¨ STORES INC.

It’s all in the game plan

1997 Annual Report

Fiscal Year Ended February 22, 1997 ¨ Mission The mission of ShopKo is to be a “specialty Consolidated Net Sales discount retailer” that continuously differentiates (in thousands) our services and merchandise in our retail markets. Our vision is to offer quality merchan- dise for casual apparel, home, family and health needs – at prices that communicate real value. $2,333,407 $1,968,016 ¨ Mission $1,852,929 $1,738,746 $1,682,854

We listen to our customers and understand their $1,648,427 $1,520,545 health care benefit management needs. $1,420,300

We deliver uncompromising quality of service to $1,247,819 customers through dedicated associates and state $1,051,245 of the art technology. 88 89 90 91 92 93 94 95 96 97 We provide the highest quality products and services at the best value available in the marketplace. Financial Highlights We are committed to lowering our customers’ ShopKo Stores, Inc. and Subsidiaries overall health care costs while maintaining Fiscal years ended positive patient outcomes. February 22, February 24, 1997 1996 (Dollars in thousands, except per share data) (52 weeks) (52 weeks) Consolidated Net Sales $2,333,407 $1,968,016 Net Earnings 44,946 38,439 Fiscal 97 Comparable Retail Store Sales Net Earnings Per Common Share 1.40 1.20 Shareholders' Equity $ 460,864 $ 421,631 Stores Open at Year End 130 129

Apparel +12% Business Segment Information Retail Health +8% Fiscal years ended February 22, February 24, Hardlines/ 1997 1996

Total +6% Home +3% (In thousands) (52 weeks) (52 weeks) Consolidated Net Sales Retail Store $2,005,731 $1,881,038 ProVantage 348,780 93,845 ProVantage Net Sales Intercompany (21,104) (6,867) (in thousands) Total Net Sales $2,333,407 $1,968,016 Operating Earnings Before Interest and Income Taxes

$348,780 Retail Store $ 113,683 $ 107,216 ProVantage 9,533 2,713 Corporate Expenses (17,417) (12,507) Income from Operations 105,799 97,422 Net Interest Expense (31,777) (34,282)

$93,845 Provision for Income Taxes (29,076) (24,701) Net Earnings $ 44,946 $ 38,439 $14,060 $411

94 95 96 97 See the Company’s enclosed financial statements Letter from the President

Earnings Before Interest, Taxes, Total Retail Sales Depreciation and Amortization (in billions) (EBITDA) (in thousands) $2.01 $1.88 $1.84 $165,632 $1.74 $153,805 $144,934 Dale P. Kramer $121,642 President and Chief

Executive Officer

A Championship Season 94 95 96 97 94 95 96 97 What a year. ShopKo broke the $2-billion sales mark for the first time, reaching a record $2.33 billion for the year ending February 22, 1997. to outside influences, we’re now taking the lead and being the influencer. Sales were up an impressive 18.6 percent. We (After all, you can’t win a championship on defense alone.) And in doing so, increased net earnings for the third year in a row, our plan delivered the most important aspect of change: results. This is to $44.9 million, or $1.40 a share. For the sec- demonstrated by our strong six percent comparable retail store sales increase ond straight year, we set a record for Earnings in fiscal 1997 which, by the way, put us among the leaders in the discount Before Interest, Taxes, Depreciation and store industry. Amortization (EBITDA), at $166 million. And to The second part of the plan was a leading-edge managed healthcare top it all off, our hometown Green Bay Packers strategy, leveraging our expertise in retail pharmacy and optical services and won the Super Bowl. I mention these events our use of technology. ProVantage was the result. together because, while unrelated, they bear an uncanny resemblance in how they were achieved. We launched ProVantage three short years ago to provide lower-cost alterna- tives in the managed-care arena, as healthcare costs were soaring. And as Several years ago, the Packers set a goal optimistic as we were, we could not have foreseen ProVantage’s success, with and took radical steps to achieve it. They hired sales gains of 272 percent and operating income increases of 251 percent in a new general manager and head coach, fiscal 1997. and they created a plan – a long-term, inte- grated, top-to-bottom plan that re-engineered Our future success is based on following through with both parts of the plan. the team. The plan called for intelligent, hard- Senior management has refocused on leading, teaching, and developing driving coaches who could teach and nurture. strategies on a corporate level, instead of on task management. It called for dedicated, skilled players. It called Today, ShopKo associates are encouraged to be creative and entrepreneurial for a flexible, adaptable style of play. Most within the discipline of our plan. For instance, previously independent depart- importantly – it required that everyone embrace ments were formed into Merchandising Performance Teams, so when a buyer core fundamentals to achieve the final goal: finds a new product, he or she can depend on others in marketing, logistics, a Super Bowl victory. finance and store operations to work together, strategically toward improved About the same time the Packers were developing customer satisfaction through superior in-store execution. In doing so, we plan their plan, our senior executives were also for success, and let buyers focus on aspects of the business that really make a forming a plan to re-engineer ShopKo in very difference. Our “players” operate not as individuals, but as part of a powerful much the same way. Our plan had two parts. team within a team, a “special team.” First was VISION 2000, a retail repositioning Probably the most earthshaking paradigm shift brought about by the plan was strategy that is today propelling ShopKo into the how we sell. Most retailers think in terms of merchandise categories: ladies next century. It changed everything about apparel, small appliances, health and beauty, etc. Today, after a total corpo- ShopKo. It changed our culture from a reactive rate culture shift, we sell by merchandise families as defined by our customers’ model to a proactive model. Instead of responding lifestyles. Each contains assortments of merchandise for our customers’ lifestyle needs, making their shopping experiences quick and easy. 1 Just as you must alter a game plan when you meet unanticipated conditions, we are constantly evolving, living by the code, “Better, faster and

smarter – in a smaller store.” Generally, we oper- By offering more sizes, styles and ate our nearly 90,000 square foot stores in small colors in classic, timeless items, to midsize communities. Rather than trying to offer every item found in traditional discount we carved out a niche for our

stores, we offer more sizes, styles, shapes, and retail apparel sales and realized colors of select, targeted items, dominating exceptional gains. the category. Today, when you visit a ShopKo store, you’ll see departments that look more like individual Our plan also guided a marketing shift at ShopKo. In fiscal 1997, our news- specialty shops than a traditional discount store – paper inserts contained fewer pages, but focused on more powerful items in with our flexibility and nimbleness, we can move our core growth businesses – items that draw buyers into the store. And quickly on new business ideas relative to the we launched a new, year-round television advertising campaign that high- competition. Our “test, validate, plunge” philoso- lights ShopKo’s focused assortment of high-quality, private-label and national phy means when we see a need, we develop brand-name products. a solution, test it in a set of dedicated stores, All this distinguishes us from our discount competitors. Rather than trying validate it, then expand it quickly to all stores. For to offer the absolute lowest-cost merchandise possible, we are raising the example, we exited a stagnant and unproductive value of our products by increasing quality and comfort standards, gift business and replaced it with a breakthrough adhering to those standards religiously, and charging a competitive price. bath and body boutique. Dominant in both We add value to the busy customers’ shopping experience by offering ease ™ concept and presentation, Bath, Body, Etc. and simplicity, friendliness and speed. And shoppers have responded to quickly grew to more than double the sales of the this value proposition by buying more and more often. The proof is in our gift department. Even more successful is retail numbers. an activewear segment that in fiscal 1997 did eight times the sales of the dress clothing business In fiscal 1997, for the first time in our 35-year history, ShopKo surpassed it replaced. $2 billion in sales. To put this milestone into perspective, it took ShopKo 26 years to reach our first $1 billion in sales, which occurred in fiscal 1988. Nine Our back-to-school sales were very strong in fis- short years later, we’ve doubled that. cal 1997. And we had an especially joyous holi- day season. ShopKo’s sales trended upward and Here’s a quick summary of our 1997 fiscal year (ended February 22, 1997) ended the fourth quarter far exceeding last year, achievements: up 12.5 percent in retail comparable store sales. • Sales for fiscal 1997 reflected an 18.6 percent increase over last year’s sales of $1.97 billion • Retail comparable store sales increased an impressive 6.0 percent over last year • Net earnings improved again, rising to $44.9 million, $1.40 per share, Our greatest potential for compared to $38.4 million or $1.20 per share last year, a 16.9 Six Long-Term percent increase long-term sales growth lies Growth • Our in-store pharmacies filled 9.6 million prescriptions this year, a in segments that address Businesses 5.2 percent increase from last year. Fiscal 1997 also saw us surpass our customers’ lifestyle bed & casual the 100-million prescription mark bath furniture needs. The segments will • Our in-store optical departments sold 617,374 pairs of glasses and housewares intimate contacts in fiscal 1997, a 7.6 percent increase from last year change as our customers’ apparel • Our first four Vision Advantage Stores – a test concept of free-standing lifestyles change. special sizes retail optical centers – are now open in Mansfield, Lima, Akron, and Cuyahoga in apparel health Falls, Ohio • Consolidated selling, general and administrative expenses for the year were 17.0 percent of sales, versus 18.4 percent for last year, an improvement of 140 basis points – the third year in a row of improved SG&A leverage 2 • ShopKo was named NFL Discount Retailer of the Year in recognition of our dominant in-store marketing position and creative ProVantage Retail Pharmacy and Optical sales promotion Number of Lives Under Contract Prescription Count – (in thousands) • Earnings before interest, taxes, depreciation and amortization (EBITDA) set a company record for the second year in a row, at 4,116,443 10,232.6 $166 million, 8 percent higher than last 9,869.1 9,192.9 8,784.6

