-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NvQM56f0c8hXR5q42xJupxvYoqKnsHP3Wnn1Le31kyXX0q9W80EmB+ppgRoHHtOa l9ISePhYQT3X/VhCfuiEtA== 0000893877-99-000160.txt : 19990308 0000893877-99-000160.hdr.sgml : 19990308 ACCESSION NUMBER: 0000893877-99-000160 CONFORMED SUBMISSION TYPE: 10-Q/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981107 FILED AS OF DATE: 19990305 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FRED MEYER INC CENTRAL INDEX KEY: 0001043273 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-DEPARTMENT STORES [5311] IRS NUMBER: 911826443 STATE OF INCORPORATION: DE FISCAL YEAR END: 0201 FILING VALUES: FORM TYPE: 10-Q/A SEC ACT: SEC FILE NUMBER: 001-13339 FILM NUMBER: 99557446 BUSINESS ADDRESS: STREET 1: 3800 SE 22ND AVE CITY: PORTLAND STATE: OR ZIP: 97202 BUSINESS PHONE: 5032328844 MAIL ADDRESS: STREET 1: 3800 SE 22ND AVENUE CITY: PORTLAND STATE: OR ZIP: 97202 FORMER COMPANY: FORMER CONFORMED NAME: MEYER SMITH HOLDCO INC DATE OF NAME CHANGE: 19970730 10-Q/A 1 FORM 10-Q/A ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A Amendment No. 1 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 7, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File No. 1-13339 FRED MEYER, INC. (Exact name of registrant as specified in its charter) Delaware 91-1826443 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3800 SE 22nd Avenue Portland, Oregon 97202 (Address of principal executive offices) (Zip Code) (503) 232-8844 (Registrant's telephone number, including area code) 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 [ ] Number of shares of Common Stock outstanding at December 5, 1998: 155,169,609 ================================================================================ Table of Contents - -------------------------------------------------------------------------------- Items of Form 10-Q Page Part I - FINANCIAL INFORMATION Item 1 Financial Statements ....................................... 3 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 15 Part II - OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K............................ 25 Signatures ............................................................... 26 2 Part I - FINANCIAL INFORMATION - -------------------------------------------------------------------------------- Item 1. Financial Statements. - ---------------------------- Consolidated Statements of Income (Unaudited)
12 Weeks Ended 40 Weeks Ended --------------------------- --------------------------- November 7, November 8, November 7, November 8, (In thousands, except per share data) 1998 1997 1998 1997 ----------- ----------- ----------- ----------- Net sales $ 3,477,091 $ 1,945,543 $11,022,471 $ 4,996,582 Cost of goods sold 2,434,961 1,370,439 7,749,272 3,515,612 ----------- ----------- ----------- ----------- Gross margin 1,042,130 575,104 3,273,199 1,480,970 Operating and administrative expenses 833,836 488,660 2,668,306 1,272,227 Amortization of goodwill 22,930 6,514 66,166 8,269 Merger related costs 31,484 - 237,542 - ----------- ----------- ----------- ----------- Income from operations 153,880 79,930 301,185 200,474 Interest expense 92,945 30,174 284,720 66,189 ----------- ----------- ----------- ----------- Income (loss) before income taxes and extraordinary charge 60,935 49,756 16,465 134,285 Provision for income taxes 31,771 21,091 46,936 53,655 ----------- ----------- ----------- ----------- Income (loss) before extraordinary charge 29,164 28,665 (30,471) 80,630 Extraordinary charge, net of taxes (324) (91,210) (217,934) (91,210) ----------- ----------- ----------- ----------- Net income (loss) $ 28,840 $ (62,545) $ (248,405) $ (10,580) =========== =========== =========== =========== Basic earnings per common share: Income (loss) before extraordinary charge $ 0.19 $ 0.24 $ (0.20) $ 0.83 Extraordinary charge - (0.77) (1.45) (0.94) ----------- ----------- ----------- ----------- Net income (loss) $ 0.19 $ (0.53) $ (1.65) $ (0.11) =========== =========== =========== =========== Basic weighted average number of common shares outstanding 154,690 118,331 150,601 97,355 =========== =========== =========== =========== Diluted earnings per common share: Income (loss) before extraordinary charge $ 0.18 $ 0.23 $ (0.20) $ 0.79 Extraordinary charge - (0.74) (1.45) (0.89) ----------- ----------- ----------- ----------- Net income (loss) $ 0.18 $ (0.51) $ (1.65) $ (0.10) =========== =========== =========== =========== Diluted weighted average number of common and common equivalent shares outstanding 162,127 123,546 150,601 101,562 =========== =========== =========== =========== See Notes to Consolidated Financial Statements.
3 Consolidated Balance Sheets (Unaudited)
November 7, January 31, (In thousands) 1998 1998 ------------ ----------- Assets Current assets: Cash and cash equivalents $ 186,045 $ 117,311 Receivables 140,291 108,496 Inventories 2,007,875 1,240,866 Prepaid expenses and other 60,540 70,536 Current portion of deferred taxes 201,001 90,804 ------------ ----------- Total current assets 2,595,752 1,628,013 Property and equipment--net 3,570,974 2,432,040 Other assets: Goodwill--net 3,684,442 1,279,130 Long-term deferred tax assets 272,573 - Other 170,919 83,753 ------------ ----------- Total other assets 4,127,934 1,362,883 ------------ ----------- Total assets $ 10,294,660 $ 5,422,936 ============ =========== Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 1,294,311 $ 766,678 Accrued expenses and other 1,007,617 407,167 Current portion of long-term debt and lease obligations 134,650 19,650 ------------ ----------- Total current liabilities 2,436,578 1,193,495 Long-term debt 4,999,856 2,184,794 Capital lease obligations 173,341 82,782 Deferred lease transactions 30,175 38,556 Deferred income taxes - 83,183 Other long-term liabilities 478,492 137,766 Stockholders' equity: Common stock 1,550 1,288 Additional paid-in capital 1,895,533 1,173,760 Notes receivable from officers (335) (298) Unearned compensation (3,236) (466) Retained earnings 282,706 528,076 ------------ ----------- Total stockholders' equity 2,176,218 1,702,360 ------------ ----------- Total liabilities and stockholders' equity $ 10,294,660 $ 5,422,936 ============ =========== See Notes to Consolidated Financial Statements.
4 Consolidated Statements of Cash Flows (Unaudited)
40 Weeks Ended ---------------------------- November 7, November 8, (In thousands) 1998 1997 ------------ ----------- Cash flows from operating activities: Income (loss) before extraordinary charge $ (30,471) $ 80,630 Adjustments to reconcile income (loss) before extraordinary charge to net cash provided by operating activities: Depreciation and amortization of property and equipment 270,039 141,807 Amortization of goodwill 66,166 8,269 Deferred lease transactions (9,791) (8,884) Merger related asset write-offs 80,360 - Deferred income taxes 43,903 (1,140) Changes in operating assets and liabilities: Receivables (4,740) (10,156) Inventories (170,119) (189,050) Other current assets 12,896 12,780 Accounts payable 198,018 138,750 Accrued expenses and other liabilities (35,515) (5,953) Income taxes 19,628 6,235 Other 16,930 (35) ------------ ----------- Net cash provided by operating activities 457,304 173,253 Cash flows from investing activities: Cash acquired in acquisitions 66,519 71,476 Payments made for acquisitions (173,847) (419,402) Purchases of property and equipment (497,616) (250,302) Proceeds from sale of property and equipment 23,028 64,625 Other (27,096) 5,375 ------------ ----------- Net cash used for investing activities (609,012) (528,228) Cash flows from financing activities: Issuance of common stock - net 59,377 223,679 Net increase in notes receivable 319 928 Payment of deferred financing fees (69,571) - Long-term financing: Borrowings 4,514,075 1,989,653 Repayments (4,288,488) (1,728,105) Other 4,730 - ------------ ----------- Net cash provided by financing activities 220,442 486,155 ------------ ----------- Net increase in cash and cash equivalents for the period 68,734 131,180 Cash and cash equivalents at beginning of year 117,311 63,340 ------------ ----------- Cash and cash equivalents at end of period $ 186,045 $ 194,520 ============ =========== See Notes to Consolidated Financial Statements.
