10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended October 29, 2005.

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from                                          to                                         .

Commission file number 001-14565

FRED’S, INC.

(Exact name of registrant as specified in its charter)

Tennessee
(State or other jurisdiction of
incorporation or organization) 62-0634010
(I.R.S. Employer
Identification No.)

4300 New Getwell Rd., Memphis, Tennessee
(Address of principal executive offices) 38118
(Zip code)

(901) 365-8880
(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 þ No o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes þ No o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ

The registrant had 39,856,500 shares of Class A voting, no par value common stock outstanding as of December 2, 2005.

FRED’S, INC.

INDEX

	Page No.
Part I — Financial Information
Item 1 — Financial Statements (unaudited):
Condensed Consolidated Balance Sheets as of October 29, 2005 and January 29, 2005	3
Condensed Consolidated Statements of Income for the Thirteen and Thirty-nine Weeks Ended October 29, 2005 and October 30, 2004	4
Condensed Consolidated Statements of Cash Flows for the Thirty-nine Weeks Ended October 29, 2005 and October 30, 2004	5
Notes to Condensed Consolidated Financial Statements	6 - 9
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	10 - 15
Item 3 — Quantitative and Qualitative Disclosures about Market Risk	15
Item 4 — Controls and Procedures	15 - 16
Part II — Other Information	17
Item 6 — Exhibits
Signatures	18
EX-10.19 LEASE AGREEMENT
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32 SECTION 906 CERTIFICATION OF THE CEO AND CFO

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Part 1 — FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

FRED’S, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except for number of shares)

	October 29,			January 29,
	2005			2005
	(unaudited)
ASSETS:
Current assets:
Cash and cash equivalents	$	19,306		$	5,365
Inventories		342,628			275,365
Receivables, less allowance for doubtful accounts of $686 and $629, respectively		18,876			19,449
Other non-trade receivables		15,831			11,821
Prepaid expenses and other current assets		11,660			6,967
Total current assets		408,301			318,967
Property and equipment, at depreciated cost		140,140			139,302
Equipment under capital leases, less accumulated amortization of $4,089 and $3,722, respectively		878			1,245
Other noncurrent assets, net		8,126			5,710
Total assets	$	557,445		$	465,224
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	105,698		$	70,503
Current portion of indebtedness		585			18
Current portion of capital lease obligations		588			666
Accrued expenses and other		36,963			26,708
Deferred income taxes		18,388			17,490
Income taxes payable		4,854			—
Total current liabilities		167,076			115,385
Long-term portion of indebtedness		42,619			23,181
Deferred income taxes		10,124			7,701
Capital lease obligations, long term portion		596			1,031
Other noncurrent liabilities		6,349			3,380
Total liabilities		226,764			150,678
Commitments and Contingencies
Shareholders’ equity:
Preferred stock, nonvoting, no par value, 10,000,000 shares authorized, none outstanding		—			—
Preferred stock, Series A junior participating nonvoting, no par value, 224,594 shares authorized, none outstanding		—			—
Common stock, Class A voting, no par value, 60,000,000 shares authorized, 39,838,548 and 39,692,091 shares issued and outstanding, respectively		134,057			132,511
Common stock, Class B nonvoting, no par value, 11,500,000 shares authorized, none outstanding		—			—
Retained earnings		198,897			184,732
Unearned compensation		(2,273	)		(2,697	)
Total shareholders’ equity		330,681			314,546
Total liabilities and shareholders’ equity	$	557,445		$	465,224

See accompanying notes to condensed consolidated financial statements.

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FRED’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(unaudited)
(in thousands, except per share amounts)

	Thirteen Weeks Ended					Thirty-nine Weeks Ended
	October 29,			October 30,		October 29,			October 30,
	2005			2004		2005			2004
				(as restated)					(as restated)
Net sales	$	376,754		$	349,139	$	1,132,811		$	1,031,475
Cost of goods sold		267,942			247,890		810,238			739,462
Gross profit		108,812			101,249		322,573			292,013
Depreciation and amortization		7,073			8,005		20,519			21,561
Selling, general and administrative expenses		91,878			82,154		276,502			243,546
Operating income		9,861			11,090		25,552			26,906
Interest income		(47	)		—		(47	)		—
Interest expense		307			260		767			542
Income before income taxes		9,601			10,830		24,832			26,364
Provision for income taxes		3,280			3,414		8,306			8,824
Net income	$	6,321		$	7,416	$	16,526		$	$17,540
Net income per share
Basic	$	.16		$	.19	$	.42		$	.45
Diluted	$	.16		$	.19	$	.42		$	.44
Weighted average shares outstanding
Basic		39,661			39,220		39,616			39,130
Effect of dilutive stock options		98			297		145			455
Diluted		39,759			39,517		39,761			39,585
Dividends per common share	$	.02		$	.02	$	.06		$	.06

See accompanying notes to condensed consolidated financial statements.

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FRED’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)
(in thousands)

	Thirty-nine Weeks Ended
	October 29,			October 30,
	2005			2004
				(as restated)
Cash flows from operating activities:
Net income	$	16,526		$	17,540
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation and amortization		20,519			21,561
Provision for uncollectible receivables		57			—
Lifo reserve increase		1,447			1,314
Deferred income taxes		3,321			3,466
Amortization of unearned compensation		424			59
Net expense related to equity-based compensation		13			—
Income tax benefit on exercise of stock options		131			407
(Increase) decrease in assets:
Receivables		(3,494	)		(432	)
Inventories		(68,710	)		(79,837	)
Other assets		(4,713	)		(2,172	)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities		45,451			18,038
Income taxes payable		4,854			3,551
Other noncurrent liabilities		2,970			(35	)
Net cash provided by (used in) operating activities		18,796			(16,540	)
Cash flows from investing activities:
Capital expenditures		(19,375	)		(25,980	)
Asset acquisitions (primarily intangibles)		(4,012	)		(1,419	)
Net cash used in investing activities		(23,387	)		(27,399	)
Cash flows from financing activities:
Payments of indebtedness and capital lease obligations		(527	)		(586	)
Proceeds from revolving line of credit, net of payments		18,886			46,264
Proceeds from term loan, net of payments		1,133			—
Proceeds from exercise of stock options and issuances under employee stock purchase plan		1,429			1,175
Cash dividends paid		(2,389	)		(2,352	)
Net cash provided by financing activities		18,532			44,501
Increase (decrease) in cash and cash equivalents		13,941			562
Beginning of period cash and cash equivalents		5,365			4,741
End of period cash and cash equivalents	$	19,306		$	5,303
Supplemental disclosures of cash flow information:
Interest paid	$	641		$	452
Income taxes paid	$	—		$	1,400

See accompanying notes to condensed consolidated financial statements.

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FRED’S, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1: BASIS OF PRESENTATION

     Fred’s, Inc. (“We”, “Our” or “Us”) operates, as of October 29, 2005, 635 discount general merchandise stores, including 24 franchised Fred’s stores, in 15 states in the southeastern United States. 273 of the stores have full service pharmacies.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and are presented in accordance with the requirements of Form 10-Q and therefore do not include all information and notes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with GAAP. The statements do reflect all adjustments (consisting of only normal recurring accruals, except as set forth in Note 6) which are, in the opinion of management, necessary for a fair presentation of financial position in conformity with GAAP. The statements should be read in conjunction with the Notes to the Consolidated Financial Statements for the fiscal year ended January 29, 2005 incorporated into Our Annual Report on Form 10-K.