year’s record of $154 million 8,396.7 8,032.4

• Corporate inventory turnover increased 10 7,295.3 percent. This is our second consecutive year of substantial improvement 626,898 And there are stories these figures don’t tell. We 1,664,714 320,079 are making great advances in areas that point to increased customer satisfaction. For instance, 94 95 96 97 91 92 93 94 95 96 97 rainchecks are down significantly, a result of improved ad-in-stock. ShopKo customers are buying more; the average sale per customer is ProVantage Health Services up. They are also buying more often. Since we’ve When a football team executes well, it generates “momentum.” ProVantage, achieved all this without relying on close- ShopKo’s managed healthcare business has plenty of it. In fiscal 1997, outs, clearances or other margin-decimating ProVantage sales increased 272 percent to $348.8 million, up from $93.8 tactics, we can conclude that our customers are million the previous year. EBIT (earnings before interest and taxes) jumped more satisfied. from $2.7 million to $9.5 million, an increase of 251 percent. At the end of fiscal year 1997, ProVantage had over 4.1 million lives under contract, a 147 More and percent increase over fiscal 1996. more families are Our ProVantage, Inc. subsidiary consists of three unique operations: discovering Prescription Benefit Management (PBM), Vision Benefit Management (VBM) and Healthcare Information Technology. ShopKo apparel The ProVantage PBM offers custom prescription benefit management, encom- is compellingly passing benefit plan design, a network of over 46,000 retail pharmacies, priced and of prescription mail service, program administration, formulary administration, superior quality. clinical services, and claims and benefit processing services to insurance com- panies, third party administrators and self-funded healthcare plan sponsors. Recently, we acquired CareStream Scrip Card, a PBM offering services similar In fact, all our efforts and successes have to ProVantage PBM. garnered some rather coveted accolades: the Healthcare plan sponsors are increasingly utilizing PBM firms to control Discounter of the Year Award from Discount Store pharmacy costs by monitoring decisions regarding the usage of, for example, News – the leading trade publication in the generic drugs instead of brand-name drugs. As healthcare sponsors continue discount store industry. I call this award “coveted” to seek ways to contain costs, ProVantage PBM will play a greater role in the for good reason: it is judged, voted upon and effort to produce the best medical results at the lowest cost. awarded by our peers, the readers of Discount ProVantage VBM leverages our expertise in retail optical services with our Store News. They chose ShopKo over an PBM experience. We have developed a growing national network, currently at impressive list of nominees, including those from 4,500, of retail optical chains and private ophthalmologists, optometrists and large national discount chains. Traditionally, this opticians. In August of 1996, VBM completed the acquisition of United award is given to a single chief executive, but Wisconsin Insurance Company’s vision benefit management business. Unlike Discount Store News graciously allowed me to the PBM, the VBM offers insured as well as uninsured services. VBM currently accept it on behalf of all ShopKo associates, in provides services to approximately 190,000 plan participants. recognition of their dedication and tireless efforts.

3 Health Information Technology, the third compo- nent of ProVantage, is currently being applied in two different ways. The first is a division called ProVMed, which focuses on turning data of managed care organizations, other purchasers, payers, and providers of healthcare, and phar- ProVantage had an excellent year, maceutical companies into useful, actionable increasing lives under contract by 147 information through a concept called decision percent and sales by 272 percent. support services (DSS). Using an IBM SP2, a massive parallel processing computer, Oracle database technology and DSS tools, ProVMed capitalizes on ShopKo’s investment in leading- growth strategy will allow us to maintain our competitive position and finan- edge technology, extracting actionable informa- cial integrity while leveraging our investment in infrastructure, advanced tion from enterprise-wide databases. The other management information and distribution systems. At the same time, we are use is for a PBM product we call ProVRx which focused on avoiding excessive debt and maintaining adequate liquidity. focuses the same technology on the pharmacy Any new or refurbished stores we develop will remain true to the concept of claims data of ProVantage’s PBM customers. the existing ShopKo stores to take advantage of our long-term vision and We expect continued ProVantage growth through our successful planning and merchandising strategies. initiatives including increased marketing efforts Of course, ProVantage is a major part of our future and its growth from our existing sales force and through oppor- continues unabated. With the addition of ProVantage VBM, ProVRx and tunistic acquisitions. ProVMed, ProVantage has new dimensions upon which to build. We have high expectations for their performance. The Future Many people called the 1996-97 Green Bay Packers a “team of destiny.” So what lies ahead? Our plan, the reason True as that may be, their destiny was not the result of luck. The Packers for our present success, has been a strategic created their own destiny, through planning, intelligence, logic, hard work repositioning agent of change. Continuous and, of course, teamwork – putting team goals over personal goals. They transformation will involve relentless evaluation put the pieces in place and labored to make their dream come true. of our business operating assumptions and principles for progressive lifestyle merchandising, As did we. And we had another year of record sales. Our cash flow and marketing, logistics, and store operations balance sheets are among the strongest in the industry. We’ve thrived in improvements. The average ShopKo customer times that have weakened other retailers. spends a lot of money on the kinds of merchan- Our strong performance is testament to the soundness of our plan dise ShopKo offers, yet only a portion of it at and to the winning attitude and hard work of everyone at ShopKo. ShopKo. We’re focused on enticing existing I especially want to thank our more than 18,000 store associates whose customers to spend more at ShopKo, increasing commitment, loyalty and enthusiasm directly contributed to our success, and our sales with little or no additional expenditures our vendors, who have committed to our game plan like true teammates. In in new stores or staff, marketing, etc. It’s a strat- fact, everyone – store associates, vendors, corporate staff and senior egy that’s been working. management – have worked together like a championship team to achieve Our proprietary branded apparel business will one of our most memorable years ever. We are in an enviable position in expand, a strategy with very exciting potential, the industry, the position of a team that is driven to succeed. aided by new external and in-store marketing support. Sincerely, We plan to grow the retail business by increasing the number of stores to achieve economies of scale and capitalize on our existing infrastructure. Selective and opportunistic acquisitions of retail stores or sites will allow us to improve profitability Dale P. Kramer and maintain our financial strength. A disciplined President and Chief Executive Officer

4 ¨

Take a look inside…

The Power of Big Thinking:

ShopKo strategically plans every

square foot to market more in

stores smaller than most national

discount chains. One of the smallest

stadiums in the NFL, Lambeau Field

nonetheless has been the home to

NFL Champions three times. ShopKo sold enough T-shirts last

ShopKo had record sales year to put one on every man,

of $2.3 billion this year. woman and child in Lambeau Field

Lambeau Field holds the for 29 games.

NFL record for sold out games,

every single one since 1960. The 212,000 people Speed of service is paramount at who purchase ShopKo, and our goal is to meet merchandise at our customers’ needs immediately. ShopKo on an average day would The wait for a season ticket to fill Lambeau Field three-and- Lambeau Field, however, is over one-half times. 30 years. (There are 32,000 people ahead of you.)

In two Monday Night Football

The fashions at Lambeau games last season, 33,660,000

Field are predominantly households were treated to views

green and gold. ShopKo, on of Lambeau Field. ShopKo’s new

the other hand, strives to and aggressive marketing strategy offer more sizes and more colors than used TV to create 137,208,000 many other discounters in America. impressions of ShopKo merchandise.

¨ To prepare for the

Last year, the licensed NFC Championship game, over

doctors of optometry 87,000 square feet of sod was

at ShopKo Optical replaced in Lambeau Field in 48

Centers performed 301,927 eye hours. In less than eight hours, exams, the equivalent of five sold- ShopKo replaces all the signs in out home crowds at Lambeau Field. nearly 12,000,000 square feet of

store space for every major sale.

ShopKo’s data management systems store every purchase, down to the Named the NFL’s color and size for tracking and Discount Retailer of

research purposes. the Year, ShopKo

The concessions sold 2.5 million units of Packers-

company for Lambeau licensed products. To get that

Field has a detailed many in Lambeau Field, each fan

breakdown of would have to wear, hold and wave every hot dog, brat, beverage, 41 items bearing the green-and- popcorn, soda and peanut sold gold “G.” (And some do.) at Lambeau Field.

¨ ¨ ShopKo had record sales of $2.3 billion this year. Lambeau Field holds the NFL record for sold out games, every single one since 1960. • ShopKo sold enough T-shirts last year to put one on every man, woman and child in Lambeau Field for 29 games. • Speed of service is paramount at ShopKo, and our goal is to meet our customers’ needs immediately. The wait for a season ticket to Lambeau Field, however, is over 30 years. (There are 32,000 people ahead of you.) • The fashions at Lambeau Field are predominantly green and gold. ShopKo, on the other hand, strives to offer more sizes and more colors than many other discounters in America. • The 212,000 people who purchase merchandise at ShopKo on an average day would fill Lambeau Field three-and-one-half times. • In two Monday Night Football games last season, 33,660,000 households were treated to views of Lambeau Field. ShopKo’s new and aggressive marketing strategy used TV to create 137,208,000 impressions of ShopKo merchandise. • ShopKo’s data management systems store every purchase, down to the color and size for tracking and research purposes. The concessions company for Lambeau Field has a detailed breakdown of every hot dog, brat, beverage, popcorn, soda and peanut sold at Lambeau Field. • To prepare for the NFC Championship game, over 87,000 square feet of sod was replaced in Lambeau Field in 48 hours. In less than eight hours, ShopKo replaces all the signs in nearly 12,000,000 square feet of store space for every major sale.• Named the NFL’s Discount Retailer of the Year, ShopKo sold 2.5 million units of Packers-licensed products. To get that many in Lambeau Field, each fan would have to wear, hold and wave 41 items bearing the green-and-gold “G.” (And some do.) • All the planning and work paid off. ShopKo won the Discounter of the Year Award, presented by Discount Store News magazine. The Packers won Super Bowl XXXI. • When the fans show up on game day, you better have food and refreshments ready. At ShopKo, when we run an ad, Job #1 is making sure we have the merchandise in stock for our value-hungry customers. • Last year, the licensed doctors of optometry at ShopKo Optical Centers performed 301,927 eye exams, the equivalent of five sold-out home crowds at Lambeau Field. • Lambeau Field sold 234,220 bratwurst, hot dogs, hamburgers and sandwiches at eight home games last season. ShopKo Pharmacies fill that many prescriptions in less than two weeks. • ShopKo filled 617,000 eyeglass and contact lens prescriptions, enough to correct the eyesight of every fan attending 10 home games. The 4.1 million people ProVantage has under contract would sell out all Green Bay Packer home games for the next eight years. Photo courtesy of the Green Bay Packers and Harmann Studios. • Green Bay Packers®, Packers®, Super Bowl®, NFL®, and NFC® are registered trademarks, trade names or service marks of National Football League, Inc. Monday Night Football® is a registered trademark, trade name or service mark of ABC Sports, Inc. All the planning and work paid off.

The 4.1 million people ShopKo won the Discounter of

ProVantage has under the Year Award, presented by contract would sell out all Green Discount Store News magazine.