5 Notes to Consolidated Financial Statements 1. Organization Fred Meyer, Inc., a Delaware corporation, collectively with its subsidiaries ("Fred Meyer" or the "Company") is one of the largest food retailers in the United States, operating 830 supermarkets and multi-department stores located primarily in the Western portion of the United States. The Company operates multiple formats that appeal to customers across a wide range of income brackets including stores under the following banners: Fred Meyer, Smith's Food & Drug Centers, Smitty's, QFC, Ralphs, and Food 4 Less. 2. Recent Events On October 19, 1998, the Company announced the signing of a definitive merger agreement with The Kroger Co. ("Kroger"), the largest retail grocery chain in the United States. On that date, Kroger operated 1,398 food stores, 802 convenience stores and 34 manufacturing facilities that manufacture products for sale in all Kroger divisions, as well as to external customers. Under the terms of the merger agreement, Fred Meyer stockholders will receive one newly issued share of Kroger common stock for each share of Fred Meyer common stock. The transaction will be accounted for as a pooling of interests. It is expected to close in early 1999 subject to approval of Kroger and Fred Meyer stockholders and antitrust and other regulatory authorities and customary closing conditions. In anticipation of the intended merger with Kroger, the Company has secured approval from its banks to amend its 1998 Senior Credit Facility (as defined herein) as well as its operating lease facility. These proposed amendments are subject to completion of the merger and will be guaranteed by Kroger. The Company's outstanding senior notes due 2003 through 2008 are expected to remain outstanding after the merger. Additional information regarding the merger can be found in the Company's current report on Form 8-K dated October 20, 1998. On December 6, 1998, Ralphs Grocery Company, a subsidiary of the Company, sold 38 grocery stores located in Kansas and Missouri to Associated Wholesale Grocers, Inc., a member-owned grocery cooperative. 3. Acquisitions On March 9, 1998, Fred Meyer issued 41.2 million shares of Fred Meyer common stock for all the outstanding stock of Quality Food Centers, Inc. ("QFC"), a supermarket chain operating 89 stores in the Seattle/Puget Sound region of Washington state and 56 Hughes Family Markets stores in Southern California as of the date of the merger. As a result, QFC became a wholly owned subsidiary of Fred Meyer. The merger of Fred Meyer and QFC was accounted for as a pooling of interests and the accompanying financial statements reflect the consolidated results of Fred Meyer and QFC for all periods presented. The amounts included in the prior year results of operations from Fred Meyer and QFC are as follows (in thousands, except per share data):
Fred Meyer QFC Total Historical Historical Company ------------ ------------ ----------- 12 Weeks Ended November 8, 1997 Net sales $ 1,460,372 $ 485,171 $ 1,945,543 Net income (loss) (72,933) 10,388 (62,545) Diluted earnings (loss) per common share (0.89) 0.25 (0.51) 40 Weeks Ended November 8, 1997 Net sales 3,611,323 1,385,259 4,996,582 Net income (loss) (40,554) 29,974 (10,580) Diluted earnings (loss) per common share (0.64) 0.79 (0.10)
6 On March 10, 1998, the Company acquired Food 4 Less Holdings, Inc. ("Ralphs/Food 4 Less"), a supermarket chain operating 409 stores primarily in Southern California on that date, which 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 is being accounted for under the purchase method of accounting. The financial statements reflect the preliminary allocation of the purchase price and assumption of certain liabilities and include the operating results of Ralphs/Food 4 Less from the date of acquisition. In conjunction with the acquisitions of Ralphs/Food 4 Less and QFC, the Company entered into a settlement agreement with the State of California in which it agreed to divest 19 specific stores in Southern California to settle potential antitrust and unfair competition claims. Currently, the Company has sold five of the stores and has sale agreements or letters of intent on another 13 stores. On September 9, 1997, the Company succeeded to the businesses of Fred Meyer Stores, Inc. ("Fred Meyer Stores" and known as Fred Meyer, Inc. prior to September 9, 1997) and Smith's Food & Drug Centers, Inc. ("Smith's"). 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 on that date, 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. On August 17, 1997, the Company acquired substantially all of the assets and liabilities of Fox Jewelry Company ("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 accounting. 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. On March 19, 1997, QFC acquired the principal operations of Hughes Markets, Inc. ("Hughes"), including the assets and liabilities related to 57 stores located in Southern California and a 50% interest in Santee Dairies, Inc., one of the largest dairy plants in California. The merger was effected through the acquisition of 100% of the outstanding voting securities of Hughes for approximately $360.5 million in cash and the assumption of approximately $33.2 million of indebtedness of Hughes. The Hughes 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 Hughes from the date of acquisition. On February 14, 1997, QFC acquired the principal operations of Keith Uddenberg, Inc. ("KUI"), including assets and liabilities related to 25 stores in the western and southern Puget Sound region of Washington. The merger was effected through the acquisition of 100% of the outstanding voting securities of KUI for $34.5 million cash, 1.7 million shares of common stock and the assumption of approximately $23.8 million of indebtedness of KUI. The KUI 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 KUI from the date of acquisition. Additionally, the Company completed the acquisition of food and fine jewelry stores during the 40 weeks ended November 7, 1998. On October 4, 1998, the Company acquired 123 Littman Jewelers and 9 Barclays Jewelers stores located primarily in 10 states on the East coast. On October 1, 1998, the Company acquired 13 Albertson's and Buttrey grocery stores in Montana and 7 Wyoming. These acquisitions were accounted for under the purchase method of accounting. The results of operations for these acquired stores do not have a material effect on the consolidated operating results, and therefore are not included in the pro forma data presented. The following unaudited pro forma information presents the results of the Company's operations assuming the Ralphs/Food 4 Less, Smith's, QFC, KUI, and Hughes acquisitions occurred at the beginning of each period presented. In addition, the following unaudited pro forma information gives effect to refinancing certain debt as if such refinancing occurred at the beginning of each period presented (in thousands, except per share data):
40 Weeks Ended ---------------------------- November 7, November 8, 1998 1997 ----------- ----------- Net sales $11,568,003 $11,285,962 Income (loss) before extraordinary charge (91,239) 55,684 Net loss (309,173) (161,926) Diluted earnings per common share: Income (loss) before extraordinary charge (0.59) 0.37 Net loss (2.02) (1.06)
The pro forma financial information does not reflect anticipated annualized operating savings and assumes all notes subject to the refinancings were redeemed pursuant to tender offers made. Additionally, each year includes an extraordinary charge of $217.9 million, net of the related tax benefit, 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 acquisitions been consummated as of the beginning of each period nor is it necessarily indicative of future operating results. The supplemental schedule of business acquisitions is as follows (in thousands):
40 Weeks Ended ---------------------------- November 7, November 8, 1998 1997 ----------- ----------- Fair value of assets acquired $ 2,165,950 $ 2,055,091 Goodwill recorded 2,397,030 1,221,141 Value of stock issued (652,514) (767,145) Liabilities assumed (3,736,619) (2,089,685) ----------- ----------- Cash paid $ 173,847 $ 419,402 =========== ===========
8 4. Merger Related Costs The Company is in the process of implementing its plan to integrate its five primary operations (Fred Meyer Stores, Ralphs/Food 4 Less, Smith's, QFC and Hughes) resulting in merger related costs of $31.4 million and $237.5 million for the 12 and 40 weeks ended November 7, 1998. The integration plan includes the consolidation of distribution, information systems, and administrative functions, conversion of 78 store banners, closure of seven stores, and transaction costs incurred to complete the mergers. The costs were reported in the periods in which cash was expended except for $25.9 million that was accrued for liabilities incurred to exit certain activities and retain certain key employees and an $80.4 million charge to write-down certain assets. The following table presents components of the merger related costs by quarter for the 40 weeks ended November 7, 1998 (in thousands):