     The results of operations for the thirty-nine week period ended October 29, 2005 are not necessarily indicative of the results to be expected for the full fiscal year.

     As previously disclosed, the Company restated previously reported financial statements for the quarterly periods of its 2004 fiscal year, by means of its Form 10-K for the fiscal year ended January 29, 2005, which was filed on April 29, 2005. The restatement involved accounting for leases and related property and equipment. Certain prior amounts have also been reclassified to conform to the 2005 presentation.

NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS

     In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”). SFAS No. 123R establishes standards that require companies to record the cost resulting from all share-based payment transactions using the fair value method. Transition under SFAS No. 123R requires using a modified version of prospective application under which compensation costs are recorded for all unvested share-based payments outstanding or a modified retrospective method under which all prior periods impacted by SFAS No. 123R are restated. In April 2005, the SEC announced the adoption of a new rule that delays the compliance date for the adoption of SFAS No. 123R. The SEC’s new rule will allow implementation at the beginning of the fiscal year that begins after June 15, 2005, with early adoption permitted. The Company intends to adopt SFAS No. 123R in 2006. We expect that our reported results will be reduced for larger stock compensation charges after adoption.

     In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4” (“SFAS No. 151”). The purpose of this statement is to clarify the accounting of abnormal amounts of idle facility expense, freight, handling costs and waste material. ARB No. 43 stated that under some circumstances these costs may be so abnormal that they are required to be treated as current period costs. SFAS No. 151 requires that these costs be treated as current period costs regardless if they meet the criteria of “so abnormal.” The provisions of SFAS No. 151 shall be effective for inventory costs incurred during fiscal

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years beginning after June 15, 2005. Although the Company will continue to evaluate the application of SFAS No. 151, management does not believe adoption will have a material impact on its results of operations or financial position.

     In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153, “Exchanges of Nonmonetary Assets, and Amendment of APB Opinion No. 29” (“SFAS No. 153”). SFAS No. 153 is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, with earlier application permitted. Although the Company will continue to evaluate the application of SFAS No. 153, management does not believe adoption will have a material impact on its results of operations or financial position.

     In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“SFAS No. 154”). This Statement replaces APB Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 applies to all voluntary changes in an accounting principle and to any changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. SFAS No. 154 requires that all voluntary changes in accounting principles are retrospectively applied to prior financial statements as if that principle had always been used, unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes and error corrections occurring in fiscal years beginning after December 15, 2005. Although the Company will continue to evaluate the application of SFAS No. 154, management does not believe adoption will have an immediate material impact on its results of operations or financial position.

     In October 2005, the FASB issued FASB Staff Position (FSP) FAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period.” The FASB concludes in this FSP that rental costs associated with ground or building operating leases that are incurred during a construction period should be expensed. FASB Technical Bulletin (FTB) No. 88-1, Issues Relating to Accounting for Leases, requires that rental costs associated with operating leases be allocated on a straight-line basis in accordance with FASB Statement No. 13, Accounting for Leases, and FTB 85-3, Accounting for Operating Leases with Scheduled Rent Increases, starting with the beginning of the lease term. The FASB believes there is no distinction between the right to use a leased asset during the construction period and the right to use that asset after the construction period. As discussed in Note 2 to the Company’s Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended January 29, 2005, the Company has already adopted this accounting guidance based on the letter issued by the Office of the Chief Accountant of the SEC to the American Institute of Certified Public Accountants in February 2005.

NOTE 3: INVENTORIES

     Warehouse inventories are stated at the lower of cost or market using the FIFO (first-in, first-out) method. Retail inventories are stated at the lower of cost or market as determined by the retail inventory method (“RIM”). Under RIM, the valuation of inventories at cost and the resulting gross margin are calculated by applying a calculated cost-to-retail ratio to the retail value of inventories. RIM is an averaging method that has been widely used in the retail industry due to its practicality. Also, it is recognized that the use of the RIM will result in valuing inventories at lower of cost or market if markdowns are currently taken as a reduction of the retail value of inventories. Inherent in the RIM calculation are certain significant management judgments and estimates including, among others, initial markups, markdowns, and shrinkage, which significantly impact the ending inventory valuation at cost as well as resulting gross margin. These significant estimates, coupled with the fact that the RIM is an averaging process, can, under certain circumstances, produce distorted or inaccurate cost figures. Based upon our historical information, we have not experienced any significant change in our cost valuation to date. Management believes that the Company’s RIM provides an inventory valuation which reasonably

7

approximates cost and results in carrying inventory at the lower of cost or market.

     For pharmacy inventories, which are $35.3 million and $35.1 million at October 29, 2005 and January 29, 2005, respectively, cost was determined using the retail LIFO (last-in, first-out) method in which inventory cost are maintained using the RIM method, then adjusted by application of the Producer Price Index published by the U.S. Department of Labor for the cumulative annual periods. The current cost of inventories exceeded the LIFO cost by $11.2 million at October 29, 2005 and $9.7 million at January 29, 2005. LIFO pharmacy inventory costs can only be determined annually when inflation rates and inventory levels are finalized; therefore, LIFO pharmacy inventory costs for interim financial statements are estimated.

NOTE 4: INCENTIVE STOCK OPTIONS

     We account for our stock-based compensation plans using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), to stock-based employee compensation.

	Thirteen Weeks Ended						Thirty-nine Weeks Ended
	October 29,			October 30,			October 29,			October 30,
	2005			2004			2005			2004
				(as restated)						(as restated)
	(Amounts in thousands, except per share data)
Net income, as reported	$	6,321		$	7,416		$	16,526		$	17,540
Deduct:
SFAS No. 123 pro forma compensation expense, net of income taxes		(87	)		(258	)		(336	)		(601	)
SFAS No. 123 pro forma Net income	$	6,234		$	7,158		$	16,190		$	16,939
Earnings per share, as reported:
Basic	$	0.16		$	0.19		$	.42		$	.45
Diluted	$	0.16		$	0.19		$	.42		$	.44
Pro forma earnings per share:
Basic	$	0.16		$	0.18		$	.41		$	.43
Diluted	$	0.16		$	0.18		$	.41		$	.43

NOTE 5: Property and Equipment

     Property and equipment are carried at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets. Improvements to leased premises are amortized using the straight-line method over the shorter of the initial term or the lease of the useful life of the improvement. Leasehold improvements added late in the lease term are amortized over the shorter of the remaining term of the lease (including the upcoming renewal option, if the renewal is reasonably assured) or the useful life of the improvement, whichever is lesser. Assets under capital leases are amortized in accordance with the Company’s normal depreciation policy for owned assets or over

8

the lease term (regardless of renewal options), if shorter, and the charge to earnings is included in depreciation expense in the condensed consolidated financial statements. Gains or losses on the sale of assets are recorded at disposal as a component of operating income. The following illustrates the breakdown of the major categories within Property and Equipment:

	October 29,			January 29,
	2005			2005
	(unaudited)
Building and building improvements	$	78,773		$	75,015
Furniture, fixtures and equipment		193,631			184,145
Leasehold improvements		36,240			30,949
Automobiles and vehicles		6,143			5,970
Airplane		4,697			4,697
		319,484			300,776
Less: Accumulated Depreciation and Amortization		(184,175	)		(166,322	)
		135,309			134,454
Construction in Progress		555			572
Land		4,276			4,276
Total Property and Equipment, at depreciated cost	$	140,140		$	139,302

     In the fourth quarter of 2004, the Company changed the estimated lives of certain store fixtures from five to ten years. Based on the Company’s historical experience, ten years is a closer approximation of the actual lives of these assets. The change in estimate was applied prospectively. Expenses for the third quarter of 2005 were favorably impacted by approximately $1.1 million ($.02 per diluted share) and for the first nine months of 2005 were favorably impacted by approximately $3.5 million ($.06 per diluted share) as a result of this change.