Bay Packer home games for the The Packers won Super Bowl XXXI. next eight years.

When the fans show up on game

day, you better have

Lambeau Field sold 234,220 food and refreshments bratwurst, hot dogs, hamburgers ready. At ShopKo, and sandwiches at eight home games when we run an ad, last season. ShopKo Pharmacies fill Job #1 is making sure

that many prescriptions we have the merchandise in stock

in less than two weeks. for our value-hungry customers.

ShopKo filled 617,000 eyeglass and

contact lens prescriptions, enough

to correct the eyesight of every fan

attending 10 home games.

¨ Management’s Discussion and Analysis

Results of Operations The following tables set forth items from the Company’s The following table sets forth items from the Company’s business segments as percentages of net sales: Consolidated Statements of Earnings as percentages of consolidated net sales: Retail Store Segment Fiscal years ended Fiscal years ended Feb. 22, Feb. 24, Feb. 25, Feb. 22, Feb. 24, Feb. 25, 1997 1996 1995 1997 1996 1995 (52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) Revenues: Revenues: Net sales 100.0% 100.0% 100.0% Net sales 100.0% 100.0% 100.0% Licensed department Licensed department rentals and rentals and other income 0.6 0.7 0.7 other income 0.6 0.7 0.7 100.6 100.7 100.7 100.6 100.7 100.7 Costs and expenses: Costs and expenses: Cost of sales 76.4 74.5 73.7 Cost of sales 73.8 73.8 73.6 Selling, general and Selling, general and administrative administrative expenses 17.0 18.4 19.2 expenses 18.3 18.3 18.6 Depreciation Depreciation and amortization and amortization expenses 2.6 2.9 2.9 expenses 2.8 2.9 2.9 96.0 95.8 95.8 94.9 95.0 95.1 Income from operations 4.6 4.9 4.9 Income from operations 5.7% 5.7% 5.6% Interest expense – net 1.4 1.7 1.6 Earnings before income taxes 3.2 3.2 3.3 ProVantage Segment Provision for Fiscal years ended income taxes 1.3 1.2 1.3 Feb. 22, Feb. 24, Feb. 25, Net earnings 1.9% 2.0% 2.0% 1997 1996 1995 (52 Weeks) (52 Weeks) (52 Weeks) The Company has redefined its business segments from the Revenues: classifications of General Merchandise and Health Services Net sales 100.0% 100.0% 100.0% (which had included ProVantage’s managed healthcare Licensed department operations and ShopKo’s retail pharmacy and optical rentals and departments), to a Retail Store segment (which includes other income 0.2 0.5 0.4 general merchandise, retail pharmacy and retail optical 100.2 100.5 100.4 Costs and expenses: operations) and a ProVantage segment (which includes Cost of sales 93.1 91.0 78.0 prescription benefit management, mail service pharmacy, Selling, general and vision benefit management and healthcare information administrative technology). The new segment reporting will provide better expenses 3.8 5.5 10.0 information for shareholders and business analysts. Depreciation Intercompany sales, which consist of prescriptions that and amortization were both sold at a ShopKo pharmacy and processed by expenses 0.6 1.1 1.8 ProVantage, have been eliminated. 97.5 97.6 89.8 Income from operations 2.7% 2.9% 10.6%

5 ¨ Management’s Discussion and Analysis

Fiscal 1997 Compared to Fiscal 1996 processing activities and to an increase in the percentage Consolidated net sales for fiscal 1997 (52 weeks) of formulary fees shared with clients. Management antici- increased 18.6% or $365.4 million over fiscal 1996 (52 pates that this downward trend in gross margin percent for weeks) to $2,333.4 million. ProVantage will continue.

Retail Store sales increased 6.6% or $124.7 million over Consolidated selling, general and administrative expenses fiscal 1996 to $2,005.7 million. Comparable Retail Store decreased 1.4% of net sales to 17.0% compared with sales increased 6.0%. The comparable Retail Store 18.4% in fiscal 1996. The decrease is due to increased increases by category were as follows: Apparel – 12%, sales related to ProVantage. Retail Store selling, general Retail Health – 8% and Hardline/Home goods – 3%. The and administrative expenses were 18.3% of net sales for Company attributes these increases in large part to the suc- both fiscal years. ProVantage selling, general and admini- cess of its merchandising operations and marketing initia- strative expenses decreased 1.7% of net sales to 3.8% com- tives. Changes in retail comparable store sales for a fiscal pared with 5.5% in fiscal 1996. This decrease is primarily year are based upon those stores which were open for the due to leveraging costs against increasing sales volumes. entire preceding fiscal year. The Company’s operating earnings (earnings before inter- ProVantage sales increased 271.7% or $254.9 million est and income taxes) increased 8.6% to $105.8 million in over fiscal 1996 to $348.8 million. Management attributes fiscal 1997 from $97.4 million in fiscal 1996. Retail Store this increase primarily to internally generated growth and operating earnings (earnings before corporate expenses, supplementally to the acquisition of CareStream Scrip Card interest and income taxes) increased 6.0% to $113.7 mil- in August 1996. Included in ProVantage sales are amounts lion in fiscal 1997 compared to $107.2 million in fiscal billed to insurance companies, third party administrators 1996. This increase is primarily due to increased sales. and self-funded medical plan sponsors and the amounts ProVantage operating earnings increased in fiscal 1997 to billed to pharmaceutical manufacturers and third party $9.5 million compared to $2.7 million in fiscal 1996. This formulary administrators for formulary fees. The formulary increase is primarily due to growth in prescription benefit fees included in ProVantage sales were $16.7 million and management services and business acquisitions. $5.7 million for fiscal years 1997 and 1996, respectively. Net interest expense in fiscal 1997 decreased from the On a per claim basis, net formulary fees were $0.51 and prior year by 0.3% of net sales to 1.4% of net sales. This $0.79 for fiscal years 1997 and 1996, respectively. decrease is primarily due to increased sales and increased Management expects the net formulary fees per claim to interest income. Interest income increased to $4.3 million in decrease in fiscal 1998. fiscal 1997 compared with $1.8 million in fiscal 1996. Consolidated gross margins as percentages of sales were 23.6% and 25.5% for fiscal 1997 and 1996, respectively. Fiscal 1996 Compared to Fiscal 1995 Retail Store gross margins as percentages of sales were Consolidated net sales for fiscal 1996 (52 weeks) 26.2% for both fiscal years and include LIFO charges of increased 6.2% or $115.1 million over fiscal 1995 (52 $2.6 million and $2.2 million for fiscal 1997 and 1996, weeks) to $1,968.0 million. respectively. Retail Store gross margins, before LIFO expense, were 26.3% in fiscal 1997 and fiscal 1996. Retail Store sales increased 2.2% or $41.1 million over ProVantage gross margins as percentages of sales were fiscal 1995 to $1,881.0 million. Management attributes 6.9% and 9.0% for fiscal 1997 and 1996, respectively. this sales increase to the opening of five new stores and This decrease is attributable to a larger percentage of the increased business in the Company’s retail pharmacy and sales coming from the lower gross margin claims optical centers. Comparable Retail Store sales decreased

¨ 6 Management’s Discussion and Analysis

0.5%. Management believes Retail Store sales were nega- The Company’s operating earnings (earnings before tively impacted by a difficult retail environment, planned interest and income taxes) increased 6.5% to $97.4 million contraction of several departments and increased competi- in fiscal 1996 from $91.5 million in fiscal 1995. Retail tive entries. Store operating earnings (earnings before corporate expenses, interest and income taxes) increased 4.4% to ProVantage sales increased 567.5% or $79.8 million over $107.2 million in fiscal 1996 compared to $102.7 million fiscal 1995 to $93.8 million. In fiscal 1995, ProVantage in fiscal 1995. This increase is primarily due to increased sales only included prescription benefit management sales sales and expense control initiatives. ProVantage operating for the eight week period from the date of the Company’s earnings increased in fiscal 1996 to $2.7 million acquisition of Bravell, Inc. (“Bravell”) to the end of the fiscal compared to $1.5 million in fiscal 1995. The increase is year, in addition to mail service revenues. Of the increase, due to growth in prescription benefit management services. $53.4 million or 380.1% is due to fiscal 1995 including only a partial year of Bravell sales. Management attributes Net interest expense in fiscal 1996 increased from the prior the rest of the increase to growth in prescription benefit year by 0.1% of net sales to 1.7% of net sales. The increase management services business. reflects a full year of interest charges on fiscal 1995’s issuance of long-term debentures. Consolidated gross margins as percentages of sales were 25.5% and 26.3% for fiscal 1996 and 1995, respectively. Retail Store gross margins as percentages of sales were Liquidity and Capital Resources 26.2% and 26.4% for fiscal 1996 and 1995, respectively. The Company relies on cash generated from its operations, The Retail Store gross margin for fiscal 1996 includes a with the remaining needs being met by short-term and LIFO charge of $2.2 million and for fiscal 1995 includes a long-term borrowings. Cash provided from operating activ- LIFO credit of $2.0 million and a $5.5 million charge to ities was $111.7 million, $155.6 million and $40.9 million reduce certain inventories to market value. Retail Store in fiscal years 1997, 1996 and 1995, respectively. gross margin before LIFO expense was 26.3% in fiscal 1996 and 26.2% in fiscal 1995. ProVantage gross On November 9, 1994, the Company issued $100 million margins as percentages of sales were 9.0% and 22.0% for 9.0% senior unsecured notes due November 15, 2004. The fiscal 1996 and 1995, respectively. This decrease is attrib- net proceeds of $98.9 million, after underwriting and utable to an increase in the percentage of formulary fees issuance costs, were used to reduce the Company’s short- shared with clients and a larger portion of the sales coming term borrowings and to provide for working capital needs from the lower gross margin claims processing activities. and other general corporate purposes.