16 Weeks 12 Weeks 12 Weeks 40 Weeks Ended Ended Ended Ended May 23, Aug 15, Nov 7, Nov 7, 1998 1998 1998 1998 -------- -------- -------- -------- Charges recorded as cash expended Distribution consolidation $ 10,717 $ 1,900 $ 321 $ 12,938 Systems integration 12,643 6,201 13,017 31,861 Store conversions 24,511 11,517 5,924 41,952 Transaction costs 29,215 2,839 1,138 33,192 Store closures 133 133 Administration integration 5,370 2,460 3,327 11,157 -------- -------- -------- -------- 82,589 24,917 23,727 131,233 Noncash asset write-down Distribution consolidation 28,588 28,588 Systems integration 18,722 2,000 2,333 23,055 Store conversions Transaction costs Store closures 6,959 18,532 25,491 Administration integration 3,226 3,226 -------- -------- -------- -------- 57,495 20,532 2,333 80,360 Accrued charges Distribution consolidation Systems integration 1,445 1,445 Store conversions Transaction costs 1,581 2,108 2,108 5,797 Store closures 6,686 6,686 Administration integration 8,705 3,316 12,021 -------- -------- -------- -------- 18,417 2,108 5,424 25,949 -------- -------- -------- -------- Total merger related costs $158,501 $ 47,557 $ 31,484 $237,542 ======== ======== ======== ======== Total charges Distribution consolidation $ 39,305 $ 1,900 $ 321 $ 41,526 Systems integration 32,810 8,201 15,350 56,361 Store conversions 24,511 11,517 5,924 41,952 Transaction costs 30,796 4,947 3,246 38,989 Store closures 13,778 18,532 32,310 Administration integration 17,301 2,460 6,643 26,404 -------- -------- -------- -------- Total merger related costs $158,501 $ 47,557 $ 31,484 $237,542 ======== ======== ======== ========
9 Distribution Consolidation--Represents costs to consolidate manufacturing and distribution operations and eliminate duplicate facilities. The costs include a $28.6 million write-down to estimated net realizable value for the Hughes distribution center in Southern California. Net realizable value was determined by a market analysis. The facilities are held for sale and depreciation expense for the closed Hughes distribution facility has been suspended. Depreciation expense in the second and third quarter would have totaled $1.1 million if it had not been suspended. Efforts to dispose of the facilities are ongoing and a sale is expected in 1999. Also included are $12.9 million incurred for incremental labor during the closing of the distribution center and other incremental costs incurred as a part of the realignment of the Company's distribution system. Systems Integration--Represents the costs of integrating systems from QFC, Hughes and Smith's computer platforms into Fred Meyer and Ralphs' platforms and the related conversion of all corporate office and store systems. The asset write-down of $23.1 million includes $17 million for computer equipment and related software that have been abandoned and $6 million associated with computer equipment at QFC which is being written off over one year at which time it will be abandoned. Costs totaling $31.8 million were expensed as incurred and includes $16.7 million of incremental operating costs, principally labor, during the conversion process, $9.5 million paid to third parties, and $5.0 million of training costs. Also included are severance costs for system employees who will be terminated as the integration is completed. Store Conversions--Includes the costs to convert 55 Hughes stores to the Ralphs' banner, 15 Smitty's stores to the Fred Meyer banner, five QFC stores to the Fred Meyer banner, and three Fred Meyer stores to the Smith's banner. As of November 7, 1998, the conversion of the Hughes and QFC stores was substantially complete. Costs totaling $42.0 million represented incremental cash expenditures for advertising and promotions to establish the banner, changing store signage, labor required to remerchandise the store inventory and other services which were expensed as incurred. Transaction Costs--Represents $33.2 million for fees paid to outside parties and employee bonuses that were contingent upon the completion of the mergers and $5.8 million for an employee stay bonus program. The stay bonus program is being accrued ratably over the stay period and will be paid in the fourth quarter of 1998. Store Closures--Includes the costs to close four stores identified as duplicate facilities and to sell three stores pursuant to a settlement agreement with the State of California ("AG Stores"). Annual sales and operating income for the four duplicate facilities and three AG Stores are approximately $133 million and $3 million, respectively. The asset write-down represents $6.0 million of book value in excess of sale proceeds, $18.5 million for the write-off of the goodwill associated with the AG Stores, and $6.7 million of lease termination costs. As of November 7, 1998, all stores were closed or sold except for three AG Stores which are expected to be sold in the fourth quarter of fiscal 1998. The net book value on the AG Stores representing building, fixtures and equipment was written down to an estimated net realizable value of $5.7 million. Depreciation expense continues to be recorded at the historical rate. Administration Integration--Includes $14.7 million for labor and severance costs of which $9.0 million has been expended and the employees have been terminated and $9.4 million to conform accounting policies of QFC and Hughes to Fred Meyer, including the calculation of bad debt and costs for real estate transactions. 10 The following table presents the activity in the reserve accounts for the 40 weeks ended November 7, 1998. The beginning balance was zero (in thousands):
Cash payments ---------------------------------- 16 Weeks 12 Weeks 12 Weeks Reserve Charged Ended Ended Ended Balance to May 23, Aug 15, Nov 7, at Nov 7, Expense 1998 1998 1998 Reclass 1998 ------- -------- -------- -------- ------- --------- Systems integration Severance $ 1,445 $ 1,445 Transaction costs Stay bonus program 5,797 5,797 Store closures Lease obligation 6,686 $ 23 $ 746 $ 511 5,406 Administration integration Severance 12,021 2,681 1,090 3,812 4,438 ------- -------- -------- -------- ------- ------- Total amounts included in Current Liabilities $25,949 $ 2,704 $ 1,836 $ 4,323 $ - $17,086 ======= ======== ======== ======== ======= =======
Severance--Severance relates to 183 Hughes administrative employees in Southern California and 75 QFC administrative employees in Seattle. As of November 7, 1998, all of the Hughes employees have been terminated. The QFC employees have been notified of their terminations on various dates ranging from February 15, 1999 to December 31, 1999. Under severance agreements, the amount of severance will be paid over a period following the date of termination. Lease Obligation--Following the merger, the Company closed a QFC store in the first quarter and agreed to dispose of the AG Stores under a settlement agreement with the State of California. The lease obligation represents future contractual lease payments on these stores over the expected holding period, net of any sublease income. The Company is actively marketing the stores to potential buyers and sub-lease tenants. The disposition of the AG Stores is expected to occur in the fourth quarter of fiscal 1998. Stay Bonus Program--Represents amounts to be paid under a stay bonus program in the fourth quarter of fiscal 1998. 5. Summary of Significant Accounting Policies Amended Form 10-Q--The Company amended its third quarter 10-Q to revise the accounting for its plan to dispose of Santee Dairy. The amended 10-Q reflects a change in the accounting treatment to recognize the loss on disposition when a definitive agreement for the sale of the dairy has been reached. The original filing reflected management's estimate of the loss that is anticipated upon disposition of the dairy. The impact of the amendment on the third quarter 10-Q was a $44.3 million reduction of merger related costs and a corresponding decrease in net loss of $27.0 million for the 40 weeks ended November 7, 1998. Basis of Presentation--The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the statements do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments of a normal recurring nature which are considered necessary for a fair presentation have been included. The consolidated results of operations presented herein are not necessarily indicative of the results to be expected for the year due to the seasonality of the Company's business. These consolidated financial statements should be read in 11 conjunction with the financial statements and related notes incorporated by reference in the Company's latest annual report filed on Form 10-K. Fiscal Year--The Company's fiscal year ends on the Saturday closest to January 31. Fiscal year 1997 ended on January 31, 1998 ("1997") and fiscal year 1998 ends on January 30, 1999 ("1998"). As a result of its acquisition, QFC changed its year end to that of Fred Meyer beginning February 1, 1998, the first day of fiscal 1998. Revenues and expenses of QFC from the end of QFC's fiscal year 1997, ended on December 27, 1997, to February 1, 1998 (5 weeks) were immaterial and have been excluded from the statement of operations. Accordingly, net income of $3.3 million for that period has been added to retained earnings. Inventories--Inventories 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 $66.9 million at November 7, 1998 and $51.8 million at January 31, 1998. The pretax LIFO charge in the third quarter was $4.1 million in 