NOTE 6: Contract Renewal with Primary Pharmaceutical Wholesaler

During the quarter ended October 29, 2005, the Company renewed its contract with its primary pharmaceutical wholesaler, AmerisourceBergen Corporation. As noted in prior public filings, the renewal of this contract would, and did impact the Company’s financial statements because of the application of the provisions of EITF 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor. The effect on the financial statements, which occurred during the third quarter, was a deferral of the associated rebates against cost of sales of $2.2 million pretax (estimated at $0.03 per diluted share, after tax). This change in timing had no effect on cash flow for the quarter. While the contract was not due to mature until January 31, 2006, the renewal terms were positive to overall earnings for the quarter and will benefit the Company through better pricing.

9

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL

Executive Overview

Throughout 2005, Fred’s has continued its strategy of growth initiatives and productivity improvements. In the first nine months of 2005, the Company opened 56 new stores. The majority of our new store openings were in Alabama, Georgia, North Carolina, and South Carolina. We have now also entered into Oklahoma. Additionally, we have opened seventeen new pharmacies during the first nine months. We plan to add approximately 10 new stores and approximately 5 pharmacies to our chain during the fourth quarter. We have increased our selling square footage by 9% during the first 9 months of 2005 and will continue to increase our selling square footage to 10% to 12% for the year.

We continue to focus our merchandising and store direction on maintaining a competitive differentiation within the $25 shopping trip. Our unique store format and strategy combine the attractive elements of a discount dollar store, drug store and mass merchant. In comparison, the discount dollar stores average $8 — $9 and chain drugs and mass merchants average in the range of $40 — $80 per transaction. Our stores operate equally well in rural and urban markets. Our everyday low pricing strategy is supplemented by 14 promotional circulars per year. Our product selection is enhanced by a private label program and opportunistic buys.

During the year, the Company has seen continued payback on key technology initiatives we have implemented. These initiatives include store point of sale systems upgrades, allocation system upgrades, and radio frequency devices in the stores to facilitate scanning in-store deliveries and correct inventory counts.

We completed our new refrigerated foods program, which has added a totally new merchandise category in our stores. The rollout of the coolers was completed under budget. This rollout greatly enhanced the convenience of our stores. The program is seen as a sound traffic generator while lifting our average customer transaction amount. Stores equipped with the refrigerated foods program accept government assistance cards.

We will be investing in more aggressive television and radio advertising in the fourth quarter to help drive sales in our highly competitive market. Radio advertising began in September and will run for approximately six months across all markets. Television advertising ran the last week of October and will run in November to highlight special items. We estimate advertising expenses will increase 10 basis points as a percentage of sales in 2005, with a similar increase in 2006.

Inventories increased approximately 7.7%, essentially in-line with sales growth. However, on a per store average basis, inventory levels are down 6% year-over-year. This increase in the overall inventory level relates to elevated levels at the distribution centers to support new allocation and sorting programs. Improvements in purchasing and more effective inventory systems have helped to minimize inventory throughout the stores over the past three quarters. Inventory turns in the third quarter were at 3.7 times (versus 3.6 times in the prior year’s third quarter) and are expected to improve to 3.9 times by year-end.

Our business is subject to seasonal influences, but has tended to experience less seasonal fluctuation than many other retailers due to the mix of everyday basic merchandise and pharmacy business. Our fiscal fourth quarter is typically the most profitable quarter because it includes the Christmas selling season. However, the overall strength of the fourth quarter is partially mitigated by the inclusion of the month of January, which is generally the least profitable month of the year.

The impact of inflation on labor and occupancy costs can significantly affect our operations. Many of our employees are paid hourly rates related to the federal minimum wage and, accordingly, any increase affects us. In addition, payroll

10

taxes, employee benefits and other employee-related costs continue to increase. Occupancy costs, including rent, maintenance, taxes and insurance, also continue to rise. We believe that maintaining adequate operating margins through a combination of price adjustments and cost controls, careful evaluation of occupancy needs, and efficient purchasing practices are the most effective tools for coping with increasing costs and expenses.

On August 1, 2005, the State of Tennessee initiated significant cuts to its “TennCare” Medicaid program, eliminating approximately 230,000 recipients and reducing the allowed prescriptions for all other enrollees from an unlimited number to just five per month. This has had a dramatic impact on the pharmacy sales of our almost 100 stores in the state. We had understood that this change would be phased in and we planned accordingly for a gradual drop of ineligible recipients from the TennCare roll over a 12-month period. The impact of this sales loss to earnings was approximately two cents per share in the third quarter, and we expect the effect to be approximately two cents per share in the fourth quarter. However, our customers’ needs have not vanished; so, we are hopeful that some of this business will come back to us as alternatives to TennCare emerge.

During the quarter ended October 29, 2005, Hurricanes Katrina and Rita impacted the Gulf Coast, affecting a large part of our service area. The storms caused the temporary closure of up to 90 stores for up to 10 days at the peak of Hurricane Katrina, and resulted in the complete destruction of 3 stores. The stores that were destroyed are being re-built and will be open for business in the near future.

The most significant losses caused by the storms were inventory and fixed assets, in the form of store fixtures and improvements. These losses were partially offset by insurance proceeds, and the Company expects to record additional insurance proceeds as they are received. While business interruption was experienced during the storms, the Company did not record any business interruption proceeds during the quarter, and will not do so until the business interruption claims are substantially settled.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The critical accounting matters that are particularly important to the portrayal of the Company’s financial condition and results of operations and require some of management’s most difficult, subjective and complex judgments are described in detail in the Company’s Annual Report on Form 10-K for the fiscal year ended January 29, 2005. The preparation of condensed consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to inventories, income taxes, insurance reserves, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. With the exception of the application of EITF 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor, to our renewal contract with our primary pharmaceutical wholesaler, as mentioned in Note 6, there have been no material changes in the application of our critical accounting policies during the thirty-nine weeks ended October 29, 2005.

Included in ending inventory are capitalized costs of the product itself, inbound freight and duties and the costs associated with purchasing, receiving, handling, and securing the product.

Cost of merchandise sold includes the cost of the product sold, along with all costs associated with inbound freight.

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Selling, general and administrative expenses include the costs associated with purchasing, receiving, handling, securing, and storing the product. These costs are associated with products that have been sold and no longer remain in ending inventory.