Consolidated selling, general and administrative expenses Funds generated from operations, and if necessary, the decreased 0.8% of net sales to 18.4% compared with existing $125 million revolving credit agreement are 19.2% in fiscal 1995. Retail Store selling, general and expected to fund the projected working capital needs and administrative expenses were 18.3% and 18.6% for fiscal total capital expenditures through fiscal 1998, including 1996 and 1995, respectively. This improvement is primar- the stock repurchase from Supervalu. See Note L of ily due to expense control initiatives. ProVantage selling, the Notes to Consolidated Financial Statements included general and administrative expenses decreased to 5.5% of herein. The revolving credit agreement expires net sales from 10.0% of net sales in fiscal 1995. This October 4, 1997. The Company anticipates being able to decrease is primarily due to leveraging costs against replace this agreement with a revolving credit agreement increased sales volumes. based on current market terms.

7 ¨ Management’s Discussion and Analysis

Capital Expenditures and Acquisitions excluding capital required for acquisitions of businesses or The Company’s principal use of cash was for capital real estate. Such plans may be reviewed and revised from expenditures and business acquisitions. The Company time to time in light of changing conditions. spent $38.9 million on capital expenditures (excluding The Company expects to pursue growth of its retail store acquisitions) in fiscal 1997, compared to $53.0 million in business through acquisition of existing retail stores or busi- fiscal 1996 and $94.6 million in fiscal 1995. The following nesses. The Company may also consider the acquisition of table sets forth the components of the Company’s capital health services businesses. Such plans may be reviewed expenditures and acquisitions (in millions): and revised from time to time in light of changing condi- tions. Depending upon the size and structure of any such Fiscal years ended acquisitions, the Company may require additional capital Feb. 22, Feb. 24, Feb. 25, resources. The Company believes that adequate sources of 1997 1996 1995 capital will be available. (52 Weeks) (52 Weeks) (52 Weeks) Capital Expenditures On August 2, 1996, the Company completed the acquisi- New stores $ 2.5 $14.9 $31.3 tion of CareStream Scrip Card from Avatex Corporation, Remodeling and formerly known as FoxMeyer Health Corporation refixturing 14.6 24.7 45.2 (“Avatex”). CareStream Scrip Card is a prescription benefit Distribution centers 1.3 0.7 2.8 management company which is being integrated with the Management information Company’s ProVantage subsidiary. The purchase price and point-of-sale was $30.5 million in cash, with a supplemental cash equipment and systems 18.8 11.7 14.8 payment of between $2.5 million and $5.0 million due Other 1.7 1.0 0.5 between six months and five years after August 2, 1996. Total $38.9 $53.0 $94.6 The purchase price was funded from the Company’s Acquisitions $30.5 $ — $15.9 available cash.

In fiscal 1997, the Company opened two new stores under On October 4, 1996, the Company and the founders of the Vision 2000 format (one of which was a relocation) Bravell entered into an agreement whereby the Company and four Vision Advantage stores, which are stand alone (i) acquired the remaining 3% of the common stock of optical centers. With respect to store remodels, the Bravell which the Company did not acquire in January Company completed seven remodels under the Vision 1995, (ii) extinguished all remaining contingent payment 2000 format in fiscal 1997. The rate of remodeling activity obligations to the founders, and (iii) terminated the in fiscal years 1997 and 1996 was substantially reduced founders’ employment agreements. On April 10, 1997, the compared to fiscal 1995 and is expected to approximate Company satisfied its obligations under this agreement the future annual level of major remodels based on a seven by making a payment of approximately $8.9 million to to ten year cycle. There are no plans to complete any the founders. major remodels or to construct any new stores in fiscal 1998; however, the Company plans to reallocate store Termination of Plan of Reorganization space and modernize fixturing throughout the chain for On September 7, 1996, the Company entered into an certain merchandise categories. Expansion and remodel Agreement and Plan of Reorganization, as amended as plans for fiscal 1999 and after are under review. of October 9, 1996, (the “Plan of Reorganization”) with The Company’s total capital expenditures for fiscal 1998 Phar-Mor, Inc. (“Phar-Mor”) and Cabot Noble, Inc. for management information systems and other (“Cabot Noble”). Pursuant to the Plan of Reorganization, expenditures are anticipated to approximate $40 to $50 the Company and Phar-Mor would have become sub- million, the majority of which would relate to existing retail sidiaries of Cabot Noble. business to support ongoing replacements, merchandise initiatives and continued investment in systems technology,

¨ 8 Management’s Discussion and Analysis

The planned business combination was terminated on April Recent Pronouncements 2, 1997 by mutual agreement between the Company, In February 1997, Statement of Financial Accounting Cabot Noble and Phar-Mor. The Company incurred a Standards (“SFAS”) No. 128, “Earnings Per Share,” and one-time pre-tax charge of $2.8 million ($0.05 per share), SFAS No. 129, “Disclosure of Information about Capital during the first quarter of fiscal 1998 to cover costs Structure,” were issued. SFAS No. 128 specifies the com- associated with the proposed combination. putation, presentation and disclosure requirements for earnings per share. SFAS No. 129 requires an entity to Dividend Policy explain the pertinent rights and privileges of the various securities outstanding. Both Statements must be adopted no As a result of the proposed transaction with Phar-Mor and later than fiscal 1998. The Company is in the process of Cabot Noble, the Company was prohibited from declaring evaluating the impact of SFAS No. 128 and SFAS No. 129 or paying any dividends. Upon termination of such trans- on its financial statements. action, the Company determined to retain earnings, if any, for the growth and expansion of its business and not declare or pay any cash dividends. The Company intends Stock Buyback Agreement to reconsider its dividend policy after completion of the sec- On April 24, 1997, the Company and Supervalu (the ondary offering and the stock repurchase contemplated in “Selling Shareholder”) entered into a Stock Buyback and the Stock Buyback and Secondary Offering Agreement Secondary Offering Agreement pursuant to which the dated April 24, 1997 between ShopKo and Supervalu. See Company has agreed to repurchase 8,174,387 shares of Note L to the Notes to Consolidated Financial Statements Common Stock from the Selling Shareholder for $18.35 included herein. Future dividends will be sub- per share. The obligation of the Company and the Selling ject to the discretion of the Company’s Board of Directors Shareholder to consummate the Stock Buyback is condi- and will depend upon the Company’s results of opera- tioned upon completion of a secondary public offering of tions, financial condition, capital expenditure program, the Selling Shareholder’s remaining 6,557,280 shares of debt repayment requirements and other factors, some of Common Stock (the “Offering”). The Stock Buyback and the which are beyond the Company’s control. There can Offering are expected to be significantly accretive be no assurance as to whether or when the Company’s to the Company’s earnings per share, excluding one-time Board of Directors will change the current policy charges in fiscal 1998 related to the termination of regarding dividends. the Phar-Mor transaction. See Note L of the Notes to Consolidated Financial Statements included herein. Inflation Inflation has not had a significant effect on the results of operations of the Company or its internal and external sources of liquidity.

9 ¨ Ten Year Financial Summary ShopKo Stores, Inc. and Subsidiaries

Fiscal years ended Feb. 22, Feb. 24, Feb. 25, Feb. 26, Feb. 27, Feb. 29, Feb. 23, Feb. 24, Feb. 25, Feb. 27, 1997 1996 1995 1994(1) 1993 1992 1991 1990(2) 1989 1988 (52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) (53 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) (52 Weeks) Summary of Operations (Millions) Net sales $2,333 $1,968 $1,853 $1,739 $1,683 $1,648 $1,521 $1,420 $1,248 $1,051 Licensed department rentals and other income 13 14 12 12 11 11 12 11 10 9 Gross margin 550 501 488 453 457 452 417 396 360 298 Selling, general and administrative expenses 397 361 356 344 326 325 296 282 262 221 Depreciation and amortization expenses 60 56 53 47 43 40 39 35 31 25 Interest expense – net 32 34 29 21 18 17 21 20 16 13 Earnings before income taxes 74 63 62 53 81 81 73 70 61 48 Net earnings 45 38 38 32 50 50 45 43 37 27 Per Share Data (Dollars) Net earnings per common share $ 1.40 $ 1.20 $ 1.18 $ 1.00 $ 1.56 $ 1.55(3) $ 1.41(3) $ 1.33(3) $ 1.15(3) $ 0.85(3) Cash dividends declared per common share (4)(5) 0.22 0.44 0.44 0.44 0.44 0.11 Financial Data (Millions) Working capital $ 232 $ 215 $ 187 $ 119 $ 82 $ 79 $ 70 $ 59 $ 57 $ 37 Property and equipment – net 603 617 618 578 493 445 432 412 369 313 Total assets 1,234 1,118 1,110 953 792 706 692 648 576 485 Total debt (6) 421 416 429 337 225 193 215 237 231 193 Total shareholders’ equity 461 422 397 374 355 320 273 228 186 149 Capital expenditures 39 53 95 134 91 53 59 80 91 88 Financial Ratios Current ratio 1.7 1.8 1.7 1.5 1.4 1.4 1.4 1.3 1.4 1.3 Return on beginning assets 4.0% 3.5% 4.0% 4.1% 7.1% 7.2% 7.0% 7.4% 7.6% 6.9% Return on beginning shareholders’ equity 10.7% 9.7% 10.1% 9.0% 15.7% 18.1% 19.7% 22.9% 24.8% 22.3% Total debt as % of total capitalization (7) 46.6% 48.5% 50.9% 46.2% 37.9% 36.7% 42.8% 50.0% 53.9% 54.9% Other Year End Data Stores open at year end 130 129 124 117 111 109 104 98 87 75 Average store size – square feet 89,840 89,945 90,260 90,440 89,500 87,400 87,200 87,000 85,900 84,700

(1) The effect of adopting Statement of Financial Accounting Standards (4) First quarterly dividend was declared in the fourth quarter of (“SFAS”) No. 106, “Employers’ Accounting for Postretirement Ben- fiscal 1992. efits Other Than Pensions,” resulted in a decrease in net earnings (5) In the third quarter of fiscal 1997, the Company entered into a of $0.6 million ($0.02 per share). Adoption of SFAS No. 109, Plan of Reorganization with Phar-Mor and Cabot Noble that “Accounting for Income Taxes,” had no effect on reported net prohibited the declaration or payment of dividends. earnings or financial position. (6) Total debt includes short-term debt, current portion of long-term (2) Includes the effect of a change in the method of accounting for obligations, long-term obligations and payable to related party. LIFO inventories which increased net earnings by $3.0 million. (7) Total capitalization includes shareholders’ equity, total debt and (3) The number of common shares used in the computation is the total non-current deferred income taxes. number of shares of the Company’s Common Stock outstanding upon completion of the initial public offering.