1998 and $2.1 million in 1997. The pretax LIFO charge for the first 40 weeks was $15.1 million in 1998 and $5.6 million in 1997. Goodwill--Goodwill is being amortized on a straight-line basis over 15 to 40 years. Goodwill recorded in connection with the acquisition of Ralphs/Food 4 Less, Smith's, Hughes, and KUI (see Note 3) is being amortized over 40 years. Goodwill recorded in connection with the Fox acquisition is being amortized over 15 years. Management periodically evaluates the recoverability of goodwill based upon current and anticipated net income and undiscounted future cash flows. Use of Estimates--The preparation of financial statements in conformity with generally accepted accounting principles requires management 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. Income Taxes--Deferred 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 consequences 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. Deferred tax assets recognized by the Company are presented net of any deferred tax liabilities and valuation allowance and consist primarily of net operating loss carryforwards. The deferred tax assets will be used to offset future tax liabilities generated from taxable income. However, the amount available to offset the consolidated tax liability will be limited by each subsidiary's tax circumstances and availability of its net operating loss carryforwards. Earnings per Share--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 which consist of outstanding stock options and warrants. Common equivalent shares are excluded from the diluted weighted average share and common equivalent shares outstanding for the first 40 weeks of 1998 due to the net loss. Reclassifications--Certain prior period amounts have been reclassified to conform to current period presentation. The reclassifications have no effect on reported net income. 12 6. Comprehensive Income Effective February 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," which requires items previously reported as a component of stockholders' equity to be more prominently reported in a separate financial statement as a component of comprehensive income. Components of comprehensive income include the following (in thousands):
12 Weeks Ended 40 Weeks Ended ------------------------- ------------------------- November 7, November 8, November 7, November 8, 1998 1997 1998 1997 ---------- ---------- ---------- ---------- Net income (loss) $ 28,840 $ (62,545) $ (248,405) $ (10,580) Income tax benefit from the exercise of stock options 595 2,150 5,078 5,978 ---------- ---------- ---------- ---------- Comprehensive income (loss) $ 29,435 $ (60,395) $ (243,327) $ (4,602) ========== ========== ========== ==========
7. Long-term Debt Long-term debt consisted of the following (in thousands):
November 7, January 31, 1998 1998 ---------- ----------- 1997 Senior Credit Facility $ - $ 1,300,000 1998 Senior Credit Facility 2,448,750 - Senior notes, unsecured, due 2003 through 2008, fixed interest rate from 7.15% to 7.45% 1,750,000 - QFC Credit Facility 214,293 Commercial paper with maturities through February 10, 1999, classified as long-term, interest rates of 5.78% to 6.10% at August 15, 1998 628,075 367,156 QFC 8.7% Senior Subordinated Notes, principal due 2007 with interest payable semi-annually 3,065 150,000 Long-term notes secured by trust deeds, due through 2016, interest rates from 5.00% to 10.50% 59,941 61,075 Uncommitted bank borrowings classified as long-term 85,000 79,000 Ralphs senior subordinated notes, due 2002 through 2007, fixed interest rates from 9.0% to 13.75% 35,232 - Ralphs senior notes, unsecured, due 2004, fixed interest rate of 10.45% 13,458 - Other 70,475 29,448 ----------- ----------- Total 5,093,996 2,200,972 Less current portion 94,140 16,178 ----------- ----------- Total $ 4,999,856 $ 2,184,794 =========== ===========
In conjunction with the acquisitions of QFC and Ralphs/Food 4 Less in March 1998, the Company entered into new financing arrangements that refinanced a substantial portion of the Company's principal debt facilities and indebtedness assumed in the acquisitions. The new financing arrangements included a new bank credit facility and a public issue of $1.75 billion senior unsecured notes. The new bank credit facility (the "1998 Senior Credit Facility") provided for a $1.875 billion five-year revolving credit agreement and a $1.625 billion five-year term note. All indebtedness under the 1998 Senior Credit Facility is guaranteed by certain of the Company's 13 subsidiaries and secured by the stock in the subsidiaries. The revolving portion of the 1998 Senior Credit Facility is available for general corporate purposes, including the support of the commercial paper program of the Company. Commitment fees are charged at .30% on the unused portion of the five-year revolving credit facility. Interest on the 1998 Senior Credit Facility is at Adjusted LIBOR plus a margin of 1.0%. At November 7, 1998, the weighted average interest rate on the five year term note and the amounts outstanding under the revolving credit facility were 6.5% and 6.3%, respectively. The unsecured senior notes issued on March 11, 1998, included $250 million 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% (the "Notes"). In connection with the issuance of the Notes, each of the Company's direct or indirect wholly-owned subsidiaries has jointly and severally guaranteed the Notes on a full and unconditional basis ("Subsidiary Guarantors"). The Subsidiary Guarantors are 100% wholly owned subsidiaries of the Company and constitute all of the Company's direct and indirect subsidiaries, other than inconsequential subsidiaries. The non-guaranteeing subsidiaries represent less than 3%, on an individual and aggregate basis, of the Company's consolidated assets, pretax income, cash flow and net investment in subsidiaries. The Company is a holding company with no independent operations or assets other than those relating to its investments in its subsidiaries. Separate financial statements of the Subsidiary Guarantors are not included because the guarantees are full and unconditional, the Subsidiary Guarantors are jointly and severally liable and the separate financial statements and other disclosures concerning the Subsidiary Guarantors are not deemed material to investors by management of the Company. No restrictions exist on the ability of the Subsidiary Guarantors to make distributions to the Company, except, however, the obligations of each Guarantor under its Guarantee are limited to the maximum amount as will result in obligations of such Guarantor under its Guarantee not constituting a fraudulent conveyance or fraudulent transfer for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act or any similar Federal or state law (e.g. adequate capital to pay dividends under corporate laws). The 1998 Senior Credit Facility requires the Company to comply with certain ratios related to indebtedness to earnings before interest, taxes, depreciation and amortization ("EBITDA") and fixed charge coverage. In addition, the 1998 Senior Credit Facility limits dividends on and redemption of capital stock. In conjunction with the Smith's acquisition in September 1997, the Company entered into a 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 was refinanced by the 1998 Senior Credit Facility. The Company has established uncommitted money market lines with five banks of $125.0 million. These lines, which generally have terms of approximately one year, allow the Company to borrow from the banks at mutually agreed upon rates, usually below the rates offered under the 1998 Senior Credit Facility. The Company also has $900.0 million of unrated commercial paper facilities with four 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 $713.1 million at November 7, 1998, as long-term debt. The Company on occasion enters into various interest rate swap, cap and collar agreements to reduce the impact of changes in interest rates on its floating rate long-term debt. At November 7, 1998, the Company had outstanding one collar agreement which expires on July 24, 2003 and effectively sets interest rate limits on a notional principal amount of $300.0 million on the Company's floating rate long-term debt. The agreement limits the interest rate fluctuation of the 3-month adjusted LIBOR (as defined in the collar agreement) to a range between 4.10% and 6.50% 14 and requires quarterly cash settlements for interest rate fluctuations outside of the limits. As of November 7, 1998, the 3-month adjusted LIBOR was 5.38%. The Company is exposed to credit loss in the event of nonperformance by the counterparties to the interest rate collar agreement. 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 November 7, 1998 are $18.1 million in 1998, $134.8 million in 1999, $240.9 million in 2000, $362.2 million in 2001, and 472.7 million in 2002. The Company recorded in the first 40 weeks of 1998 an extraordinary charge of $357.8 million less a $139.9 million income tax benefit which consisted of premiums paid in the prepayment of certain notes and bank facilities of Fred Meyer, QFC and Ralphs/Food 4 Less and the write-off of the related deferred financing costs. 