax LIFO income was $4.3 million in 1997, $1.2 million in 1996, and $1.0 million in 1995.Property and EquipmentProperty and equipment is stated at cost. Depreciation on owned buildings and equipment is provided using the straight-line method over the estimated useful lives of the related assets of three to 31 years. Amortization of buildings and equipment under capital leases is provided using the straight-line method over the remaining related lease terms of 16 to 40 years. Accumulated amortization of buildings and equipment under capitalized leases was $7.8 million at January 31, 1998 and $7.2 million at February 1, 1997.GoodwillGoodwill is being amortized on a straight-line basis over 15 to 40 years. Goodwill recorded in connection with the Smith's Food & Drug Centers, Inc. (Smith's) and Fox Jewelry Company (Fox) acquisitions is being amortized over 40 and 15 years, respectively. Other previously recorded goodwill continues to be amortized over 30 years. Management periodically evaluates the recoverability of goodwill based upon current and anticipated net income and undiscounted future cash flows. Accumulated amortiza-tion was $15.1 million at January 31, 1998 and $4.7 million at February 1, 1997.Impairment of Long-lived AssetsThe Company reviews and evaluates long-lived assets for impairment when events or circumstances indicate costs may not be recoverable. The net book value of long-lived assets is compared to expected undiscounted future cash flows. An impairment loss would be recorded for the excess of net book value over the fair value of the asset impaired.Investment SecuritiesAt January 31, 1998, the carrying value of all debt and equity securities approximated their aggregate fair value. Debt securities are classified as held to maturity and are included in Other Assets.Bank OverdraftsChecks that are issued on zero balance accounts and that have not yet cleared the banks are included in current liabilities.Use of EstimatesThe preparation of financial statements in conformity with generally accepted accounting principles requires manage-ment to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.Buying and Promotional AllowancesVendor allowances and credits that relate to the Company's buying and merchandising activities are recognized as earned.AdvertisingAdvertising costs are expensed as incurred. Advertising costs were $49.9 million in 1997, $34.9 million in 1996, and $37.2 million in 1995.Self-insuranceThe Company is primarily self-insured for general liability, property loss, worker's compensation and non-union health and welfare. Liabilities for these costs are based on actual claims and actuarial statements for estimates of claims that have been incurred but not reported.Pre-opening CostsAll noncapital expenditures incurred in connection with the opening of new or acquired stores and other facilities or the remodeling of existing stores are expensed as incurred.Interest CostsInterest costs are expensed as incurred, except for interest costs which have been capitalized as part of the cost of properties under development. The Company's cash payments for interest (net of capitalized interest of approxi-mately $.2 million in 1997, $.1 million in 1996, and $3.6 million in 1995) totaled $73.0 million in 1997, $40.5 million in 1996, and $45.2 million in 1995.Income TaxesDeferred income taxes are provided for those items included in the determination of income or loss in different periods for financial reporting and income tax purposes. Targeted jobs and other tax credits are recognized in the year realized. Deferred income taxes are recognized for the tax conse-quences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities (see Note 6). Cash paid (refunded) for income taxes was $16.1 million in 1997, $25.7 million in 1996, and $(3.3) million in 1995.Stock-based CompensationThe Company adopted SFAS No. 123, Accounting for Stock-based Compensation, effective January 1, 1996. As allowed under SFAS No. 123, the Company will continue to mea-sure compensation expense for its stock-based employee compensation plans using the intrinsic value based method, but will provide pro forma disclosures of net income and earnings per share as if the method prescribed by SFAS No. 123 had been applied in measuring compensation expense (see Note 7).Earnings Per Common ShareThe Company adopted SFAS No. 128, Earnings Per Share. SFAS No. 128 requires the dual presentation of basic and diluted earnings per share and other additional disclosures. Basic earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per common share are computed by dividing net income by the weighted average number of common and common equivalent shares outstanding. Common equivalent shares relate to outstanding stock options and warrants. Prior year earnings per common share have been restated to conform with the standards established by SFAS No. 128.All share and per share amounts have been restated for the two-for-one stock split.The stock split, effected as a 100 per-cent stock