RESULTS OF OPERATIONS

Thirteen Weeks Ended October 29, 2005 and October 30, 2004

Net sales increased to $376.8 million in the third quarter of 2005 from $349.1 million in 2004, an increase of $27.7 million or 7.9%. This increase was attributable to sales by stores not yet included as comparable stores ($29.0 million) and an increase in sales to franchisees ($.7 million), offset by a decrease in comparable store sales of 1.0% ($2.0 million). Contributing factors to the comparable store sales decrease were the continued effect of TennCare cuts in our Tennessee market and the hurricanes on the Gulf Coast. It is anticipated that the franchise business will continue to decline as a percentage of total Company sales because the Company has not added and does not intend to add any additional franchises. The sales mix for the 2005 period was 31.6% Pharmaceuticals, 21.3% Household Goods, 13.5% Food and Tobacco, 13.3% Apparel and Linens, 9.3% Paper and Cleaning Supplies, 8.6% Health and Beauty Aids, and 2.4% Franchise. This compares with 34.1% Pharmaceuticals, 20.1% Household Goods, 13.2% Apparel and Linens, 11.9% Food and Tobacco, 9.2% Paper and Cleaning Supplies, 9.1% Health and Beauty Aids, and 2.4% Franchise for the same period last year.

Gross profit for the third quarter decreased to 28.9% of sales in 2005 from 29.0% of sales in 2004. However, excluding the effect of the EITF 02-16 deferral (as mentioned in Note 6) of approximately $2.2 million (.6%), our gross margin would have increased when compared to the same period last year. The unfavorable effect of the EITF 02-16 deferral was partially offset by higher pharmacy gross margin (.1%) and the reduction in double coupon expense (.4%) on general merchandise sales. The EITF 02-16 deferral is a timing issue and will positively impact our margins in subsequent quarters.

Selling, general and administrative expenses increased to $99.0 million in 2005 from $90.1 million in 2004. Selling, general and administrative expenses increased primarily due to higher labor of $4.2 million, additional cost related to the hurricanes of approximately $1.0 million, increases in fuel prices of $.5 million and utilities expenses of $1.7 million. Approximately $3.5 million of the increased labor costs are directly attributable to the net addition of 62 stores and 19 pharmacies when compared to last year, with approximately $.7 million at corporate. As a percentage of sales, expenses increased to 26.3% of sales compared to 25.8% of sales last year. On the positive side, the distribution center productivity improved by 15 basis points due to a reduction in the merchandise shipments from the warehouses to the stores and store labor improved by 70 basis points as a percentage of store sales due to better management of labor dollars. A change made in the prior year to estimated lives of certain store fixtures from five to ten years resulted in a favorable impact on quarterly depreciation expense by approximately $1.1 million.

For the third quarter of 2005 interest expense was $.3 million, the same as third quarter 2004. Higher interest rates were mitigated by reductions in borrowings.

For the third quarter of 2005, the effective income tax rate was 34.2%, as compared to 31.5% in the third quarter of last year. We anticipate the tax rate for the full 2005 fiscal year to be in the 33% to 34% range.

12

Thirty-nine Weeks Ended October 29, 2005 and October 30, 2004

Net sales increased to $1,132.8 million in 2005 from $1,031.5 million in 2004, an increase of $101.3 million or 9.8%. The increase was attributable to comparable store sales increases of 1.0% ($6.9 million), sales by stores not yet included as comparable stores ($93.9 million) and sales to franchisees ($0.5 million). The sales mix for the 2005 period was 32.6% Pharmaceuticals, 22.2% Household Goods, 13.6% Apparel and Linens, 12.3% Food and Tobacco, 8.7% Paper and Cleaning Supplies, 8.3% Health and Beauty Aids, and 2.3% Franchise. This compares with 33.7% Pharmaceuticals, 21.2% Household Goods, 13.5% Apparel and Linens, 11.5% Food and Tobacco, 9.0% Health and Beauty Aids, 8.7% Paper and Cleaning Supplies, and 2.4% Franchise for the same period last year. For the 2005 year to date period we opened 56 new stores and 17 new pharmacies and we closed eight stores and two pharmacies.

Gross profit increased to 28.5% of sales in 2005 compared with 28.3% of sales in the prior-year period. For the first nine months of 2005, gross profit margin was favorably affected by the reduction in double coupon expense on general merchandise sales (.5%). However, the positive effect was partially offset by the effect of the EITF 02-16 deferral (as mentioned in Note 6) of approximately $2.2 million (.4%).

Selling, general and administrative expenses increased to $297.0 million in 2005 from $265.1 million in 2004. As a percentage of sales, expenses increased to 26.2% compared to 25.7% last year. The increase is primarily due to increases in store and pharmacy expenses (.7%), principally wages, as a percent of sales offset by productivity gains in the distribution centers (.2%).

For the first nine months of 2005, we incurred interest expense of $0.7 million as compared to interest expense of $0.5 million in last year’s comparable period. The difference primarily resulted from higher interest rates and borrowings associated with new store growth.

For the first nine months of 2005, the effective income tax rate was 33.5%, the same as last year. We anticipate the tax rate for the full 2005 fiscal year to remain in the 34% to 35% range.

LIQUIDITY AND CAPITAL RESOURCES

Due to the seasonality of our business and the continued increase in the number of stores and pharmacies, inventories are generally lower at year-end than at each quarter-end of the following year.

Cash flows provided by operating activities totaled $18.8 million during the thirty-nine week period ended October 29, 2005. Cash was primarily used to increase inventories by approximately $68.7 million in the first nine months of 2005. This increase in inventory was primarily attributable to 56 new stores and 9 remodeled stores in the first nine months of 2005. The Company increased store square footage by 11.0% over the same period last year. Accounts payable and accrued liabilities increased by approximately $45.5 million in the first nine months of 2005 due to the increase in inventory and the number of stores.

Cash flows used in investing activities for the 2005 year to date activity totaled $23.4 million, and consisted primarily of capital expenditures associated with the store and pharmacy expansion program ($21.2 million) and for technology and other corporate expenditures ($2.2 million). During the first nine months of 2005, we opened 56 stores, closed 8 stores, opened 17 pharmacies, closed 2 pharmacies and remodeled 9 stores. We expect to open approximately 10 stores in the fourth quarter and approximately 66 stores for the year.

During the fourth quarter of 2005, the Company is planning capital expenditures

13

totaling approximately $5.1 million, including approximately $3.2 million for store upgrades, remodels, or new stores and pharmacies; $.8 million for technology upgrades, $.4 million for distribution center equipment and improvements and approximately $.7 million for the acquisition of customer lists and other pharmacy related items. For 2005, the Company is planning capital expenditures totaling approximately $28.5 million, including approximately $20.8 million for store upgrades, remodels, or new stores and pharmacies; $1.6 million for technology upgrades; $1.4 million for distribution center equipment and improvements and approximately $4.7 million for the acquisition of customer lists and other pharmacy related items. Depreciation expense for the year will be approximately $28 to $29 million.

Cash flows provided by financing activities totaled $18.5 million and included $18.9 million of borrowings under the Company’s revolving credit agreement for inventory needs. There were $42.0 million in borrowings outstanding at October 29, 2005 and $23.1 million in borrowings outstanding at January 29, 2005.

As previously mentioned, a major strategic initiative of the Company throughout the course of 2005 has been the installation of coolers to support our refrigerated foods program. By the end of the third quarter, the installation of the program was completed with approximately 585 stores being equipped with coolers, at an average cost of approximately $13,000 per store. During the third quarter the Company finalized a seventy-two month operating lease with Bank of America Leasing, which covers substantially all of the coolers installed to date.

We believe that sufficient capital resources are available in both the short-term and long-term through currently available cash and cash generated from future operations and, if necessary, the ability to obtain additional financing.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

Other than statements based on historical facts, many of the matters discussed in this Form 10-Q relate to events which we expect or anticipate may occur in the future. Such statements are defined as “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), 15 U.S.C.A. Sections 77z-2 and 78u-5 (Supp. 1996). The Reform Act created a safe harbor to protect companies from securities law liability in connection with forward-looking statements. Fred’s, Inc. (“Fred’s” or the “Company”) intends to qualify both its written and oral forward-looking statements for protection under the Reform Act and any other similar safe harbor provisions.