8. Commitments and Contingencies The 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. The Company is a 50% owner of Santee Dairies, L.L.C. ("Santee") and has a 10 year product supply agreement with Santee that requires the Company to purchase 9 million gallons of fluid milk and other products annually. The product supply agreement expires on July 29, 2007. Upon acquisition of Ralphs, Santee became excess capacity and a duplicate facility. The Company is currently engaged in efforts to dispose of its interest in Santee which may result in a loss of approximately $45 million in 1999. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. - ------------------------------------------------ This discussion and analysis should be read in conjunction with the Company's consolidated financial statements. The Company amended its third quarter 10-Q to revise the accounting for its plan to dispose of Santee Dairy. The amended 10-Q reflects a change in the accounting treatment to recognize the loss on disposition when a definitive agreement for the sale of the dairy has been reached. The original filing reflected management's estimate of the loss that is anticipated upon disposition of the dairy. The impact of the amendment on the third quarter 10-Q was a $44.3 million reduction of merger related costs and a corresponding decrease in net loss of $27.0 million for the 40 weeks ended November 7, 1998. RECENT EVENT On October 19, 1998, the Company announced the signing of a definitive merger agreement with The Kroger Co. ("Kroger"), the largest retail grocery chain in the United States. On that date, Kroger operated 1,398 food stores, 802 convenience stores and 34 manufacturing facilities that manufacture products for sale in all Kroger divisions, as well as to external customers. Under the terms of the merger agreement, Fred Meyer stockholders will receive one newly issued share of Kroger common stock for each share of Fred Meyer common stock. The transaction will be accounted for as a pooling of interests. It is expected to close in early 1999 subject to approval of Kroger and Fred Meyer stockholders and antitrust and other regulatory authorities and customary closing conditions. In 15 anticipation of the intended merger with Kroger, the Company has secured approval from its banks to amend its 1998 Senior Credit Facility as well as its operating lease facility. These proposed amendments are subject to completion of the merger and will be guaranteed by Kroger. The Company's outstanding senior notes due 2003 through 2008 will remain outstanding after the merger. Additional information regarding the merger can be found in the Company's current report on Form 8-K dated October 20, 1998. MERGER RELATED COSTS The Company is in the process of implementing its plan to integrate its five primary operations (Fred Meyer Stores, Ralphs/Food 4 Less, Smith's, QFC and Hughes) resulting in merger related costs of $31.4 million and $237.5 million for the 12 and 40 weeks ended November 7, 1998. The integration plan includes the consolidation of distribution, information systems, and administrative functions, conversion of 78 store banners, closure or sale of seven stores, and transaction costs incurred to complete the mergers. The costs were reported in the periods in which cash was expended except for $25.9 million that was accrued for liabilities incurred to exit certain activities, sever employees, and retain certain key employees and an $80.4 million charge to write-down certain assets. The Company estimates that the total cost to implement this plan will be approximately $355 million, of which $158.5 million, $47.6 million and $31.4 million were incurred in the first, second and third quarters of fiscal 1998, respectively. The remaining cost of $115 million includes $60 million to complete the systems integration, $10 million to complete the conversion of store banners, and $45 million to dispose of the Santee Dairy (see Disposal of Santee Dairy). Of the $115 million of remaining costs, approximately $20 million is expected to be incurred in the fourth quarter, approximately $45 million in the second quarter of 1999, and the remaining $50 million is expected to be incurred ratably in 1999. The Company estimates that successful completion of its integration plan will result in net annual cost savings and improvements attributable to operating synergies of $150 million by 2000. Such cost savings and improvements consist of reduced advertising costs from eliminating banners, reduced distribution costs by eliminating distribution centers and independent wholesalers, increased efficiencies from volume purchasing and merchandising, increased efficiencies from maximizing capacity at manufacturing facilities, and elimination of general and administrative costs by consolidating offices, processing centers, and levels of supervision. The distribution consolidation includes the transfer of purchasing and distribution functions from the Hughes facility to various Ralphs' facilities and transfer of QFC's distribution and manufacturing functions from wholesalers to various Fred Meyer facilities. Costs incurred to complete the distribution consolidation and close the Hughes facility include the write-down of assets held for sale to net realizable value, severance and incremental labor and other costs. The Company has substantially completed the distribution consolidation except for the disposition of the Hughes facility. The information systems integration plan is to consolidate into two processing platforms: a northern platform in Portland, Oregon and a southern platform in Los Angeles, California. The consolidation requires the conversion of all Smith's and QFC systems into Fred Meyer systems and the conversion of all Hughes systems into Ralphs' systems which results in the closure of three duplicate processing facilities. Costs incurred to complete the information systems integration include the write-down of assets that have been abandoned or become obsolete, incremental operating costs during the integration process, payments to third parties, training costs and severance. Computer hardware and software that was abandoned in the first quarter following the QFC merger was written-down to net realizable value. Computer hardware and software that will be utilized until the end of the integration process is being written-down over its reduced estimated useful life. The conversion of Hughes systems into Ralphs' systems is complete and the conversion of Smith's and QFC's systems into Fred 16 Meyer systems is expected to be completed by the end of 1999. The remaining costs are expected to include charges for assets write-downs, incremental operating costs, payments to third parties and training costs. The administrative plan is similar to the information systems integration plan except that in addition to Portland and Los Angeles, some administrative functions will remain in Salt Lake City resulting in the closure of two administrative offices. This integration includes the consolidation of accounting, payroll processing, benefits and risk administration, property management and legal services into the remaining administrative offices. Costs incurred to complete the administrative consolidation primarily consists of labor and severance costs. One of the two excess administrative offices is closed and the remainder of the administrative consolidation is expected to be completed by the end of 1999. The conversion of store banners includes the conversion of 55 Hughes stores to the Ralphs' banner, 15 Smitty's stores to the Fred Meyer banner, five QFC stores to the Fred Meyer banner and three Fred Meyer stores to the Smith's banner. Costs incurred to complete the banner conversions include incremental cash expenditures of $28.9 million for advertising and promotions to establish the banner, and $9.5 million for labor required to remerchandise the store inventory. The 55 Hughes stores have been converted to the Ralphs banner and the five QFC stores have been converted to the Fred Meyer banner. The remaining banner conversions are expected to be completed by the end of 1999. The remaining costs are expected to include charges for advertising and promotions costs incurred to establish the banner and labor to remerchandise the store. The closure or sale of seven stores includes three stores to be sold pursuant to a settlement agreement with the State of California (the "AG Stores") and four duplicate facilities. Costs incurred on these stores include the write-down of assets held for sale to net realizable value, the write-off of goodwill associated with the AG Stores and a charge for future contractual lease payments over the expected holding period, net of sublease income. Buyers have been identified for the three AG Stores and the sale of these stores is expected to be completed in the fourth quarter. The remaining four stores have been closed and three have been sold as of November 7, 1998. All costs to close the stores have been charged to operations and expended prior to November 7, 1998 except for lease obligations. Transaction costs represent fees paid to outside parties, employee bonuses contingent upon the closing of the merger and an accrual for an employee stay bonus program. DISPOSAL OF SANTEE DAIRY The Company is a 50% owner of Santee Dairies, L.L.C. ("Santee") and has a 10 year product supply agreement with Santee that requires the Company to purchase 9 million gallons of fluid milk and other products annually. The product supply agreement expires on July 29, 2007. Upon acquisition of Ralphs, Santee became excess capacity and a duplicate facility. The Company is currently engaged in efforts to dispose of its interest in Santee which may result in a loss of approximately $45 million in 1999. RESULTS OF OPERATIONS The following discussion summarizes the Company's operating results for 1998 compared with 1997. However, 1998 results are not comparable to prior year results due to the three recent acquisitions (See Note 3 of Notes to Consolidated Financial Statements). The 1998 results include the results from Fred Meyer Stores, Smith's and QFC for the full period and include Ralphs/Food 4 Less from March 10, 1998. The 1997 results include Fred Meyer Stores and QFC for the full period and Smith's from September 9, 1997. 