dividend, was effective on September 30, 1997. ReclassificationsCertain prior year amounts have been reclassified to con-form to current year presentation. The reclassifications have no effect on reported net income.3. AcquisitionsOn September 9, 1997, the Company succeeded to the businesses of Fred Meyer, Inc., now known as Fred Meyer Stores, Inc. ("Fred Meyer Stores"), and Smith's Food & Drug Centers, Inc. ("Smith's") as a result of mergers pursuant to the Agreement and Plan of Reorganization and Merger, dated as of May 11, 1997 (the "Smith's Acquisition").At the closing on September 9, 1997, Fred Meyer Stores and Smith's, a regional supermarket and drug store chain operating 152 stores in the Intermountain and Southwestern regions of the United States, became wholly owned subsidiaries of the Company. The Company issued 1.05 shares of Common Stock of the Company for each outstanding share of Class A Common Stock and Class B Common Stock of Smith's and one share of Common Stock of the Company for each outstanding share of Common Stock of Fred Meyer Stores.The Smith's Acquisition was accounted for under the purchase method of accounting. The financial statements reflect the allocation of the purchase price and assumption of certain liabilities and include the operating results of Smith's from the date of acquisition. In total, the Company issued 33.3 million shares of Common Stock to the Smith's stockholders. The following pro forma information presents the results of the Company's operations assuming the Smith's Acquisition occurred at the beginning of each period presented (in thousands, except per share data):
 The pro forma financial information does not reflect anticipated annualized operating savings. Additionally, each year includes an extraordinary charge of $91.2 million on the extinguishment of debt as a result of refinancing certain debt.The pro forma financial information is not necessarily indicative of the operating results that would have occurred had the Smith's Acquisition been consummated as of the beginning of each period nor is it necessarily indicative of future operating results. On August 17, 1997, the Company acquired substantially all of the assets and liabilities of Fox in exchange for common stock with a fair value of $9.2 million. The Fox acquisition was accounted for under the purchase method of account-ing. The results of operations of Fox do not have a material effect on the consolidated operating results, and therefore are not included in the pro forma data presented. The supplemental schedule of business acquisition is as follows (in thousands):
 4. Related-party TransactionsThe Company leases certain store locations and previously leased a distribution center from MetLife, which was a major beneficial stockholder of the Company's stock during the three years ended January 31, 1998. Rents paid to MetLife and other related parties on leases totaled $34.9 million in 1997, $61.8 million in 1996, and $64.0 million in 1995 (see Note 8).Rents paid for store locations leased or subleased from related parties are included in operating and administrative expenses. Rents paid to related parties for the leased distribution center are included in cost of goods sold. In 1995, the Company offered interest-free loans of up to $100,000 each to 19 executives for the purpose of acquiring common stock of the Company. Repayment of these loans is required by June 1998 or upon termination of employ-ment or sale of stock. Outstanding loans under this program amounted to $.3 million at January 31, 1998 and $1.4 million at February 1, 1997. The Company has a management agreement for management and financial services with The Yucaipa Companies ("Yucaipa"), whose managing general partner became the Company's chairman of the board effective September 9, 1997. The agreement provides for annual management fees equal to $.5 million plus reimbursement of all of Yucaipa's reasonable out-of-pocket costs and expenses. In addition, the Company may retain Yucaipa in an advisory capacity in con-nection with certain acquisitions or sale transactions, debt and equity financings, or any other services not otherwise covered by the agreement. 5. Long-term DebtLong-term debt consisted of the following (in thousands):