¨ 10 Consolidated Statements of Earnings ShopKo Stores, Inc. and Subsidiaries

Fiscal years ended February 22, February 24, February 25, 1997 1996 1995 (In thousands, except per share data) (52 Weeks) (52 Weeks) (52 Weeks) Revenues: Net sales $2,333,407 $1,968,016 $1,852,929 Licensed department rentals and other income 13,058 13,924 12,433 2,346,465 1,981,940 1,865,362

Costs and expenses: Cost of sales 1,783,741 1,466,733 1,364,913 Selling, general and administrative expenses 397,092 361,402 355,515 Depreciation and amortization expenses 59,833 56,383 53,474 2,240,666 1,884,518 1,773,902

Income from operations 105,799 97,422 91,460 Interest expense – net 31,777 34,282 29,042

Earnings before income taxes 74,022 63,140 62,418 Provision for income taxes 29,076 24,701 24,628 Net earnings $ 44,946 $ 38,439 $ 37,790

Net earnings per common share $ 1.40 $ 1.20 $ 1.18 Weighted average number of common shares outstanding 32,092 32,005 32,014

See notes to consolidated financial statements.

11 ¨ Consolidated Balance Sheets ShopKo Stores, Inc. and Subsidiaries

February 22, February 24, (In thousands) 1997 1996 Assets Current assets: Cash and cash equivalents $ 124,550 $ 89,469 Receivables, less allowance for losses of $5,585 and $3,212, respectively 95,178 55,514 Merchandise inventories 334,962 322,433 Other current assets 10,482 8,775 Total current assets 565,172 476,191 Other assets and deferred charges 5,558 4,618 Intangible assets – net 60,330 20,003 Property and equipment – net 602,832 617,148 Total assets $1,233,892 $1,117,960

Liabilities and Shareholders’ Equity Current liabilities: Accounts payable – trade $ 165,712 $ 144,638 Accrued compensation and related taxes 34,861 25,290 Accrued other liabilities 113,064 72,943 Accrued income and other taxes 17,664 16,797 Current portion of long-term obligations 2,014 1,127 Total current liabilities 333,315 260,795 Long-term obligations 418,714 415,138 Deferred income taxes 20,999 20,396 Shareholders’ equity: Preferred stock; none outstanding Common stock; shares outstanding, 32,167 in 1997 and 32,005 in 1996 322 320 Additional paid-in capital 245,137 242,843 Retained earnings 215,405 178,468 Total shareholders’ equity 460,864 421,631 Total liabilities and shareholders’ equity $1,233,892 $1,117,960

See notes to consolidated financial statements.

¨ 12 Consolidated Statements of Cash Flows ShopKo Stores, Inc. and Subsidiaries

Fiscal years ended February 22, February 24, February 25, 1997 1996 1995 (In thousands) (52 Weeks) (52 Weeks) (52 Weeks) Cash flows from operating activities: Net earnings $ 44,946 $ 38,439 $ 37,790 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 59,833 56,383 53,474 Provision for losses on receivables 1,200 23 287 (Gain) loss on the sale of property and equipment (2,140) (2,739) 421 Deferred income taxes (1,620) 5,206 (3,764) Change in assets and liabilities (excluding effects of business acquisitions): Receivables (40,636) (13,470) (5,611) Merchandise inventories (12,529) 78,190 (71,769) Other current assets 523 2,448 (1,504) Other assets and intangibles (13,062) (2,879) (2,059) Accounts payable 21,074 (4,655) 2,142 Accrued liabilities 54,133 (1,395) 31,486 Net cash provided by operating activities 111,722 155,551 40,893

Cash flows from investing activities: Payments for property and equipment (38,899) (53,012) (94,600) Proceeds from the sale of property and equipment 3,275 4,171 6,982 Business acquisitions, net of cash acquired (30,500) (15,885) Net cash (used in) investing activities (66,124) (48,841) (103,503)

Cash flows from financing activities: Net proceeds from long-term obligations 98,939 Change in short-term debt (15,000) (11,200) Change in common stock 1,249 (135) Dividends paid (10,583) (14,083) (14,087) Reduction in capital lease obligations (1,183) (756) (879) Net cash (used in) provided by financing activities (10,517) (29,839) 72,638 Net increase in cash and cash equivalents 35,081 76,871 10,028 Cash and cash equivalents at beginning of year 89,469 12,598 2,570 Cash and cash equivalents at end of year $124,550 $ 89,469 $ 12,598

Supplemental cash flow information: Noncash investing and financial activities – Capital lease obligations incurred $ 5,533 $ 2,573 $ 4,992 Restricted stock issued $ 1,012 Purchase of remaining interest in Bravell $ 8,874 Cash paid during the period for: Interest $ 31,663 $ 34,803 $ 27,734 Income taxes $ 30,086 $ 33,062 $ 12,910

See notes to consolidated financial statements.

13 ¨ Consolidated Statements of Shareholders’ Equity ShopKo Stores, Inc. and Subsidiaries

Additional Common Stock Paid-in Retained (In thousands, except per share data) Shares Amount Capital Earnings Balances at February 26, 1994 32,016 $320 $242,978 $130,408 Net earnings 37,790 Cancellation of common stock (16) (185) Issuance of common stock 5 50 Cash dividends declared on common stock – $0.44 per share (14,086)

Balances at February 25, 1995 32,005 320 242,843 154,112 Net earnings 38,439 Cash dividends declared on common stock – $0.44 per share (14,083)

Balances at February 24, 1996 32,005 320 242,843 178,468 Net earnings 44,946 Sale of common stock under option plans 97 1 1,248 Income tax benefit related to stock options 35 Issuance of restricted stock 65 1 1,011 (1,012) Restricted stock expense 63 Cash dividends declared on common stock – $0.22 per share (7,060) Balances at February 22, 1997 32,167 $322 $245,137 $215,405

See notes to consolidated financial statements.

¨ 14 Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

A. Summary of Significant Accounting Policies Merchandise Inventories Organization and Basis of Presentation Merchandise inventories are stated at the lower of cost or market. Cost, which includes certain distribution and trans- The consolidated financial statements include the accounts portation costs, is determined through use of the last-in, of ShopKo Stores, Inc. and all its subsidiaries (“ShopKo” or first-out (LIFO) method for substantially all inventories. If the the “Company”). All significant intercompany accounts and first-in, first-out (FIFO) method had been used to determine transactions have been eliminated. The Company, which is cost of inventories, the Company’s inventories would have a Minnesota corporation, was incorporated in 1961. On been higher by approximately $41.8 million at Febru- October 16, 1991, the Company sold 17,250,000 com- ary 22, 1997, $39.2 million at February 24, 1996 and mon shares or 54% of equity ownership in an initial public $37.0 million at February 25, 1995. offering. Prior to completion of the offering, the Company was a wholly owned subsidiary of Supermarket Operators of America, Inc., (“SOA”) which, in turn, is wholly owned Property and Equipment by Supervalu Inc. (“Supervalu”). As of February 22, 1997, Property and equipment are carried at cost. The cost of 46% of the Company’s common stock was owned by buildings and equipment is depreciated over the estimated Supervalu. useful lives of the assets. Buildings and certain equipment (principally computer and retail store equipment) are ShopKo is engaged in the business of providing general depreciated using the straight-line method. Remaining merchandise and health services through its retail stores. properties are depreciated on an accelerated basis. Useful The Company also provides prescription benefit manage- lives generally assigned are: buildings – 25 to 50 years; ment services; vision benefit management services; phar- retail store equipment – 8 to 10 years; warehouse, trans- macy mail service and claims processing activities through portation and other equipment – 3 to 10 years. Costs of its ProVantage subsidiary. Retail stores are operated in the leasehold improvements are amortized over the period of Upper Midwest, Western Mountain and Pacific Northwest the lease or the estimated useful life of the asset, whichever states. All other business is conducted throughout the is shorter, using the straight-line method. Property under United States. capital leases is amortized over the related lease term using the straight-line method. Interest on property under Cash and Cash Equivalents construction of $0.1, $0.2 and $1.3 million was capital- The Company records all highly liquid investments with a ized in fiscal years 1997, 1996 and 1995, respectively. maturity of three months or less as cash equivalents. In The components of property and equipment are: accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Feb. 22, Feb. 24, Investments in Debt and Equity Securities,” these invest- (In thousands) 1997 1996 ments are classified as trading securities and are reported Property and equipment at cost: Land $107,982 $107,915 at fair value. Buildings 492,001 479,124 Equipment 313,505 286,763 Receivables Leasehold improvements 49,929 49,306 Receivables consist of amounts collectible from merchan- Property under construction 2,219 10,585 dise vendors for promotional and advertising allowances, Property under capital leases 26,419 21,968 from third party pharmacy insurance carriers and self- 992,055 955,661 funded medical plan sponsors for medical claims, from Less accumulated depreciation and amortization: pharmaceutical manufacturers and third party formulary Property and equipment 380,643 331,541 administrators for formulary fees and from retail store Property under capital leases 8,580 6,972 customers for optical, main store layaway and pharmacy Net property and equipment $602,832 $617,148 purchases. Substantially all amounts are expected to be collected within one year.