17 Comparison of the 12 and 40 weeks ended November 7, 1998 with the 12 and 40 weeks ended November 8, 1997 Net sales for the 12 weeks ended November 7, 1998 increased $1.5 billion to $3.5 billion from $2.0 billion for the 12 weeks ended November 8, 1997 and increased $6.0 billion to $11.0 billion in the 40 weeks ended November 7, 1998 from $5.0 billion in the 40 weeks ended November 8, 1997. The increases in sales were caused primarily by the recent acquisitions of Ralphs/Food 4 Less and Smith's. Sales at Smith's accounted for $203.9 million and $1.9 billion of the increases and Ralphs/Food 4 Less accounted for $1.5 billion and $4.3 billion of the increases for the 12 and 40 weeks ended November 7, 1998, respectively. Comparable store sales including the Ralphs/Food 4 Less and Smith's stores as if acquired at the beginning of the comparable periods and excluding the Hughes and Smitty's stores which are currently being converted to other formats increased 3.4% and 2.4% from the prior year for the 12 and 40 weeks ended November 7, 1998, respectively. Gross margin increased as a percentage of net sales from 29.6% for the 12 weeks ended November 8, 1997 to 30.0% for the 12 weeks ended November 7, 1998 and from 29.6% for the 40 weeks ended November 8, 1997 to 29.7% for the 40 weeks ended November 7, 1998. Increases in gross margin as a percent of sales were generated primarily from economies of scale resulting from the Company's increased sales offset almost entirely by losses on liquidated inventory of $2.3 million and $8.9 million for the 12 and 40 weeks ended November 7, 1998, respectively, incurred in connection with store banner conversions and distribution consolidations and by changes in the Company's sales mix between food and nonfood. The amount of food sales, which have a lower gross margin percent, compared to total sales increased over the prior year due to the recent acquisitions. Operating and administrative expenses were $833.8 million and $488.7 million for the 12 weeks ended November 7, 1998 and November 8, 1997, respectively and were $2.7 billion and $1.3 billion for the 40 weeks ended November 7, 1998 and November 8, 1997, respectively. Operating and administrative expenses decreased as a percentage of sales 1.1% and 1.25% from the prior year for the 12 and 40 weeks ended November 7, 1998, respectively. The reduction of operating and administrative expenses as a percent of sales is due to economies of scale resulting from the Company's increased sales and lower operating and administrative expenses as a percent of sales at Smith's and Ralph's/Food 4 Less, which were recently acquired and are lower cost operations. Additionally, the Company benefited from the suspension of contributions to certain multi-employer pension and benefit plans totaling $15.2 million and $32.3 million in the 12 and 40 weeks ended November 7, 1998, respectively. Amortization of goodwill increased $16.4 million and $57.9 million from the prior year for the 12 and 40 weeks ended November 7, 1998, respectively, as a result of the recent acquisitions. The merger related costs of $31.4 million and $237.5 million for the 12 and 40 weeks ended November 7, 1998, respectively, were incurred in connection with the Company's plan to integrate its five primary operations. See Merger Related Costs. Interest expense increased to $92.9 million from $30.2 million for the 12 weeks ended November 7, 1998 and November 8, 1997, respectively and increased to $284.7 million from $66.2 million for the 40 weeks ended November 7, 1998 and November 8, 1997, respectively. The increase in interest expense for the 12 and 40 week periods primarily reflect the increased amount of indebtedness assumed and/or incurred in conjunction with the acquisitions of Smith's and Ralphs/Food 4 Less. The effective tax rates are affected by increased goodwill amortization and certain merger costs which are not deductible for tax purposes. The effective tax rates for the income tax expense were 52.1% and 42.4% for the 12 weeks ended November 7, 1998 and November 8, 1997, respectively. For 18 the 40 weeks ended November 7, 1998, the amount of nondeductible goodwill amortization and merger costs was greater than the income before income tax which resulted in an unusually high effective tax rate of 285.1%. Income (loss) before extraordinary charge was $29.2 million and $(30.5) million for the 12 and 40 weeks ended November 7, 1998, respectively, compared to $28.7 million and $80.6 million for the 12 and 40 weeks ended November 8, 1997, respectively. The changes are a result of the above mentioned factors. The extraordinary charges of $.3 million and $217.9 million for the 12 and 40 weeks ended November 7, 1998, respectively, consist of fees incurred in conjunction with the prepayment of certain indebtedness and the write-off of related debt issuance costs. Net income increased to $28.8 million for the 12 weeks ended November 7, 1998 from a net loss of $62.5 million for the 12 weeks ended November 8, 1997 and decreased to a loss of $248.4 million for the 40 weeks ended November 7, 1998 from a loss of $10.6 million for the 40 weeks ended November 8, 1997 primarily due to the factors discussed above. LIQUIDITY AND CAPITAL RESOURCES The Company funded its working capital and capital expenditure needs in 1998 through internally generated cash flow and the issuance of unrated commercial paper, supplemented by borrowings under committed and uncommitted bank lines of credit and lease facilities. Cash provided by operating activities was $457.3 million for the 40 weeks ended November 7, 1998 compared to $173.3 million for the 40 weeks ended November 8, 1997. The increase in cash provided from operating activities is due primarily to an improvement in operating income resulting from the recent acquisitions. The Company's principal use of cash during the period is for seasonal purchases of inventory. Because of the inventory turnover rate, the Company is able to finance a substantial portion of the increased inventory through trade payables. Cash used for investing activities was $609.0 million for the 40 weeks ended November 7, 1998 compared to $528.2 million for the 40 weeks ended November 8, 1997. The investing activities consisted primarily of capital expenditures and business acquisitions. Capital expenditures of $497.6 million in the current period were for the construction of new stores, remodeling existing stores and additions to distribution centers and offices. During the 40 weeks ended November 7, 1998, the Company opened 17 new stores and completed the remodel of 72 stores. The Company intends to use the combination of cash flows from operations and borrowings under its credit facilities to finance its capital expenditure requirements for 1998, currently budgeted to be approximately $750.0 million, net of estimated real estate sales and stores financed on leases. If the Company determines that it is preferable, it may fund its capital expenditure requirements by mortgaging facilities, entering into sale/leaseback transactions, or by issuing additional debt or equity. The Company currently owns real estate with a net book value of approximately $1.6 billion. Additionally, the Company completed several business acquisitions which resulted in the use of cash for investing activities. See Note 3 of Notes to Consolidated Financial Statements for a discussion of the Company's acquisitions. Cash provided by financing activities was $220.4 million for the 40 weeks ended November 7, 1998. The financing activities consisted primarily of cash receipts on the exercise of stock options, principal payments on long-term debt and capital leases, and activity related to the debt refinancing completed in conjunction with the acquisitions of Ralphs/Food 4 Less and QFC. 19 On March 11, 1998 the Company entered into new financing arrangements which included a public issue of $1.75 billion of senior unsecured notes (the "Notes") and a bank credit facility (the "1998 Senior Credit Facility"). The 1998 Senior Credit Facility included a $1.875 billion five-year revolving credit agreement and a $1.625 billion five-year term loan. The Notes consisted of $250 million 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%. Each of the Company's direct or indirect wholly-owned subsidiaries has jointly and severally guaranteed the Notes on a full and unconditional