 In conjunction with the Smith's Acquisition, the Company entered into a new bank credit facility (the "1997 Senior Credit Facility") that refinanced a substantial portion of the Company's indebtedness and indebtedness assumed in the Smith's Acquisition.The 1997 Senior Credit Facility provides a five year $1.03 billion revolving credit facility, a $500.0 million 364-day revolving credit facility and a five year $500.0 million bridge facility. All indebtedness under the 1997 Senior Credit Facility is guaranteed by certain of the Company's sub-sidiaries. The revolving portion of the 1997 Senior Credit Facility is available for general corporate purposes, including the support of the commercial paper program of the Company. The revolving credit facility and the bridge facility mature on September 9, 2002. Commitment fees are charged at .175% on the unused portion of the five year revolving credit facility and .08% on the unused portion of the 364-day facility. The 364-day facility matures on September 9, 1998 with a one year extension available upon the request of the Company. Interest on the 1997 Senior Credit Facility is at the prime rate plus a margin of .5% or the Adjusted LIBOR plus a margin of .30%. At January 31, 1998, the interest rate was 5.89% on the five year revolving credit facility and 6.21% on the five year bridge facility. No amounts were outstanding under the 364-day revolving credit facility. The 1997 Senior Credit Facility requires the Company to comply with certain ratios related to fixed charges and indebt-edness to earnings before interest, taxes, depreciation and amortization ("EBITDA"). In addition, the 1997 Senior Credit Facility limits dividends on and redemption of capital stock. The Company has established uncommitted money market lines with four banks of $125.0 million. These lines, which generally have terms of one year, allow the Company to borrow from the banks at mutually agreed upon rates, usually below the rates offered under the 1997 Senior Credit Facility. The Company also has $500.0 million of unrated commercial paper facilities with three commercial banks. The Company has the ability to support commercial paper and other debt on a long-term basis through its bank credit facilities and therefore, based upon management's intent, has classified these borrowings, which totaled $446.2 million at January 31, 1998, as long-term debt. The Company has entered into interest rate swap, cap, and collar agreements to reduce the impact of changes in interest rates on its floating rate long-term debt. At January 31, 1998, the Company had outstanding four interest rate contracts, for a total notional principal amount of $180.0 million, with commercial banks. One swap agreement effectively fixes the Company's interest rate on unrated commercial paper, floating rate facilities and uncommitted lines of credit at 5.20% on a notional principal amount of $15.0 million. This contract expires in 1998. Two cap agreements effectively limit the maximum interest rate the Company will pay at rates between 5.0% and 9.0% on notional principal amounts totaling $35.0 million.These contracts expire through 1999. One collar agreement effectively limits the maximum interest rate the Company will pay at 7. 5% and limits the minimum interest rate the Company will pay at 5.3% on a notional principal amount of $130.0 million. This contract expires in 1998. The Company has entered into swap and cap agreements to reduce the impact of changes in rent expense on its two lease lines of credit. At January 31, 1998, the Company had outstanding seven rent rate contracts, for a total notional principal amount of $80.0 million, with commercial banks. Three of these agreements effectively fix the Company's rental rate on the lease lines at rates between 6.28% and 6.54% on notional amounts of $40.0 million.The remaining four agreements effectively limit the maximum rental rate the Company will pay at 7.25% on notional amounts totaling $40.0 million. All seven of these contracts expire in 2000. Gains and losses on swaps and caps are amortized over the life of the instruments.The Company is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap and cap agreements.The Company requires an "A" or better rating of the counterparties and, accordingly, does not anticipate nonperformance by the counterparties. Annual long-term debt maturities for the five fiscal years subsequent to January 31, 1998 are $1.5 million in 1998, $5.1 million in 1999, $369.7 million in 2000, $2.8 million in 2001, and $1,381.6 million in 2002. The Company recorded an extraordinary charge of $148.3 million less a $57.1 million income tax benefit which consisted of premiums paid in the prepayment of certain notes and bank facilities of Fred Meyer Stores and Smith's and the write-off of their related deferred financing costs. 6. Income TaxesThe provision for income taxes includes the following (in thousands):
 A reconciliation between the statutory federal income tax rate to the provision for income taxes is as follows (in thousands):
 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at January 31, 1998 and February 1, 1997 were as follows (in thousands):