15 ¨ Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

Intangible Assets Net Earnings Per Common Share The excess of cost over fair value of the net assets of busi- Net earnings per common share are computed by dividing nesses acquired is amortized using the straight-line method net earnings by the weighted average number of common over 20 to 22 years. Accumulated amortization for these shares outstanding. Outstanding stock options do not have costs was $2.5 million and $0.9 million at February 22, a significant dilutive effect on earnings per share. 1997 and February 24, 1996, respectively. Use of Estimates Impairment of Long Lived Assets The preparation of financial statements in conformity with The Company evaluates whether events and circumstances generally accepted accounting principles requires manage- have occurred that indicate the remaining estimated useful ment to make estimates and assumptions that affect the life of long lived assets may warrant revision or that the reported amounts of assets and liabilities and disclosure of remaining balance of an asset may not be recoverable. The contingent assets and liabilities at the date of the financial measurement of possible impairment is based on the ability statements and the reporting period. Actual results could to recover the balance of assets from expected future differ from those estimates. operating cash flows on an undiscounted basis. In the opinion of management, no such impairment existed as of Reclassifications February 22, 1997 or February 24, 1996. Certain reclassifications have been made to the fiscal 1996 and 1995 consolidated financial statements to conform to Accrued Other Liabilities those used in fiscal 1997. Accrued other liabilities include amounts related to ProVantage for medical claims and formulary rebate shar- B. Acquisitions ing and other current liabilities not related to compensation On August 2, 1996, the Company completed the acquisi- or taxes. As of February 22, 1997 and February 24, tion of CareStream Scrip Card from Avatex Corporation, 1996, the amounts payable by ProVantage for medical formerly known as Foxmeyer Health Corporation. claims and formulary rebate sharing included in CareStream Scrip Card is a prescription benefit manage- the accrued other liabilities were $39.8 million and ment company which is being integrated with the $11.6 million, respectively. Company’s ProVantage subsidiary. The purchase price was $30.5 million in cash, with a supplemental cash pay- ProVantage Accounting ment of between $2.5 million and $5.0 million due ProVantage records as sales the amounts billed to insur- between six months and five years after August 2, 1996. ance companies, third party administrators and self-funded The purchase price was funded from the Company’s medical plan sponsors and the amounts billed to pharma- available cash. ceutical manufacturers and third party formulary adminis- trators for formulary fees. Cost of sales includes the On January 3, 1995, the Company completed the acquisi- amounts paid to network pharmacies and optical centers tion of Bravell, Inc. (“Bravell”). The transaction was for medical claims and the amounts paid to plan sponsors accounted for as a purchase, whereby the Company for shared formulary fees. acquired 97% of the outstanding common stock of Bravell for approximately $17.3 million. The Company was also required to make additional payments which were contin- Pre-opening Costs gent upon future results of Bravell’s operations. In fiscal Pre-opening costs of retail stores are charged against earn- 1997, $0.7 million was paid based on the results of fiscal ings in the year of the store openings. 1996. Bravell is a pharmacy benefit management firm that provides custom prescription benefit plan design, program administration and claims and benefit processing services to insurance companies, third party administrators and self-funded medical plan sponsors.

¨ 16 Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

On October 4, 1996, the Company and the founders of D. Long-Term Obligations and Leases Bravell entered into an agreement whereby the Company Feb. 22, Feb. 24, (i) acquired the remaining 3% of the common stock of (In thousands) 1997 1996 Bravell which the Company did not acquire in January Senior Unsecured Notes, 1995, (ii) extinguished all remaining contingent payment 9.0% due November 15, 2004, obligations to the founders and (iii) terminated the less unamortized discount of founders’ employment agreements. On April 10, 1997, the $227 and $257, respectively $ 99,773 $ 99,743 Company satisfied its obligations under this agreement Senior Unsecured Notes, by making a payment of approximately $8.9 million to 8.5% due March 15, 2002, the founders. less unamortized discount of $184 and $221, respectively 99,816 99,779 The allocation of the purchase prices of Bravell and Senior Unsecured Notes, CareStream Scrip Card were based on fair values at the 9.25% due March 15, 2022, dates of acquisition. The excess of the purchase prices over less unamortized discount of the fair value of the net assets acquired (“goodwill”) of $480 and $499, respectively 99,520 99,501 approximately $57.3 million is being amortized on a Senior Unsecured Notes, 6.5% due August 15, 2003, straight-line basis over 20 to 22 years. The results of less unamortized discount of Bravell's and Carestream Scrip Card’s operations since the $182 and $209, respectively 99,818 99,791 dates of acquisition have been included in the consolidated Industrial Revenue Bond, statement of earnings. 6.4% due May 1, 2008 1,000 1,000 Capital lease obligations 20,801 16,451 C. Short-Term Debt 420,728 416,265 As of February 22, 1997, the Company had a $125.0 mil- Less current portion 2,014 1,127 lion revolving credit agreement with a consortium of banks. Long-term obligations $418,714 $415,138 The credit agreement is unsecured and will expire October 4, 1997. The Company pays an annual facility and com- The notes contain certain covenants which, among other mitment fee of 1⁄4 of one percent. As of February 22, 1997 things, restrict the ability of the Company to consolidate, and February 24, 1996, the Company had no amounts merge or convey, transfer or lease its properties and assets outstanding under this agreement. There were no borrow- substantially as an entirety, to create liens or to enter into ings under the credit agreement during fiscal 1997. The sale and leaseback transactions. Company anticipates being able to replace this agreement The underwriting and issuance costs of all the long-term with a revolving credit agreement based on current mar- obligations are being amortized over the terms of the notes ket terms. using the straight-line method. At February 22, 1997 The Company also issues letters of credit during the ordi- and February 24, 1996, $2.6 million and $2.9 million nary course of business as required by foreign vendors. As remained to be amortized over future periods. of February 22, 1997 and February 24, 1996, the Amortization expense for these costs was $0.3, $0.3 Company had issued letters of credit for $33.4 million and and $0.2 million in fiscal years 1997, 1996 and $19.8 million, respectively. 1995, respectively. The Company leases certain stores and computer equipment under capital leases. Many of these leases include renewal options, and occasionally, include options to purchase.

17 ¨ Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

Amortization of property under capital leases was $2.7, statements of earnings reflect rent expense on a straight- $1.1 and $0.9 million in fiscal years 1997, 1996 and line basis over the term of the leases. An obligation of $1.8 1995, respectively. Minimum future obligations under million and $1.4 million, representing pro-rata future capital leases in effect at February 22, 1997 are as follows payments, is reflected in the accompanying consolidated (in thousands): balance sheets at February 22, 1997 and February 24, 1996, respectively. Lease Year Obligations 1998 $ 4,112 E. Income Taxes 1999 3,968 Deferred income taxes reflect the net tax effect of tempo- 2000 2,689 rary differences between the carrying amounts of assets 2001 2,492 and liabilities for financial reporting purposes and the 2002 2,492 amounts used for income tax purposes. Components of Later 27,297 the Company’s net deferred tax liability are as follows Total minimum future obligations 43,050 (in thousands): Less interest 22,249 Present value of minimum future obligations $20,801 1997 1996 Deferred tax liabilities: The present values of minimum future obligations shown Property and equipment $ 25,812 $ 22,556 LIFO inventory valuation 6,518 6,415 above are calculated based on interest rates ranging from Other 2,418 2,181 7.4% to 13.4%, with a weighted average of 11.8%, deter- Total deferred tax liabilities 34,748 31,152 mined to be applicable at the inception of the leases. Deferred tax assets: Interest expense on the outstanding obligations under capi- Reserves and allowances (15,155) (11,239) tal leases was $2.2, $1.7 and $1.2 million in fiscal years Capital leases (2,033) (733) 1997, 1996 and 1995, respectively. Total deferred tax assets (17,188) (11,972) Net deferred tax liability $ 17,560 $ 19,180 Contingent rent expense, based primarily on sales perfor- mance, for capital and operating leases was $0.5 million The amounts reflected in the provision for income taxes are in each of the fiscal years 1997, 1996 and 1995. based on applicable federal statutory rates, adjusted for In addition to its capital leases, the Company is obligated permanent differences between financial and taxable under operating leases, primarily for land and buildings. income. The provision for federal and state income taxes Minimum future obligations under operating leases in effect includes the following (in thousands): at February 22, 1997 are as follows (in thousands): 1997 1996 1995 Lease Current Year Obligations Federal $25,858 $16,163 $24,379 1998 $ 4,037 State 4,838 3,332 4,488 1999 3,951 General business and 2000 3,765 other tax credits — — (475) 2001 3,625 Deferred (1,620) 5,206 (3,764) 2002 3,383 Total provision $29,076 $24,701 $24,628 Later 48,066 Total minimum obligations $66,827 The effective tax rate varies from the statutory federal income tax rate for the following reasons: Total minimum rental expense, net of sublease income, 1997 1996 1995 related to all operating leases with terms greater than one Statutory income year was $4.6, $3.5 and $2.9 million in fiscal years 1997, tax rate 35.0% 35.0% 35.0% 1996 and 1995, respectively. State income taxes, net of federal tax benefits 4.0 4.0 4.1 Certain operating leases require payments to be made on Other 0.3 0.1 0.3 an escalating basis. The accompanying consolidated Effective income tax rate 39.3% 39.1% 39.4%

¨ 18 Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

Provision is made for deferred income taxes and future immediately upon a change of control. Changes in the income tax benefits applicable to temporary differences options are as follows (shares in thousands): between financial and tax reporting. The sources of Weighted these differences and the effects of each are as follows Average (in thousands): Price Exercise Shares Range Price 1997 1996 1995 Outstanding, Depreciation $ 3,256 $2,804 $ (247) Feb. 26, 1994 1,924 $10.13- $16.25 $ 13.99 Inventory and Granted 250 10.00- 11.00 10.31 LIFO valuation reserves (212) 2,544 (3,631) Canceled and Bad debt and forfeited (238) 10.00- 16.25 (13.80) return reserves (685) 241 (806) Insurance accruals and Outstanding, valuation reserves (1,625) (537) (315) Feb. 25, 1995 1,936 10.00- 16.25 13.54 Other property Granted 576 10.50- 10.75 10.64 related items (707) 117 432 Canceled and Deferred compensation (433) (329) (224) forfeited (139) 10.00- 16.25 (13.77) Other (1,214) 366 1,027 Outstanding, Total deferred tax Feb. 24, 1996 2,373 10.00- 16.25 12.82 (benefit) expense $(1,620) $5,206 $(3,764) Granted 542 10.63- 16.25 11.59 Exercised (97) 10.00- 15.00 (12.91) Canceled and Other temporary differences between financial and tax forfeited (182) 10.00- 16.25 (11.84) reporting include amortization and interest relating to capi- Outstanding, tal leases and certain provisions for expenses which are not Feb. 22, 1997 2,636 10.00- 16.25 12.63 deducted for tax purposes until paid. The following tables summarize information about stock options outstanding at February 22, 1997 (shares F. Preferred and Common Stock in thousands): The Company has 20,000,000 shares of $0.01 preferred stock authorized but unissued. Options Outstanding Weighted There are 75,000,000 shares of $0.01 par value common Shares Average Weighted stock authorized with 32,166,720 and 32,005,000 shares Outstanding Remaining Average Range of at Feb. 22, Contractual Exercise issued and outstanding at February 22, 1997 and Exercise Prices 1997 Life Price February 24, 1996, respectively. $10.00 to $12.00 1,451 8.1 years $10.62 The Company’s Stock Option Plans allow the granting of 12.01 to 14.00 — — — 14.01 to 16.25 1,185 5.1 15.09 stock options to various officers, directors and other $10.00 to $16.25 2,636 6.7 $12.63 employees of the Company at prices not less than 100 percent of fair market value, determined by the closing Options Exercisable price on the date of grant. The Company has reserved Shares Weighted 2,400,000 and 1,200,000 shares for issuance under the Exercisable Average 1991 and 1995 Stock Option Plans. The majority of these Range of at Feb. 22, Exercise options vest at the rate of 40% on the second anniversary Exercise Prices 1997 Price of the grant date and 20% annually thereafter for officers $10.00 to $12.00 263 $10.64 and employees and at the rate of 60% on the second 12.01 to 14.00 — — 14.01 to 16.25 1,042 15.03 anniversary of the date of grant and 20% annually there- $10.00 to $16.25 1,305 $14.14 after for non-employee directors. All stock options vest