basis. No restrictions exist on the ability of the Subsidiary Guarantors to make distributions to the Company, except, however, the obligations of each Subsidiary Guarantor under its Guarantee are limited to the maximum amount as will result in obligations of such Guarantor under its Guarantee not constituting a fraudulent conveyance or fraudulent transfer for purposes of Bankruptcy Law, the Uniform Fraudulent Conveyance Act, the Uniform Fraudulent Transfer Act or any similar Federal or state law (e.g. adequate capital to pay dividends under corporate laws). The obligations of the Company under the 1998 Senior Credit Facility are guaranteed by certain subsidiaries and are also collateralized by the stock of certain subsidiaries. In addition to the 1998 Senior Credit Facility and Notes, the Company entered into a $500 million five-year operating lease facility, which refinanced $303 million in existing lease financing facilities. At November 7, 1998, $332.0 million was outstanding on this lease facility. The remaining balance of this lease facility will be used for land acquisition and construction costs for new stores. The obligations of the Company under the lease facility are guaranteed by certain subsidiaries and are also collateralized by the stock of certain subsidiaries. At November 7, 1998, the Company had $125.0 million of uncommitted money market lines with five banks and $900.0 million in unrated commercial paper facilities with four banks. The uncommitted money market lines and unrated commercial paper are used primarily for seasonal inventory requirements, new store construction and financing existing store remodeling, acquisition of land, and major projects such as management information systems. At November 7, 1998, a total of approximately $265.6 million was available for borrowings under the 1998 Senior Credit Facility and the commercial paper facilities and $40.0 million was available for borrowings from the uncommitted money market lines. See Note 7 of Notes to Consolidated Financial Statements for a discussion of the Company's interest rate swap, cap and collar agreements. The Company had $44.3 million of outstanding Letters of Credit as of November 7, 1998. The Letters of Credit are used to support the importation of goods and to support the performance, payment, deposit or surety obligations of the Company. Effect of LIFO During each year, the Company estimates the LIFO adjustment for the year based on estimates of three factors: inflation rates (calculated by reference to the Department Stores Inventory Price Index published by the Bureau of Labor Statistics for soft goods and jewelry and to internally generated indices based on Company purchases during the year for all other departments), expected inventory levels, and expected markup levels (after reflecting permanent markdowns and cash discounts). At year-end, the Company makes the final adjustment reflecting the difference between the Company's prior quarterly estimates and actual LIFO amount for the year. Effect of Inflation While management believes that some portion of the increase in sales is due to inflation, it is difficult to segregate and to measure the effects of inflation because of changes in the types of 20 merchandise sold year-to-year and other pricing and competitive influences. By attempting to control costs and efficiently utilize resources, the Company strives to minimize the effects of inflation on its operations. Recent Accounting Changes SFAS No. 131 - Disclosures about Segments of an Enterprise and Related Information is effective for the Company's fiscal 1998. However, under this standard no interim disclosures are required. Any required disclosure will be included in the Company's Form 10-K for fiscal 1998. The Company believes that the disclosure will not have a material impact to financial reporting. SFAS No. 133 - Accounting for Derivative Instruments and Hedging Activities is effective for the Company's fiscal 2000. The Company currently has outstanding one collar agreement that would be reported under this standard and has determined that the impact of this agreement on financial reporting is immaterial. Year 2000 The Company and each of its subsidiaries are dependent on computer hardware, software, systems, and processes ("Information Technology") and non-information technology systems such as telephones, clocks, scales, and refrigeration units or other equipment containing embedded microprocessor technology ("Non-IT Systems") in several critical operating areas, including store and distribution operations, product merchandise and procurement, manufacturing plant operations, inventory and labor management, and accounting. The Company is currently working to resolve the potential effect of the year 2000 on the processing of date-sensitive information within these various systems. The year 2000 problem is the result of computer programs being written using two digits (rather than four) to define the applicable year. Company programs that have date-sensitive software may recognize a date using ?00" as the year 1900 rather than 2000, which could result in a miscalculation or system failure. The date issue also applies to equipment with embedded microprocessor chips. The Company has developed a plan (the "Plan") to access and update its Information Technology systems and Non-IT Systems for year 2000 readiness and to provide for continued functionality. The Plan focuses on critical business areas, which are separated into three major categories: (1) Information Technology, which includes all hardware and software on all processing platforms; (2) merchandise and external entities, including product suppliers, service providers, and those with whom the Company exchanges information; and (3) Non-IT Systems. Additionally, the Plan consists of three phases: (1) creating an inventory of systems and assessing the scope of the year 2000 problem as it relates to those systems; (2) remediating any year 2000 problems; and (3) testing and implementing systems following remediation. The following table estimates the Company's completion status for each phase of the Plan as of November 7, 1998, based on information currently available:
Percent Complete ------------------------------- Category Phase 1 Phase 2 Phase 3 -------- ------- ------- ------- Information Technology 1 83% 55% 28% Merchandise and external entities 2 63% 28% 3% Non-IT Systems 3 63% 15% 5%
21 Phase 1 is expected to be completed by the end of the first quarter of 1999 for all three categories. Phase 2 and 3 will continue throughout calendar 1999. Systems are regularly monitored and procedures are in place to detect potential re-introduction of date problems. The Company's management is currently formulating contingency plans in the event that any critical elements of the Plan should fail, or any of the Company's vendors or service providers fail to be year 2000 ready. The contingency plans may be implemented to minimize the risk of interruption of the Company's business. We expect that contingency plans will be completed by the end of the third quarter of 1999. The Company's principal vendors, service providers, and other third parties on which the Company relies for business operations have been contacted for a status on year 2000 readiness. Based on the Company's assessment of their responses, the Company believes that many of its principal vendors, service providers and other third parties are taking action for year 2000 readiness. However, the Company has limited ability to test and control such third parties' year 2000 readiness and no assurance can be given that failure of such third parties to address the year 2000 issue will not cause an interruption of the Company's business. The Company expects the Plan for critical systems to be substantially completed during the fourth calendar quarter of 1999. However, the Company's ability to timely execute its Plan may be adversely affected by a variety of factors, some of which are beyond the Company's control, including the potential for unforeseen implementation problems, delays in the delivery of products, and disruption of store operations resulting from a loss of power or communication links between stores, distribution centers, and headquarters. Based on currently available information, the Company is unable to determine if such interruptions are likely to have a material adverse effect on the Company's results of operations, liquidity, or financial condition. The Company has committed significant resources in connection with resolving its year 2000 issue. The total estimated costs of the Plan, exclusive of capital expenditures, are expected to be $25.0 to $30.0 million, of which approximately $3.0 million was expensed in 1997. Costs charged to operations for the 40 weeks ended November 7, 1998 totaled $4.0 million, which represents an immaterial portion of the Company's information services budget over the period. Estimated costs expected to be incurred and expensed are approximately $2.0 million in the fourth quarter of 1998 and $13.0 to $21.0 million thereafter. Forward-looking Statements; Factors Affecting Future Results Certain information set forth in this report contains "forward-looking statements" within the meaning of federal securities laws. The Company may make other