The words “believe”, “anticipate”, “project”, “plan”, “expect”, “estimate”, “objective”, “forecast”, “goal”, “intend”, “will likely result”, or “will continue” and similar expressions generally identify forward-looking statements. All forward-looking statements are inherently uncertain, and concern matters that involve risks and other factors which may cause the actual performance of the Company to differ materially from the performance expressed or implied by these statements. Therefore, forward-looking statements should be evaluated in the context of these uncertainties and risks, including but not limited to:

o Economic and weather conditions which affect buying patterns of our customers and supply chain efficiency;

o Weather anomalies that impact our ability to operate our facilities and stores;

o Changes in consumer spending and our ability to anticipate buying patterns and implement appropriate inventory strategies;

o Continued availability of capital and financing;

14

o Competitive factors;

o Changes in reimbursement practices for pharmaceuticals;

o Governmental regulation;

o Increases in fuel and utility rates;

o Other factors affecting business beyond our control and;

Consequently, all forward-looking statements are qualified by this cautionary statement. We undertake no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made.

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

We have no holdings of derivative financial or commodity instruments as of October 29, 2005. We are exposed to financial market risks, including changes in interest rates. All borrowings under our Revolving Loan and Credit Agreement bear interest at 1.5% below prime rate or a LIBOR-based rate. An increase in interest rates of 100 basis points would not significantly affect our income. All of our business is transacted in U.S. dollars and, accordingly, foreign exchange rate fluctuations have not had a significant impact on us, and they are not expected to in the foreseeable future.

Item 4.

CONTROLS AND PROCEDURES

(a) Disclosure Controls and Procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a — 15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that, as of the date of their evaluation, the Company’s disclosure controls and procedures are effective in timely alerting them to material information required to be included in the Company’s periodic SEC reports, subject to the effectiveness of the Company’s internal control over financial reporting.

(b) Changes in Internal Control Over Financial Reporting. During the quarter ended April 30, 2005, the Company instituted procedures to remediate the material weakness in internal control that resulted from the inappropriate application of Generally Accepted Accounting Principles related to the accounting for leases (straight-line rent) and the depreciable lives of leasehold improvements (as previously disclosed by the Company in its report on internal control over financial reporting in Form 10-K for the fiscal year ended January 29, 2005). The Company will be testing these procedures over the upcoming quarters to ensure that this material weakness is remediated in the current fiscal year.

Additionally, the Company reported a material weakness in internal control in its Form 10-K for the fiscal year ended January 29, 2005, related to the financial closing process. The Company continued in the 3rd quarter to implement

15

procedural and staff improvements as steps toward remediation of this weakness. However, additional improvements will be required in the fourth quarter, with the intention of remediating this material weakness in the current fiscal year.

There have been no other changes in the Company’s internal control over financial reporting that occurred during the Company’s first nine months that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 6. Exhibits

     Exhibits:

10.19	Lease agreement by and between Banc of America Leasing & Capital, LLC and Fred’s Stores of Tennessee, Inc. dated July 26, 2005 for the lease of equipment to Fred’s Stores of Tennessee, Inc.
31.1	Certification of Chief Executive Officer.
31.2	Certification of Chief Financial Officer.
32	Certification of Chief Executive Officer and Chief Financial Officer pursuant to rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

17

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’S, INC.
	/s/ Michael J. Hayes
	Michael J. Hayes
Date: December 7, 2005	Chief Executive Officer
	/s/ Jerry A. Shore
	Jerry A. Shore
Date: December 7, 2005	Chief Financial Officer

18

EX-10.19

                                                                   Exhibit 10.19
[BANK OF AMERICA LOGO]

                                                                  LEASE NUMBER
BANC OF AMERICA LEASING & CAPITAL, LLC     LEASE AGREEMENT        15689 - 00400

THIS LEASE AGREEMENT (this "Agreement") dated as of July 26, 2005 between BANC
OF AMERICA LEASING & CAPITAL, LLC ("Lessor"), a Delaware limited liability
company having an office at 2059 Northlake Parkway, 4 South, Tucker, GA 30084,
and Fred's Stores of Tennessee, Inc. ("Lessee"), a Tennessee corporation, having
their chief executive office at 4300 New Getwell Road, Memphis, Tennessee 38118.

1. LEASE AGREEMENT; SCHEDULES; TITLE. Subject to the terms and conditions
hereof, Lessor shall lease to Lessee, and Lessee shall lease from Lessor, the
items of personal property (collectively with all attachments and accessories
thereto, the "Units") described in one or more schedules (each, a "Schedule";
each Schedule, together with this Agreement as it pertains thereto, a "Lease")
which incorporate by reference this Agreement. Each Schedule shall constitute a
separate and independent lease and contractual obligation of Lessee. Upon
delivery and acceptance by Lessee of each Unit, Lessee shall execute and deliver
the Schedule relating to the Unit, with all information required on the Schedule
fully completed, identifying and accepting the Unit. Lessee hereby assigns to
Lessor all of Lessee's interest in any purchase orders, invoices or other
contracts of sale with respect to the Units provided that Lessor assumes no
obligations under such agreements other than the obligation to pay for the Units
if Lessee has complied with the terms of this Agreement. Lessee hereby conveys
whatever right, title and interest it may have in the Units to the Lessor
hereunder.

2. TERM OF LEASE; RENTALS. The lease term with respect to any Unit shall consist
of an "Interim Term" (if any) and a "Base Term" as specified in the Schedule
covering such Unit. Lessee shall pay rent for the Interim Term ("Interim Rent")
and for the Base Term ("Base Rent") as specified in the applicable Schedule.