At January 31, 1998, the Company has net operating loss carryforwards for federal income tax purposes of $186.9 million which expire from 2010 through 2013. In addition, the Company has net operating loss carryforwards for state income tax purposes of $356.4 million which expire from 1998 through 2013. The Company has federal Alternative Minimum Tax ("AMT") credit carryforwards of $7.8 million which are available to reduce future regular taxes in excess of AMT. These credits have no expiration date. 7. Stockholders' EquityAt January 31, 1998, 15.9 million shares of common stock were reserved for issuance to employees, including officers and directors, and nonemployee agents, consultants and advisors, under stock incentive plans.These plans provide for the granting of incentive stock options, nonqualified stock options, stock bonuses, stock appreciation rights, cash bonus rights and performance units.Under the terms of the plans, the option price is determined by the Board of Directors at the time the option is granted. The option price for incentive stock options cannot be less than the fair value of the Company's stock on the date of grant. Nonqualified stock options may not be granted at less than 50% of the fair value on the date of grant. Stock OptionsActivity under the plans was as follows (in thousands, except per share data):
 Stock options granted in 1995, 1996, and 1997 expire in 10 years. The options vest over five years, 20 percent each year, beginning at the end of the first year. In conjunction with the Smith's Acquisition, option holders could elect to accelerate to the closing date of September 9, 1997 the vesting of previously unvested options. Accordingly, nearly all options outstanding became fully vested at the closing date. Options outstanding at Smith's became fully vested at the closing date and were converted at the exchange ratio into options exercisable in the Company's Common Stock expiring on the original terms. All stock options granted in 1995 and 1996 were granted at an amount equal to or greater than the fair market value on the date prior to the grant date. Accordingly, no compensation was recorded in 1995 and 1996. Compensation expense for options granted in 1997 at an amount below the fair market value was recorded for the amortization of the difference between the market value on the date of grant and the grant price. The amortization was determined on a straight-line basis over the vesting period. The amount charged to operations in 1997 was immaterial. The following table summarizes information concerning currently outstanding and exercisable options at January 31, 1998:
 Shares available for option were 8.5 million as of January 31, 1998 and 1.9 million as of February 1, 1997. Of the shares available at January 31, 1998, 1.4 million shares have been approved for grant to employees of the companies that were acquired subsequent to the year end. The Company issued a replacement grant election program in 1996 that allowed stock option holders with options granted at more than $13.00 per share to reset the price at $13.00, on up to 1,968,000 options that were previously granted at prices ranging from $13.62 to $20.63. For those who elected to reset their option price to $13.00, the vest-ing period started over. The Company has adopted the disclosure-only provisions of SFAS No. 123. Accordingly, no compensation cost has been recognized for stock options granted at the market value on the date of grant. Had compensation cost for the Company's stock option plans been determined based on the estimated fair value of the options at the date of grant, the Company's net income and income per share would have been reduced to the pro forma amounts below:
 The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants awarded in each year:
 The effects of applying SFAS 123 in this pro forma disclosure are not indicative of future amounts. SFAS 123 does not apply to stock options granted prior to 1995. It is anticipated that additional stock options will be granted in future years. Other OptionFMI Associates, which was the Company's principal shareholder in 1996, exercised an option in 1996 for the purchase of 3.1 million shares with an aggregate value of $5.1 million.WarrantAs part of the Smith's Acquisition, the Company converted a warrant for Smith's stock into a warrant for Fred Meyer stock.The warrant issued to Yucaipa is for the purchase of up to 3.9 million shares of Common Stock at an exercise price of $23.81 per share. Half of the warrant expires in 2005 and half expires in 2006. Additionally, at the option of Yucaipa, the warrant is exercisable without the payment of cash consideration. Under this condition, the Company will withhold upon exercise the number of shares having a market value equal to the aggregate exercise price from the shares issuable.Management BonusIn 1996, the Company awarded a stock bonus to a corporate officer for 20,000 shares totaling $291,250. Shares vest annually over five years.In 1997, the Company awarded stock bonuses to corporate officers for 3,000 shares totaling $60,562 that vest annually over five years and 8,606 shares totaling $177,498 that vest annually over three years. Nonemployee Directors Stock Compensation PlanIn 1996, the Company purchased 25,116 shares of its common stock at market prices for the benefit of six of its nonemployee directors in lieu of a portion of current and future Board of Director fee payments. The shares total $400,103 and became fully vested in conjunction with the Smith's Acquisition.Stock SplitOn September 5, 1997, the