19 ¨ Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

In October 1995, SFAS No. 123 “Accounting for Stock- In fiscal 1994, the Company adopted a Restricted Stock Based Compensation” was issued. SFAS No. 123 estab- Plan which provides awards of up to 200,000 shares of lishes a fair value based method of accounting for common stock to key employees of the Company. Plan par- stock-based compensation; however, it allows entities to ticipants are entitled to cash dividends and to vote their continue accounting for employee stock-based compensa- respective shares. Restrictions limit the sale or transfer of tion under the intrinsic value method prescribed by the shares during a restricted period. There were 70,000 Accounting Principles Board Opinion No. 25, “Accounting and 5,000 shares of restricted stock outstanding at for Stock Issued to Employees.” SFAS No. 123 requires February 22, 1997 and February 24, 1996, respectively. certain disclosures, including pro forma net income and earnings per share as if the fair value based accounting G. Employee Benefits method had been used for employee stock-based com- Substantially all employees of the Company are covered by pensation cost. The Company has decided to adopt SFAS a defined contribution profit sharing plan. The plan pro- No. 123 through disclosure with respect to employee stock- vides for two types of company contributions; an amount based compensation. determined annually by the Board of Directors and an employer matching contribution equal to one-half of the If the Company had elected to recognize compensation first 6 percent of compensation contributed by participating cost for the Stock Option Plans based on the fair value at employees. Contributions were $11.8, $7.7 and $6.7 mil- the grant dates for awards under those plans, consistent lion for fiscal years 1997, 1996 and 1995, respectively. with the method prescribed by SFAS No. 123, net earnings and net earnings per common share would have been The Company also has change of control severance agree- changed to the pro forma amounts indicated below: ments with certain key officers. Under these agreements, 1997 1996 the officers are entitled to a lump-sum cash payment equal Net earnings (in thousands) to a multiple of one, two or three times their annual salary As reported $ 44,946 $ 38,439 plus a multiple of one, two or three times their average Pro forma 44,228 38,316 annual bonus for the three fiscal years immediately Net earnings per common share preceding the date of termination, if, within two years after As reported $ 1.40 $ 1.20 a “change of control” (as defined in such agreements) Pro forma 1.38 1.20 the Company terminates the individual’s employment without cause.

The fair value of stock options used to compute pro forma In accordance with SFAS No. 106, “Employers’ net earnings and net earnings per common share disclo- Accounting for Postretirement Benefits Other Than sures is the estimated present value at grant date using the Pensions,” the Company accrues the estimated cost Black-Scholes option-pricing model with weighted average of retiree benefits, other than pensions, during assumptions for fiscal years 1997 and 1996 as follows: employees’ credited service period. The net periodic Risk-free interest rate 7.0% costs for postretirement benefits include the following Expected volatility 29.0% (in thousands): Dividend yield 0.0% 1997 1996 1995 Expected option life, standard option 5.0 years Service cost for benefits Expected option life, accumulated during the year $ 98 $ 98 $ 78 performance vested option 2.5 years Interest cost on accumulated benefit obligation 95 96 60 Net periodic postretirement benefit cost $193 $194 $138

¨ 20 Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

The Company’s postretirement healthcare plans currently I. Fair Values of Financial Instruments are not funded. The accumulated postretirement benefit The following disclosure is made in accordance with the obligations are as follows (in thousands): requirements of SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.” The following methods and Feb. 22, Feb. 24, 1997 1996 assumptions were used by the Company in estimating its Retirees $ 423 $ 371 fair value disclosures for financial instruments. Active plan participants 1,163 1,022 Short-term debt and long-term obligations: The carrying Total accumulated amounts, if any, of the Company’s borrowings under its postretirement obligations $ 1,586 $ 1,393 short-term revolving credit agreement approximate their fair value. The fair values of the Company’s long-term The assumed discount rate used in determining the accu- obligations are estimated using discounted cash flow mulated postretirement benefit obligation was 7.3% in both analysis based on interest rates that are currently available fiscal 1997 and fiscal 1996. to the Company for issuance of debt with similar terms and The assumed healthcare cost trend rate used in measuring remaining maturities. the accumulated postretirement benefit obligation was The carrying amounts and fair values of the Company’s 8.3% for fiscal 1997 decreasing each successive year until financial instruments at February 22, 1997 are as follows it reaches 5.5% in fiscal 2015 after which it remains con- (amounts in thousands): stant. A 1% increase in the healthcare trend rate would Carrying Fair have an immaterial effect on the accumulated postretire- Amount Value ment benefit obligation at the end of fiscal 1997 and fiscal Long-term obligations: 1996 and on the net periodic cost for the fiscal years. Senior Unsecured Notes, due November 15, 2004 $99,773 $108,916 H. Related Party Transactions Senior Unsecured Notes, As a result of the initial public offering, the Company and due March 15, 2002 99,816 105,595 Supervalu entered into certain agreements of which the fol- Senior Unsecured Notes, due March 15, 2022 99,520 112,661 lowing are still in effect: Senior Unsecured Notes, A food products supply agreement under which the due August 15, 2003 99,818 95,355 Company has agreed to purchase from Supervalu, Industrial Revenue Bond, through October 16, 1998, all of the Company’s due May 1, 2008 1,000 1,000 Capital lease obligations 20,801 23,425 requirements for certain products sold in any food store owned or operated by the Company and located within the geographic areas serviced by Supervalu.

A registration rights agreement under which SOA (and certain other affiliates of Supervalu) has the right to require the Company to file up to three registration statements under the Securities Act of 1933.

The Company’s purchases of inventory from Supervalu were $1.9, $1.0 and $2.7 million for the fiscal years 1997, 1996 and 1995, respectively.

21 ¨ Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

J. Unaudited Quarterly Financial Information Unaudited quarterly financial information is as follows: Fiscal year (52 Weeks) ended February 22, 1997 First Second Third Fourth Year (In thousands, except per share data) (16 wks) (12 wks) (12 wks) (12 wks) (52 wks) Net sales $610,911 $498,517 $591,208 $632,771 $2,333,407 Gross margins 146,391 112,974 131,258 159,043 549,666 Net earnings 5,759 3,922 10,936 24,329 44,946 Net earnings per common share 0.18 0.12 0.34 0.76 1.40 Weighted average shares 32,020 32,052 32,073 32,092 32,092 Dividends declared per common share $ 0.11 $ 0.11 $ — $ — $ 0.22 Price range per common share* 161⁄2-111⁄4 161⁄4 -131⁄2 161⁄4 -15 161⁄8-143⁄8 161⁄2- 111⁄4

Fiscal year (52 Weeks) ended February 24, 1996 First Second Third Fourth Year (16 wks) (12 wks) (12 wks) (12 wks) (52 wks) Net sales $560,472 $418,165 $491,019 $498,360 $1,968,016 Gross margins 143,359 103,745 122,670 131,509 501,283 Net earnings 5,368 1,869 10,132 21,070 38,439 Net earnings per common share 0.17 0.06 0.32 0.66 1.20 Weighted average shares 32,005 32,005 32,005 32,005 32,005 Dividends declared per common share $ 0.11 $ 0.11 $ 0.11 $ 0.11 $ 0.44 Price range per common share* 113⁄4 -83⁄4 14-10 1⁄4 131⁄4-10 1⁄4 113⁄4- 10 7⁄8 14-8 3⁄4 *Price range per common share reflects the highest and lowest stock market prices on the New York Stock Exchange during the quarter.

K. Business Segment Information general merchandise, retail pharmacy and retail optical The Company has redefined its business segments from the operations) and a ProVantage segment (which includes classifications of General Merchandise and Health Services prescription benefit management, mail service pharmacy, (which had included ProVantage’s managed healthcare vision benefit management and health information operations and ShopKo’s retail pharmacy and optical technology). Information about the Company’s operations departments), to a Retail Store segment (which includes in the different businesses is as follows (in thousands):

Fiscal years 1997 1996 1995 Net sales Retail Store $2,005,731 $1,881,038 $1,839,908 ProVantage 348,780 93,845 14,060 Intercompany* (21,104) (6,867) (1,039) Total net sales $2,333,407 $1,968,016 $1,852,929 Earnings before income taxes Retail Store $ 113,683 $ 107,216 $ 102,691 ProVantage 9,533 2,713 1,494 Corporate (17,417) (12,507) (12,725) Interest expense (31,777) (34,282) (29,042) Earnings before income taxes $ 74,022 $ 63,140 $ 62,418

¨ 22 Notes to Consolidated Financial Statements ShopKo Stores, Inc. and Subsidiaries

K. Business Segment Information (continued) Fiscal years 1997 1996 1995 Assets Retail Store $ 985,374 $ 991,285 $1,066,156 ProVantage 123,847 38,981 27,267 Corporate 124,671 87,694 16,328 Total assets $1,233,892 $1,117,960 $1,109,751 Depreciation and amortization expenses Retail Store $ 57,036 $ 54,982 $ 52,727 ProVantage 2,312 1,009 254 Corporate 485 392 493 Total depreciation and amortization expenses $ 59,833 $ 56,383 $ 53,474 Capital expenditures Retail Store $ 34,258 $ 51,915 $ 93,466 ProVantage 2,953 136 620 Corporate 1,688 961 514 Total capital expenditures $ 38,899 $ 53,012 $ 94,600 *Intercompany sales consist of prescriptions that were both sold at a ShopKo pharmacy and processed by ProVantage.