3. NET LEASE; DISCLAIMER OF WARRANTIES. EACH LEASE IS A NET LEASE. ALL COSTS,
EXPENSES AND OTHER LIABILITIES ASSOCIATED WITH THE UNITS SHALL BE BORNE SOLELY
BY LESSEE. LESSEE'S OBLIGATION TO PAY RENT AND ALL OTHER OBLIGATIONS UNDER ANY
LEASE ARE ABSOLUTE AND UNCONDITIONAL, AND NOT SUBJECT TO ANY ABATEMENT,
DEFERMENT, REDUCTION, SETOFF, DEFENSE, COUNTERCLAIM OR RECOUPMENT FOR ANY REASON
WHATSOEVER. NO LEASE SHALL TERMINATE, EXCEPT AS EXPRESSLY PROVIDED HEREIN, NOR
SHALL THE OBLIGATIONS OF LESSEE BE AFFECTED, BY REASON OF ANY DEFECT OR DAMAGE
TO, OR ANY DESTRUCTION, LOSS, THEFT, FORFEITURE, GOVERNMENTAL REQUISITION OR
OBSOLESCENCE OF ANY UNIT, REGARDLESS OF CAUSE. LESSEE ACKNOWLEDGES THAT LESSOR
IS NOT A MERCHANT OR MANUFACTURER, OR AGENT OF ANY SUCH PERSON, OR ENGAGED IN
THE SALE OR DISTRIBUTION OF THE UNITS, AND HAS NOT MADE, AND DOES NOT HEREBY
MAKE, ANY REPRESENTATION OR WARRANTY AS TO MERCHANTABILITY, PERFORMANCE,
CONDITION, FITNESS OR SUITABILITY FOR LESSEE'S PURPOSES OF ANY OF THE UNITS, OR
MAKE ANY OTHER REPRESENTATION OR WARRANTY WITH RESPECT TO THE UNITS. LESSOR
SHALL NOT BE LIABLE TO LESSEE FOR, NOR SHALL LESSEE'S OBLIGATIONS UNDER ANY
LEASE BE AFFECTED BY, ANY LOSS, CLAIM, LIABILITY, COST, DAMAGE OR EXPENSE OF ANY
KIND CAUSED, OR ALLEGED TO BE CAUSED, DIRECTLY OR INDIRECTLY, BY ANY UNIT, OR BY
ANY INADEQUACY OF THE UNIT FOR ANY PURPOSE, OR BY ANY DEFECT IN, THE USE OR
MAINTENANCE OF, ANY REPAIRS, SERVICING OR ADJUSTMENTS OF, OR ANY INTERRUPTION OR
LOSS OF SERVICE OR USE OF, ANY UNIT, OR ANY LOSS OF BUSINESS, PROFITS,
CONSEQUENTIAL OR OTHER DAMAGE OF ANY NATURE. Lessor hereby transfers and assigns
to Lessee, to the extent allowable by law, for and during the lease term of each
Schedule, a non-exclusive interest in the Unit warranties, if any, of the
manufacturer, and hereby authorizes Lessee, when there exists no Event of
Default, to enforce such warranties and to obtain at its own expense the
customary services furnished by the manufacturer in connection with the Units.

4. USE, MAINTENANCE, LOCATION. Lessee shall use, operate, protect and maintain
the Units in good operating order, repair, condition and appearance, and in
compliance with all applicable insurance policies, laws, ordinances, rules,
regulations and manufacturer's recommended procedures, and shall maintain
comprehensive records regarding the Units. The Units shall be used solely for
commercial or business purposes, and not for any consumer, personal, home, or
family purpose, and shall not be abandoned. Lessee shall not, through
modifications, alterations or otherwise, impair the value or originally intended
function of any Unit without Lessor's prior consent. Any replacement or
substitution of parts, improvements, upgrades, or additions to the Units made by
Lessee shall become and remain the property of Lessor and subject to the Lease,
except that if no Event of Default exists, Lessee may at its expense remove
improvements or additions provided by Lessee that can be readily removed without
impairing the value and function of the Unit. If requested by Lessor, Lessee
shall cause each Unit to be plainly marked to disclose Lessor's ownership, as
specified by Lessor. Lessee shall not change the location or base of any Unit
specified in its Schedule without Lessor's prior consent. Lessee shall notify
Lessor at least 30 days before changing the location of its chief executive
office.

5. LOSS AND DAMAGE. Lessee assumes all risk of, and shall promptly notify Lessor
of any occurrence of, any damage to or loss, theft, confiscation, or destruction
of (together, "Casualty") each Unit from any cause whatsoever from the date the
Unit is shipped by the vendor or manufacturer or otherwise made available to
Lessee ("Shipment Date"). If any Unit suffers a Casualty from the Shipment Date
until the Acceptance Date (as defined in the applicable Schedule), Lessee shall
pay Lessor any sum required to be paid under any Progress Payment Agreement
entered into between Lessor and Lessee in relation to such Unit. If any Unit
suffers a Casualty on or after its Acceptance Date, Lessee shall, if the
Casualty is damage that is reparable in the judgment of Lessor, at its own
expense promptly place the same in good repair, condition or working order, and,
if the Unit is lost, stolen, confiscated, destroyed or damaged beyond repair
("Total Loss"), on the rent payment date following such occurrence (or, if none,
within 30 days) pay Lessor the Stipulated Loss Value (as defined in the
applicable Schedule) therefor, together with all other amounts owing under the
Lease with respect to the Unit. Upon such payment, (a) the Lease of the Unit
shall



terminate and Lessor thereupon shall become entitled to possession of the Unit
and (b) Lessee shall become entitled to proceeds of insurance maintained by
Lessee to the extent of such payment, any excess proceeds to be retained by
Lessor. If less than all Units in the applicable Schedule suffer Total Loss, the
remaining Base Rent under the Schedule shall be reduced as reasonably calculated
by Lessor and notified to Lessee.

6. INSURANCE. Lessee, at its own expense, shall keep each Unit insured against
all risks for the value of the Unit, and in no event for less than the
Stipulated Loss Value of the Unit, and shall maintain public liability insurance
against such risks and for such amounts as Lessor may require. All such
insurance shall be in such form and with such companies as Lessor shall approve,
shall specify Lessor and Lessee as insureds and shall provide that such
insurance may not be canceled as to Lessor or altered in any way that would
affect the interest of Lessor without at least 30 days' prior written notice to
Lessor (10 days' in the case of nonpayment of premium). All insurance shall be
primary, without right of contribution from any other insurance carried by
Lessor, shall contain waiver of subrogation and "breach of warranty" provisions
satisfactory to Lessor, shall provide that all amounts payable by reason of loss
or damage to the Units shall be payable solely to Lessor, unless Lessor
otherwise agrees, and shall contain such other endorsements as Lessor may
reasonably require. Lessee shall provide Lessor with evidence satisfactory to
Lessor of the required insurance upon the execution of any Schedule and promptly
upon any renewal of any required policy.

7. INDEMNITIES. (a) General Indemnity. Lessee shall indemnify, on an after-tax
basis, Lessor, its successors and assigns, and their respective officers,
directors, employees, agents and affiliates ("Indemnified Persons") against all
claims, liabilities, losses and expenses whatsoever (except those directly and
primarily caused by the Indemnified Person's gross negligence or willful
misconduct), including reasonable attorneys' fees and allocated costs of
internal counsel (together, "Attorney Costs"), in any way relating to or arising
out of this Agreement, the Units or the Leases at any time, or the ordering,
acquisition, rejection, installation, possession, maintenance, use, ownership,
condition, destruction, return, or disposition of the Units, including such
matters based in negligence and strict liability in tort, environmental
liability, statutory liability, or infringement or Lessee's breach of any
representation, warranty or covenant contained herein or any other agreement
related hereto.

(b) General Tax Indemnity. Lessee shall pay or reimburse Lessor and its
successors and assigns on demand for, and indemnify and hold Lessor harmless
from, on an after-tax basis, all taxes, assessments, fees and other governmental
charges paid or required to be paid by Lessor or Lessee in any way arising out
of or related to the Units or the Leases, before, during or after the lease
term, including foreign, Federal, state, county and municipal fees, taxes and
assessments, and property, value-added, sales, use, gross receipts, excise,
stamp and documentary taxes, and all related penalties, fines, additions to tax
and interest charges (together, "Impositions"), excluding only Federal and state
taxes based on Lessor's net income unless such taxes are in lieu of any
Imposition Lessee would otherwise be required to pay hereunder. Lessee shall
timely pay any Imposition for which Lessee is primarily responsible under law
and any other Imposition not payable or not paid by Lessor, but Lessee shall
have no obligation to pay any such Imposition that Lessee is contesting in good
faith and by appropriate legal proceedings, the nonpayment of which does not, in
the opinion of Lessor, result in a material risk of adverse effect on the title,
property, use, disposition or other rights of Lessor with respect to the Units.
Lessee shall furnish on Lessor's request proof of payment of any Imposition paid
by Lessee.