Executive Committee of the Board of Directors declared a two-for-one stock split, to be effected in the form of a 100% stock dividend. As a result, 43.9 million shares were issued on September 30, 1997 to shareholders of record on September 19, 1997. Par value remained at $.01 per share as a result of transferring $439,000 to common stock from additional paid-in capital. All references to the number of shares and to per share information in the consolidated financial statements and notes thereto have been adjusted to reflect the stock split on a retroactive basis.8. LeasesThe Company leases or subleases property and equipment used in its operations. The terms of certain leases include renewal options, escalation clauses, percentage rents based on sales, or payment of executory costs such as property taxes, utilities, insurance and maintenance. Portions of certain properties are subleased to others for periods of from one to 20 years.At January 31, 1998, minimum rentals under noncancelable leases for future fiscal years were as follows (in thousands):
 Rent expense under operating leases, including executory costs, were as follows (in thousands):
 At January 31, 1998, deferred lease transactions consisted of unamortized gains on lease financing transactions and cumulative net excess of rent expense over cash rents. The gains on lease financing transactions included the differences between property held under capital leases and capital lease obligations at the time of amendments to the capital leases which resulted in the leases qualifying as operating leases and gains resulting from sale-leaseback transactions.The gains are being amortized over the remaining life of the respective leases. The excess rent expense over cash rents results from charging to operations the average rent over the primary lease term on leases with escalating rent payments. On February 4, 1997, in a series of transactions with MetLife, the Company purchased, for approximately $49.0 million, six stores previously leased from MetLife and an option to purchase parcels at 18 of the 29 stores the Company will continue to lease from MetLife. Additionally, the Company entered into new 25-year leases on these remaining 29 stores that will result in reduced rents for accounting purposes.A distribution center that was leased to the Company by MetLife was sold to a third party who leased the center to the Company at reduced rates. In 1996 and 1997, the Company completed sale-leaseback transactions on 13 stores.The proceeds from the transactions were used to repay outstanding indebtedness on credit lines and for general working capital purposes. The initial lease terms are for 21 to 23 years and are subject to renewal at the option of the Company. The annual rent obligation, including amortization of fees and deferred gain, is approximately $12.1 million. On September 9, 1997, the Company entered into a $270.0 million five-year operating lease facility which was used to replace the leases on 17 existing leased stores and to finance the construction of three new stores. Lease payments are based on LIBOR applied to the utilized portion of the facility. As of January 31, 1998, the Company had utilized $251.0 million of the facility. On January 28, 1998, the Company entered into a $53.0 million 90-day operating lease facility. Lease payments are based on LIBOR applied to the utilized portion of the facility. As of January 31, 1998, the Company had utilized $52.0 million of the facility. 9. Employee Benefit PlansEmployees' Profit-sharing PlanProfit-sharing contributions under this Plan, which covers nonunion employees of Fred Meyer Stores, are made to a trust fund held by a third-party trustee. Contributions are based on the Company's pretax income, as defined, at rates determined by the Board of Directors and are not to exceed amounts deductible under applicable provisions of the Internal Revenue Code. In 1994, the Company added an annual 1% basic contribution to all eligible employees' accounts subject to normal plan vesting. The Company expensed $9.1 million in 1997, $7.7 million in 1996, and $6.4 million in 1995 for these contributions.Multiemployer Pension PlansThe Company contributes to multiemployer pension plan trusts at specified rates in accordance with collective bargaining agreements. Contributions to the trusts were $12.3 million in 1997, $10.4 million in 1996, and $9.9 million in 1995. The Company's relative positions in these plans with respect to the actuarial present value of the accumulated benefit obligation and the projected benefit obligation, net assets available for benefits and the assumed rates of return used by the plans are not determinable.Employee Stock Purchase PlanThe Company has a noncontributory employee stock purchase plan that allows employees to purchase stock in the Company at market prices via payroll deductions. The Company pays all brokerage fees associated with the purchase of the stock and administrative fees.The Company also pays a ten percent cash