forward-looking statements from time to time. These forward-looking statements may include information regarding the Company's plans for future operations, expectations relating to cost savings and the Company's integration strategy with respect to its recent mergers, store expansion and remodeling, capital expenditures, inventory reductions and expense reduction. The following factors, as well as those discussed below, are among the principal factors that could cause actual results to differ materially from the forward-looking statements: business and economic conditions generally and in the regions in which the Company's stores are located, including the rate of inflation; population, employment and job growth in the Company's markets; demands placed on management by the substantial increase in the Company's size; loss or retirement of senior management of the Company or of its principal operating subsidiaries; changes in the availability of debt or equity capital and increases in borrowing costs or interest rates, especially since a substantial portion of the Company's borrowings bear interest at floating rates; competitive factors, such as increased penetration in the Company's markets by large national food and nonfood chains, large category-dominant stores and large national and regional 22 discount retailers (whether existing competitors or new entrants) and competitive pressures generally, which could include price-cutting strategies, store openings and remodels; results of the Company's programs to decrease costs as a percent of sales; increases in labor costs and deterioration in relations with the union bargaining units representing the Company's employees; unusual unanticipated costs or unanticipated consequences relating to the recent mergers and integration strategy and any delays in the realization thereof; operational inefficiencies in distribution or other Company systems, including any that may result from the recent mergers; issues arising from addressing the year 2000 problem; legislative or regulatory changes adversely affecting the business in which the Company is engaged; and other opportunities or acquisitions which may be pursued by the Company. Leverage; Ability to Service Debt. The Company is highly leveraged. As of November 7, 1998, the Company has total indebtedness (including current maturities and capital lease obligations) of $5.3 billion. Total indebtedness consists of long-term debt, including borrowings under the 1998 Senior Credit Facilities, and the notes, and capitalized leases. Total indebtedness does not reflect certain commitments and contingencies of the Company, including operating leases under the lease facility and other operating lease obligations. The Company has significant interest and principal repayment obligations and significant rental payment obligations, and the ability of the Company to satisfy such obligations is subject to prevailing economic, financial and business conditions and to other factors, many of which are beyond the Company's control. A significant amount of the Company's borrowings and rental obligations bear interest at floating rates (including borrowings under the 1998 Senior Credit Facilities and obligations under the lease facility), which will expose the Company to the risk of increased interest and rental rates. Merger Integration. The significant increase in size of the Company's operations resulting from the recent mergers has substantially increased the demands placed upon the Company's management, including demands resulting from the need to integrate the accounting systems, management information systems, distribution systems, manufacturing facilities and other operations of Fred Meyer Stores, Smith's, QFC and Ralphs/Food 4 Less. In addition, the Company may experience additional unexpected costs from such integration and/or a loss of customers or sales as a result of the recent mergers. There is no assurance that the Company will be able to maintain the levels of operating efficiency which Fred Meyer Stores, Smith's, QFC and Ralphs/Food 4 Less had achieved separately prior to the mergers. The failure to successfully integrate the operations of the acquired businesses, the loss of key management personnel and the loss of customers or sales could each have a material adverse effect on the Company's results of operations or financial position. Ability to Achieve Intended Benefits of the Recent Mergers. Management believes that significant business opportunities and cost savings are achievable as a result of the Smith's, QFC and Ralphs/Food 4 Less mergers. Management's estimates of cost savings are based upon many assumptions including future sales levels and other operating results, the availability of funds for capital expenditures, the timing of certain events as well as general industry and business conditions and other matters, many of which are beyond the control of the Company. Estimates are also based on a management consensus as to what levels of purchasing and similar efficiencies should be achievable by an entity the size of the Company. Estimates of potential cost savings are forward-looking statements that are inherently uncertain. Actual cost savings, if any, could differ from those projected and such differences could be material; therefore, undue reliance should not be placed upon such estimates. There is no assurance that unforeseen costs and expenses or other factors (whether arising in connection with the integration of the Company's operations or otherwise) will not offset the estimated cost savings or other components of the Company's plan or result in delays in the realization of certain projected cost savings. Competition. The retail merchandising business in general, and the supermarket industry in particular, is highly competitive and generally characterized by narrow profit margins. The 23 Company's competitors in each of its operating divisions include national and regional supermarket chains, discount stores, independent and specialty grocers, drug and convenience stores, large category-dominant stores and the newer "alternative format" food stores, including warehouse club stores, deep discount drug stores, "supercenters" and conventional department stores. Competitors of the Company include, among others, Safeway, Albertson's, Lucky, Costco, Wal-Mart and Target. Retail businesses generally compete on the basis of location, quality of products and service, price, product variety and store condition. The Company's ability to compete depends in part on its ability to successfully maintain and remodel existing stores and develop new stores in advantageous locations. Labor Relations. The Company is party to more than 171 collective bargaining agreements with unions and locals, covering approximately 60,000 employees representing approximately 65% of the Company's total employees. Among the contracts that have expired or will expire in 1998 are those covering 15,500 employees. Typical agreements are three years in duration, and as such agreements expire, the Company expects to negotiate with the unions and to enter into new collective bargaining agreements. There is no assurance, however, that such agreements will be reached without work stoppages. A prolonged work stoppage affecting a substantial number of stores could have a material adverse effect on the Company's results of operations or financial position. Forward-looking statements speak only as of the date made. The Company undertakes no obligation to publicly release the results of any revisions to any forward-looking statements which may be made to reflect subsequent events or circumstances or to reflect the occurrence of unanticipated events. 24 Part II - OTHER INFORMATION - -------------------------------------------------------------------------------- Item 6. Exhibits and Reports on Form 8-K - ---------------------------------------- (a) Exhibits 10G* Employment Agreement between Fred Meyer, Inc. and Robert G. Miller, as amended. 10N* Employment Protection Agreement dated September 22, 1998 between Fred Meyer, Inc. and George Golleher. 10R* Employment Protection Agreement dated September 22, 1998 between Fred Meyer, Inc. and certain officers. 10S* Employment Protection Agreement dated September 22, 1998 between Fred Meyer, Inc. and certain officers. 27 Restated Financial Data Schedule * Previously filed with the quarterly report on Form 10-Q to which this amendment relates. (b) Reports on Form 8-K The Company filed a report on Form 8-K dated October 18, 1998 to disclose information under Item 5 thereof. On November 5, 1998, the Company also filed a Form 8-K/A dated March 9, 1998 to amend certain financial statement information under Item 7. 25 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. FRED MEYER, INC. Date: March 4, 1999 By JOHN STANDLEY -------------------------------- John Standley Senior Vice President and Chief Financial Officer 26 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS JAN-30-1999 NOV-07-1998 186,045 0 140,291 0 2,007,875 2,595,752 4,673,910 1,102,936 10,294,660 2,436,578 4,999,856 0 0 1,550 2,174,668 10,294,660 11,022,471 11,022,471 7,749,272 2,734,472 237,542 0 284,720 16,465 46,936 (30,471) 0 (217,934) 0 (248,405) (1.65) (1.65)
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