(c) Special Tax Indemnity. (i) All references to "Lessor" in this Section 7(c)
shall include (A) Lessor's successors and assigns, and (B) each member of the
affiliated group of corporations, as defined in Section 1504(a) of the Internal
Revenue Code of 1986, as amended (the "Code"), of which Lessor or such successor
or assign is at any time a member.

    (ii) Lessor shall be treated for Federal, state and local income tax
    purposes as the owner of the Units and shall be entitled to take into
    account in computing its income tax liabilities all items of income,
    deduction (including depreciation consistent with Lessee's representation
    in the applicable Schedule), credit, gain or loss relating to ownership of
    the Units as are provided to owners of similar equipment under the Code
    and applicable state and local tax laws as in effect on the Acceptance
    Date of such Units (collectively, the "Tax Benefits").

    (iii) If (A) Lessor loses, is delayed in claiming, is required to
    recapture (other than in connection with a sale of the Unit following the
    end of the lease term, provided Lessee is not then in default), is not
    allowed or does not claim as a result of a written opinion of Lessor tax
    counsel to the effect that Lessor's claiming of such Tax Benefits probably
    would not be upheld by a court if the matter were litigated (that is, that
    the chances of a finding against Lessor are at least as great as the
    chances of a finding in favor of Lessor) all or any portion of any Tax
    Benefits, under any circumstances, at any time and for any reason, or (B)
    Lessor is required under Section 467 of the Code or otherwise to include
    in its gross income with respect to any Lease or Unit any amount at any
    time other than rentals and other amounts as and when accrued in
    accordance with the express terms of the Lease (together, "Tax Loss"),
    then, upon Lessor's demand and at Lessor's option, either: (x) all further
    rental payments with respect to such Unit, if any, shall be increased by
    an amount, or (y) Lessee shall pay to Lessor a lump sum amount, which
    shall in either case maintain the net economic after-tax yield, cash-flow
    and rate of return Lessor originally anticipated, based on an assumed
    combined Federal, state and local income tax rate for Lessor of 38.20% and
    other assumptions originally used by Lessor in evaluating the transaction
    and setting the rental therefor and the other terms thereof. Lessee shall
    also pay to Lessor on demand all interest, costs (including Attorney
    Costs), penalties and additions to tax associated with the Tax Loss.

    (iv) Lessee shall be under no obligation to make a payment under the
    preceding paragraph (iii) relating to a Tax Loss to the extent that the
    Tax Loss is caused by Lessor's failure to have sufficient taxable income
    to benefit from any Tax Benefits. Lessor shall have no obligation to
    contest any Tax Loss.

8. RETURN; EXTENSIONS; PURCHASES. (a) Upon any termination or expiration of the
lease term with respect to any Unit, Lessee shall, at its own expense, prepare
and adequately protect the Unit for shipment and either surrender it to Lessor
in place or, if instructed by Lessor, ship the Unit to Lessor, freight and
insurance pre-paid, at a place reasonably designated by Lessor, in the condition
required under Section 4 hereof and under the applicable Schedule, and able to
be put into immediate service and to perform at manufacturer's rated levels (if
any), together with all



related manuals, documents and records. If Lessee does not so surrender or
return a Unit to Lessor, in addition to all other rights and remedies available,
at Lessor's election, such Unit shall continue to be subject to all the terms
and conditions of the Lease, with rent and other charges continuing to accrue
and be payable under the Lease with respect to such Unit until it is so
surrendered or returned to Lessor, except that Base Rent shall accrue, payable
on demand, at the rate of 150% of the rate applicable in the last period for
which Base Rent was payable.

(b) Except as set forth in the applicable Schedule, Lessee has no right to
extend any Lease or purchase any Unit.

9. LESSEE REPRESENTATIONS AND AGREEMENTS. Lessee represents, warrants and agrees
as follows: Lessee is duly organized and is in good standing in all
jurisdictions where legally required in order to carry on its business, has duly
authorized the execution, delivery and performance of this Agreement, each
Schedule and all other documents contemplated hereby, which are, or upon
signing, will be binding on Lessee, do not and will not contravene any other
instrument or agreement to which Lessee is party and there is no pending
litigation, tax claim, proceeding or dispute that may adversely affect Lessee's
financial condition or impair its ability to perform its obligation under the
terms of this Agreement.

10. PERSONAL PROPERTY. The Units shall remain personal property at all times,
notwithstanding the manner in which they may be attached or affixed to realty,
and title shall at all times continue in Lessor. Lessee shall obtain and record
such instruments and take such steps as may be necessary (a) to prevent any
person from acquiring any right or lien in or on any Unit, whether by reason of
such Unit being deemed to be attached to real or other property, or otherwise,
and (b) to ensure Lessor's right of access to and removal of the Unit, in
accordance with the Lease.

11. DEFAULT AND REMEDIES. (a) Each of the following is an "Event of Default"
hereunder and under any and all Leases then in effect: (1) Lessee fails to pay
within five days of the day when due any installment of rent or other sum owing
by Lessee under any Lease; (2) Lessee fails to maintain insurance in respect of
any Unit as required herein, or sells, leases, subleases, assigns, conveys,
encumbers or suffers to exist any lien or charge against, any Unit without
Lessor's prior consent, or any Unit is subjected to levy, seizure or attachment;
(3) Lessee fails to perform and comply with any other covenant or obligation
under any Lease, or any progress payment, assignment, security or other
agreement related to any Lease or Unit (together, "Related Agreements") and, if
curable, such failure continues for 30 days after written notice thereof by
Lessor to Lessee, (4) any representation, warranty or other written statement
made to Lessor in connection with this Agreement, any Lease, Related Agreement,
or any guaranty, by Lessee or any person providing such guaranty ("Guarantor"),
including financial statements, proves to have been incorrect in any material
respect when made; (5) Lessee (x) enters into any merger or consolidation with,
or sells or transfers all, substantially all or any substantial portion of its
assets to, or enters into any partnership or joint venture other than in the
ordinary course of business with, any entity, (y) dissolves, liquidates or
ceases or suspends the conduct of business, or ceases to maintain its existence,
or (z) enters into or suffers any transaction or series of transactions as a
result of which Lessee is directly or indirectly controlled by persons or
entities not affiliates of Lessee as of the date of this Agreement; (6) Lessee
undertakes any general assignment for the benefit of creditors or commences any
voluntary case or proceeding for relief under the Bankruptcy Code, or any other
law for the relief of debtors, or takes any action to authorize or implement any
of the foregoing; (7) the filing of any petition or application against Lessee
under any law for the relief of debtors, including proceedings under the
Bankruptcy Code, or for the subjection of property of Lessee to the control of
any court, receiver or agency for the benefit of creditors if such petition or
application is consented to by Lessee or not dismissed within 60 days from the
date of filing; (8) any payment default or other event of default occurs under
any other bilateral or multi-lateral lease, or credit, or other agreement or
instrument to which Lessee and Lessor or any affiliate of Lessor are now or
hereafter party; (9) any payment default or other event of default occurs under
any other lease, or credit, or other agreement or instrument or any combination
thereof to which Lessee is now or hereafter party and under which there is
outstanding (on a present value basis for all future rent, in the case of
leases), owing or committed an aggregate amount greater than $100,000.00; (10)
the repudiation of or breach or default under any guaranty relating to any
Lease; or (11) the occurrence of any event described in clauses (5), (6), (7),
(8) or (9) of this Section with reference to "any Guarantor" in lieu of
"Lessee", or any Guarantor dies.