bonus at year end based on the number of shares purchased and held during the previous calendar year and the market price at year end. The plan is available to all employees over age 18 who have completed six months of continuous employment with the Company.Supplemental Retirement ProgramThe Company has a supplemental retirement program for senior management, selected vice presidents and selected key individuals. Program provisions are as follows:Senior Management - The plan is funded with life insur-ance contracts on the lives of the participants.The Company is the owner of the contracts and made annual contributions per participant of $35,000 in 1997 and $25,000 in 1996 and 1995. Total contributions were $865,000 in 1997, $400,000 in 1996, and $350,000 in 1995. Retirement age under the plan is normally 62 with an alternative age of 65, at which point the Company will make 15 annual benefit payments to the executive. Selected Vice Presidents and Selected Key Individuals - The Company will contribute annually a percentage of each participant's gross salary. The plan is funded with life insur-ance contracts on participants age 54 and younger and variable annuity contracts for participants age 55 and older. Each participant is the owner of his/her respective contract. Pension PlanThe Company maintains a defined benefit pension plan for all permanent, nonunion employees of Smith's which provides for normal retirement at age 65. Employees are eligible to join when they complete at least one year of service and have reached age 21. The benefits are based on years of service and stated amounts associated with those years of service.The Company's current funding policy is to contribute annually up to the maximum amount deductible for federal income tax purposes. Net pension cost charged to operations from the date of acquisition to year end includes the following components (in thousands):
 The following table presents the plan's funded status and amounts recognized in the Company's consolidated balance sheet (in thousands):
 The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 7%. The expected long-term rate of return on plan assets was 9%. 10. Other Postretirement BenefitsFor employees who qualified prior to January 1, 1994, the Company sponsored a retiree health plan for postretirement health care coverage with eligibility requirements and benefits varying by region of the Company.Under this plan, the Company contributes 100% of the premiums of the basic plan for retired salaried employees qualifying under eligibility requirements which specify minimum age and years of continuous service at age 60 with 25 years of service, age 62 with 20 years of service and age 65 with 15 years of service. For retired salaried and hourly employees between the ages of 62 to 65 years and having completed minimum continu-ous service of 15 years, the retiree pays premiums at current employee rates. As of January 1, 1994, the Company changed the eligibility requirements and benefits available under the retiree health plan. For all salaried and non-union hourly employees in all regions who retire after January 1, 1994, eligibility require-ments changed to a minimum of 60 years of age with 10 years of continuous service. Under the revised plan, the retiree pays premiums at current employee rates. The following table sets forth the plan's funded status, reconciled with the amount shown in the Company's balance sheets (in thousands):
 Net periodic postretirement benefit cost included the fol-lowing components:  The assumed health care cost trend rates used in measuring the accumulated postretirement benefit obligation were as follows: Under Medicare Retirement Age - 6% for one year, then grading down to 4.5% by the year 2001, and Medicare Retirement Age and Over - 5% for one year, then grading down to 4.5% in 1999. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation by $1.1 million at January 31, 1998 and February 1, 1997 and increase the aggregate of the service and interest cost components of the net periodic postretirement benefit cost by $191,000 in 1997 and $169,000 in 1996. 11. Estimated Fair Value of Financial InstrumentsThe estimated fair value of financial instruments has been determined by the Company using available market information and valuation methodologies as shown below. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could actually realize.Management is not aware of any factors that would significantly change the estimated fair value amounts shown below. A comprehensive revaluation for purposes of these financial statements has not been performed since January 31, 1998, and current estimates of fair value may differ from the amounts presented herein. The Company is not subjected to a concentration of credit risk. Cash and Cash Equivalents, Receivables, Prepaid Expenses and Other Current Assets, Other Long-term Assets, Outstanding Bank Overdrafts and Accounts PayableThe carrying amounts of these items are a reasonable estimate of their fair value.Long-term Debt and Interest Rate AgreementsThe amount of long-term debt included in the balance sheet approximates its fair value at January 31, 1998. The fair value of notes, mortgages and real estate assessments payable is estimated by discounting expected future cash flows. The discount rate used is the rate currently available to the Company for issuance of debt with similar terms and remaining maturities. The amounts for commercial paper and bid lines of credit under the revolving credit agreement (see Note 5) approximates fair value at January 31, 1998. The fair value of interest rate or rent rate swap and cap agreements is the estimated settlement amount. At January 31, 1998, the Company could settle the various swap agree-ments at a loss of $699,000 and various cap agreements at a loss of $525,000. The value is determined based on the notional amount of each cap and swap, its term and the difference in rates between the date of measurement and when the cap or swaps were initiated.12. Commitments and ContingenciesThe Company and its subsidiaries are parties to various legal claims, actions and complaints, certain of which involve material amounts. Although the Company is unable to predict with certainty whether or not it will ultimately be successful in these legal proceedings or, if not, what the impact might be, management presently believes that disposition of these matters will not have a material adverse effect on the Company's consolidated financial statements.13. Subsequent EventsOn November 6, 1997, the Company entered into separate merger agreements with Quality Food Centers, Inc. ("QFC"), a supermarket chain operating 89 stores in the Seattle/Puget Sound region of Washington state and 56 Hughes Family Market stores in Southern California, and Food 4 Less Holdings, Inc. ("Ralphs/Food 4 Less"), a super-market chain operating 409 stores primarily in Southern California and Northern California.QFC AcquisitionAt the closing on March 9, 1998, QFC became a wholly-owned subsidiary of the Company. The Company issued 41.2 million shares of common stock of the Company, representing 1.9 shares of common stock of the Company for each outstanding share of QFC common stock. The acquisition will be accounted for under the pooling-of-interest method of accounting. The accompanying financial statements do not reflect any adjustments as a result of the QFC Acquisition.The following pro forma information presents the com-bined historical results of the Company and QFC assuming the Company and QFC have always been one company (in thousands, except per share data):
 The pro forma financial information does not reflect antici-pated annualized operating savings or adjustments for acquisitions made by both the Company and QFC during the most recent fiscal year as if such acquisitions occurred at the beginning of each period presented. Ralphs/Food 4 Less AcquisitionAt the closing on March 10, 1998, Ralphs/Food 4 Less became a wholly-owned subsidiary of the Company. The Company issued 21.7 million shares of common stock of the Company for all of the equity interests of Ralphs/Food 4 Less. The acquisition will be accounted for under the purchase method of accounting. The accompanying finan-cial statements do not reflect any adjustments as a result of the Ralphs/Food 4 Less acquisition.Debt RefinancingIn conjunction with the acquisitions, the Company entered into new financing arrangements that refinanced a substan-tial portion of the Company's principal debt facilities and indebtedness assumed in the acquisitions of QFC and Ralphs/Food 4 Less. The new credit facilities include a public issue of $1.75 billion senior unsecured notes and bank credit facilities which include a $1.875 billion five-year revolving credit agreement, and a $1.625 billion five-year term note. The unsecured notes were issued with $250 mil-lion of five-year notes at 7.15%, $750 million of seven-year notes at 7.38%, and $750 million of ten-year notes at 7.45%. At closing on March 11, 1998, the Company utilized $2.765 billion of bank credit facilities. An additional $403 million was used to support the Company's commercial paper program.The remaining $332 million was available at March 11, 1998 for general corporate purposes. A commitment fee of .30% will be charged on the unused portion of the five-year revolving credit agreement. Interest on the revolving credit agreement and term notes will be at the Adjusted LIBOR plus a margin of 1.0%.In addition to the new credit facilities, the Company entered into a $500 million five-year operating lease facility which refinanced $303 million in existing lease financing facilities. The balance of this lease facility will be used for land and construction costs for new stores. 14. Selected Quarterly Financial Data (Unaudited)
1. The LIFO adjustment in the fourth quarter of 1997 increased gross margin and income from operations by $9,417, income before extraordinary charge and net
income by $5,814 and diluted earnings per common share by $.06.