L. Subsequent Event 46% investment in the Company. Under the terms of the agreement, the companies will enter into two simultaneous Termination of Combination transactions. The first transaction is a secondary public On September 7, 1996, the Company entered into a Plan offering of 6,557,280 shares of the Company’s common of Reorganization with Phar-Mor, Inc. (“Phar-Mor”) and stock. The second transaction is a stock buyback of $150.0 Cabot Noble, Inc. (“Cabot Noble”). Pursuant to the Plan of million representing 8,174,387 shares of its common stock Reorganization, the Company and Phar-Mor would have held by Supervalu. Supervalu will pay the underwriting dis- become subsidiaries of Cabot Noble. On April 2, 1997, count and certain other expenses related to the secondary the Company, Cabot Noble and Phar-Mor mutually agreed offering up to an amount equal to the excess of the aggre- to terminate this planned business combination. The gate public offering price over $123.6 million ($18.85 per Company anticipates recording a one-time pre-tax charge share). The Company will pay the underwriting discount of approximately $2.8 million ($0.05 per share) during the and such expenses to the extent not paid by Supervalu. first quarter of fiscal 1998 to cover costs associated with However, the Company and Supervalu have each agreed the terminated business combination. to bear the costs and expenses of their own counsel and the Company has agreed to bear certain marketing costs. Common Stock Buyback and Secondary Offering Should the Company be required to pay all of the cost, it On April 24, 1997, the Company and Supervalu entered may incur a one-time charge of approximately $8.5 million into an agreement pursuant to which Supervalu will exit its ($0.37 per share) at the time of closing.

23 ¨ Independent Auditors’ Report Shareholders’ Information

To the Board of Directors and Shareholders ShopKo Stores, Inc. common shares are listed on the ShopKo Stores, Inc.: New York Stock Exchange under the symbol “SKO” and in the newspapers as “ShopKo.” As of June 27, 1997, We have audited the consolidated balance sheets of ShopKo’s common shares were held by 1,134 ShopKo Stores, Inc. and Subsidiaries as of February 22, record owners. 1997 and February 24, 1996 and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the three years (52 weeks) in the period ended Transfer Agent and Registrar February 22, 1997. These financial statements are the For help with questions regarding lost, stolen or destroyed responsibility of the Company's management. Our respon- stock certificates, consolidation of accounts, transferring sibility is to express an opinion on these financial state- of shares and name and address changes, call Norwest ments based on our audits. Banks at 1-800-468-9716.

We conducted our audits in accordance with generally 1997 Annual Meeting accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assur- The annual meeting of shareholders will be held ance about whether the financial statements are free of August 13, 1997 at 10 a.m. at the Radisson Inn, 2040 material misstatement. An audit includes examining, on a Airport Dr., Green Bay, Wisconsin. test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing Investor Relations/Form 10-K the accounting principles used and significant estimates A copy of the company’s 1997 Form 10-K annual report to made by management, as well as evaluating the overall the Securities and Exchange Commission will be furnished financial statement presentation. We believe that our audits without charge to any shareholder upon written request. provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements pre- Investor Information: sent fairly, in all material respects, the financial position of Information about ShopKo is available via fax, mail or ShopKo Stores, Inc. and Subsidiaries as of February 22, the Internet. 1997 and February 24, 1996, and the results of their To receive company news releases via fax, phone PR operations and their cash flows for each of the three years Newswire’s Company News on Call at 1-800-758-5804. (52 weeks) in the period ended February 22, 1997 in con- An automated attendant will ask for ShopKo’s extension formity with generally accepted accounting principles. number, which is 103639.

Written requests should be directed to: Investor Relations Department ShopKo Stores, Inc. DELOITTE & TOUCHE LLP P.O. Box 19060 Milwaukee, Wisconsin Green Bay, WI 54307-9060 April 24,1997 You can reach ShopKo via the Internet at www.shopko.com

Other Sources of Information: www.prnewswire.com (see company news) www.stockinfo.standardpoor.com (as of September 1997, see S&P index, SmallCap 600)

¨ 24 Board of Directors

Michael W. Wright Dale P. Kramer William J. Tyrrell Jeffrey C. Girard Chairman of the Board President and Chief Vice Chairman of Executive Vice President Chairman, President and Executive Officer the Board, Former and Chief Financial Chief Executive Officer of ShopKo President of ShopKo Officer of Supervalu of Supervalu

Jack W. Eugster *William J. Podany *Stephen E. Watson Chairman, President and Executive Vice President Former President of Dayton Chief Executive Officer and Chief Operating Officer Hudson Corporation and of The Musicland Group, Inc. of ShopKo Former Chairman and

*Elected to the board of Chief Executive Officer directors July 2,1997 of Dayton Hudson’s Department Store Division Officers Dale P. Kramer John J. Dembinski Ingrid A. King Dennis R. Ruebel President and Vice President, Vice President of Vice President, Merchandising/ Chief Executive Officer Replenishment Special Projects Mfg. Health Services Gregory S. Ahmann Rose A. Downs Gene M. Klawikowski James J. Sage Vice President, Pharmacy/ Vice President, Vice President, Regional Vice President Retail Operations Operations Administration Systems Development of Stores Michael J. Bettiga Steven T. Harig Glen Laschober Richard D. Schepp Senior Vice President Senior Vice President of Executive Vice President, Vice President, of Health Services Planning, Replenishment ProVantage Legal Affairs and Bonnie C. Bolton and Analysis, Distribution, Richard T. Laucks Secretary Transportation Vice President, Vice President, Loss Prevention Robert S. Segal David S. Haugen Advertising Rodney D. Lawrence Vice President, Divisional Regional Vice President Merchandise Manager Donald A. Bye Senior Vice President, of Stores Vice President, Store Marketing, Store Planning Jeffery R. Simons Thomas D. Hendra Optical/Retail Operations David A. Liebergen Vice President and Controller Senior Vice President, Oscar R. Cavazos Senior Vice President Jean R. Srour Special Tactical Initiatives Vice President, Divisional of Human Resources Vice President, Divisional Merchandise Manager Gary A. Hillerman Quality Assurance, Legal Merchandise Manager Roger J. Chustz Senior Vice President, Affairs, Internal Communication Katherine W. Steirly General Merchandise Senior Vice President, L. Terry McDonald Vice President, Divisional Manager, Hardlines General Merchandise Senior Vice President, Merchandise Manager Michael J. Hopkins Manager, Apparel Marketing Larry J. Vick Senior Vice President, Lawrence J. Clark Raymond L. Pash Vice President, Divisional General Merchandise Vice President, Finance Vice President, Divisional Merchandise Manager Manager, Hardlines/Home Joseph A. Coffini Merchandise Manager Michael F. Wilson Gary M. Jones Vice President, William J. Podany Vice President, Vice President, Divisional Managed Care Services Executive Vice President Store Planning Merchandise Manager Richard W. Cooper and Chief Operating Officer Matthew J. Zirpoli Jeffrey A. Jones Vice President, Randy L. Roiko Vice President, Senior Vice President and Distribution, Vice President, Sales/ProVantage Chief Financial Officer Transportation Merchandise Operations

¨ ¨ ShopKo’s 130 stores and 4 stand alone optical centers are located in 16 states. ProVantage serves clients in all 50 states.

ShopKo Stores

Vision Advantage Stores

Distribution Centers Boise, Idaho De Pere, Wisconsin Omaha, Nebraska

General Office 4.1 million lives under ProVantage contract Green Bay, Wisconsin States with less than 50,000 lives under ProVantage contract Fiscal 1997 New ShopKo Store Location States with more than Pullman, Washington 50,000 lives under ProVantage contract Beaver Dam, Wisconsin (relocated)

130 ShopKo Locations California (1) Minnesota (13) Nevada (3) Washington (10) Menasha Redding Albert Lea Reno (2) Kennewick Monona Austin Sparks Lacey Monroe Colorado (3) Duluth Pullman Neenah Fort Collins Fairmont Oregon (4) Spokane (3) Onalaska Longmont Hutchinson Bend Union Gap Oshkosh Loveland Mankato Eugene (2) Walla Walla Racine Salem Idaho (8) Marshall Wenatchee Rice Lake Boise (2) Rochester (2) South Dakota (6) Yakima River Falls St. Cloud (2) Rothschild Chubbuck Aberdeen Wisconsin (41) Coeur d’Alene Winona Mitchell Sheboygan Worthington Appleton Stevens Point (2) Idaho Falls Rapid City Ashwaubenon Lewiston Sioux Falls (2) Watertown Montana (5) Beaver Dam Wausau Nampa Billings Watertown Beloit Twin Falls West Bend Great Falls Utah (15) Chippewa Falls Wisconsin Rapids Illinois (3) Helena Brigham City Delavan Belvidere Kalispell Layton De Pere 4 Vision Advantage Dixon Missoula Logan Eau Claire Locations Freeport Murray Fond du Lac Nebraska (11) Fort Atkinson Ohio(4) Bellevue Ogden Akron Iowa (3) Orem Grafton Mason City Grand Island Green Bay (2) Cuyahoga Falls Hastings Provo Lima Sioux City Riverdale Janesville Spencer Lincoln (2) Kenosha Mansfield Norfolk Salt Lake City (2) Sandy City Kimberly Michigan (4) North Platte La Crosse (2) Escanaba Omaha (4) Spanish Fork West Bountiful Madison (3) Houghton Manitowoc ¨ Kingsford West Jordan STORES INC. West Valley City Marinette Marquette Marshfield 700 Pilgrim Way P.O. Box 19060 Green Bay, WI 54307-9060 920-497-2211

ShopKo® and ProVantage® are registered service marks of the company. Green Bay Packers®, Packers®, Super Bowl®, NFL® and NFC® are registered trademarks, trade names or service marks of National Football League, Inc. Monday Night Football ® is a registered trademark, trade name or service This entire report is printed mark of ABC Sports, Inc. All other trademarks, service marks and trade names referred to in this annual report are the property of their respective owners. on recycled paper.