2. In 1997, the sum of the four quarters earnings per common share does not equal the annual amount due to the acquisition of Smith's and the two-for-one
stock split in the third quarter. In 1996, the sum of the four quarters earnings per common share does not equal the annual amount due to the purchase by
the Company in October 1996 of 4,400 shares of its common stock.
3. The LIFO adjustment in the fourth quarter of 1996 increased gross margin and income from operations by $5,386, net income by $3,339 and diluted earnings
per common share by $.06.
Management's Report On Responsibility For Financial StatementsThe management of Fred Meyer, Inc. has the responsibility for preparing the accompanying financial statements and for their integrity and objectivity. The statements were prepared in accordance with generally accepted accounting princi-ples. The financial statements include amounts that are based on management's best estimates and judgments. Management also prepared other information in the annual report and is responsible for its accuracy and consistency with the financial statements. The Company's financial statements have been audited by Deloitte & Touche LLP, independent auditors. Management has made available to Deloitte & Touche LLP all the Company's financial records and related data, as well as the minutes of shareholders' and directors' meetings. Management has established and maintains an internal control structure that provides reasonable assurance as to the integrity and reliability of the financial statements, the protection of assets from unauthorized use or disposition and the prevention and detection of fraudulent financial reporting. The internal control structure provides for the appropriate division of responsibility, which is monitored for compliance. The Company maintains an internal auditing program that assesses the effectiveness of the internal control structure and recommends improvements.Deloitte & Touche LLP also considered the internal control structure in connection with its audit. Management has considered the internal auditors' and Deloitte & Touche LLP's recommendations concerning the Company's internal control structure and has taken the appropriate actions to respond to these recommendations. The Company's principles of business conduct address, among other things, potential conflicts of interests and compliance with laws, including those relating to financial disclosure and the confidentiality of proprietary information. The Board of Directors pursues its responsibility for the quality of the Company's financial reporting primarily through its Audit Committee, which is comprised of outside directors. The Audit Committee meets approximately three times a year with management, the corporate internal audit manager, and the independent auditors to ensure that each is meeting its responsibilities and to discuss matters concerning internal controls and accounting and financial reporting.The corporate internal audit manager and independent auditors have unrestricted access to the Audit Committee.
David R. Jessick
Independent Auditor's ReportTo the Shareholders and Board of Directors of Fred Meyer, Inc.:We have audited the accompanying consolidated balance sheets of Fred Meyer, Inc. and subsidiaries as of January 31, 1998 and February 1, 1997, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three fiscal years in the period ended January 31, 1998. These financial statements are the responsibility of the Company's management. Our responsi-bility is to express an opinion on these financial statements based on our audits.We conducted our audits in accordance with generally accepted auditing standards.Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial state-ment presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements pre-sent fairly, in all material respects, the financial position of Fred Meyer, Inc. and subsidiaries at January 31, 1998 and February 1, 1997, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 31, 1998, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP March 11, 1998
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