(b) Upon the occurrence of an Event of Default and in addition to all other
rights and remedies provided herein or under law, all of which rights and
remedies are cumulative and not exclusive, Lessor may: (i) proceed by
appropriate court action or actions, either at law or in equity, to enforce
performance by Lessee of the applicable covenants under any or all Leases, or
(ii) terminate any and all Leases, repossess the Units, and recover direct,
incidental, consequential and other damages for the breach thereof and, at its
election, dispose of the Units by lease, sale or otherwise, and pursue any and
all other remedies provided upon breach of personal property leases under the
Uniform Commercial Code of the state specified in Section 16(k) of this
Agreement (whether or not otherwise applicable) or as provided by other
applicable law. Lessor may recover from Lessee all Attorney Costs in the amount
of 15% of all amounts due on or after the time of such breach or default (but
not to exceed the amount actually incurred). To determine any present value
quantity for purposes of this Section, the applicable discount rate shall be the
then-current bond-equivalent yield per annum for United States Government
Treasury obligations of maturity corresponding to the weighted average life,
rounded to the second decimal place, of the discounted payment stream (or, if no
maturity exactly corresponds to such rounded weighted average life, the discount
rate shall be interpolated from the yields of the two most closely corresponding
published maturities). In the alternative, at its election, Lessor may enforce
as liquidated damages and not as a penalty, payment of an amount equal to all
accrued and unpaid rent plus the Stipulated Loss Value of any and all Units.

(c) The exercise or partial exercise of, or failure to exercise, any remedy
shall not restrict Lessor from further exercise of that remedy or any other
remedy otherwise available. To the extent permitted by applicable law, Lessee
waives any right to require Lessor to sell, release or otherwise use or dispose
of any Units or otherwise mitigate Lessor's damages, or that may otherwise limit
or modify any of Lessor's rights or remedies.

12. ASSIGNMENT, ETC. (a) Lessor (and any subsequent assignee) may assign or
transfer any or all of Lessor's interest in any Lease, Unit or the



rentals therefrom without notice to Lessee. Lessee agrees that the rights of any
assignee shall not be affected by any breach or default of Lessor or of any
prior assignee. Lessee further agrees that (i) no such assignee shall be
required to assume any of the obligations of Lessor under any Lease except the
obligation in respect of the application of any insurance monies received by
such assignee as provided above, and the obligation of non-interference as
provided below, and (ii) any assignee expressly assuming the obligations of
Lessor shall thereupon be responsible for Lessor's duties under the applicable
Lease accruing after any such assignment and Lessor shall be released from such
duties. Lessor may disclose to any potential or actual assignee or transferee
any information regarding Lessee, any Guarantor and their affiliates.

(b) LESSEE SHALL NOT ASSIGN, PLEDGE, HYPOTHECATE OR IN ANY WAY DISPOSE OF ALL OR
ANY PART OF ITS RIGHTS OR OBLIGATIONS UNDER ANY LEASE, OR ENTER INTO ANY
SUBLEASE OF ANY UNIT, WITHOUT LESSOR'S PRIOR WRITTEN CONSENT.

13. FINANCIAL AND OTHER DATA. (a) During the term of any Lease, Lessee shall (i)
maintain books and records in accordance with generally accepted accounting
principles ("GAAP") and prudent business practice, (ii) promptly and in no event
later than 120 days after each fiscal year end furnish Lessor annual audited
financial statements of Lessee and of any Guarantor, prepared in accordance with
GAAP consistently applied, together with an unqualified opinion of an
independent auditor, and (iii) at Lessor's request, furnish Lessor all other
financial information and reports reasonably requested by Lessor at any time,
including quarterly or other interim financial statements of Lessee and of any
Guarantor. Lessee shall furnish such other information as Lessor may reasonably
request at any time concerning Lessee, any Guarantor and their respective
affairs, or any Unit. Lessee shall promptly notify Lessor of any Event of
Default or event or circumstance which, with notice, lapse of time or both,
would be an Event of Default.

(b) Lessee represents and warrants that all information furnished and to be
furnished by Lessee or any Guarantor to Lessor is accurate, and that all
financial statements Lessee or any Guarantor has furnished and hereafter may
furnish to Lessor reasonably reflect and will reflect, as of their respective
dates, results of the operations and the financial condition of Lessee, such
Guarantor or any other entity they purport to cover.

(c) Credit and other information regarding Lessee, any Guarantor or their
affiliates may be shared by Lessor with its affiliates and agents.

14. INSPECTION; NON-INTERFERENCE. (a) Lessor, its agents and employees shall
have the right to enter any property where any Unit is located and inspect any
Unit, together with its related books and records, at any reasonable time. Such
right shall not impose any obligation on Lessor.

(b) So long as no Event of Default exists, Lessor shall not and each direct or
indirect assignee or transferee of Lessor agrees that it shall not, interfere
with the rights of use and enjoyment of the Units by Lessee.

15. OTHER CHARGES; APPLICATION. If Lessee fails to pay within ten days of the
date due any amount of regularly scheduled Interim Rent or Base Rent, Lessee
shall pay a late charge equal to five percent (5%) of the amount not timely
paid. Lessee shall pay interest at the per annum rate equal to the lesser of (a)
15% or (b) the highest rate permitted by applicable law ("Default Rate") on (i)
any sum other than regularly scheduled Interim Rent and Base Rent owing under
any Lease and not paid when due, and (ii) any amount required to be paid upon
termination of any Lease under Section 11 hereof. Payments received under any
Lease will be applied, first, to interest, fees and other amounts owing, other
than Interim Rent or Base Rent, then to Interim Rent or Base Rent, in order of
Acceptance Date.

16. MISCELLANEOUS. (a) Each Lease is and is intended to be a lease of personal
property for commercial and federal income tax purposes, and Lessee does not
acquire any right, title or interest in or to the Units, except the right to use
the same under the conditions of the applicable Lease. Lessee waives any right
to assert any lien or security interest on the Units in Lessee's possession or
control for any reason.

(b) Lessee's indemnity and reimbursement obligations, including under Section 7,
shall survive the termination or cancellation of any Lease or this Agreement.

(c) At Lessor's request, Lessee shall execute, deliver, file, and record such
financing statements and other documents, agreements and instruments as Lessor
shall deem necessary or advisable to protect Lessor's interest in the Units and
to effectuate the purposes of any Lease and the Related Agreements. Lessee
hereby irrevocably appoints Lessor as Lessee's agent and attorney-in-fact for
Lessee, coupled with an interest, (i) to execute, deliver, file, or record any
such item, and to take such action for Lessee and in Lessee's name, place and
stead, and (ii) to enforce claims relating to the Units against insurers,
vendors, and other persons, and to make, adjust, compromise, settle and receive
payment under such claims; without any obligation to do so.

(d) Time is of the essence.

(e) The invalidity of any portion of this Agreement, any Schedule or Related
Agreement shall not affect the force and effect of the remaining valid portions
thereof. The term "including" is not limiting. The term "affiliate" includes any
entity controlling, controlled by or under common control with the referent
entity; "control" includes the ownership of 25% or more of the voting stock of
any entity. The term "guaranty" includes any guaranty, surety instrument,
indemnity, "keep-well" agreement or other instrument or arrangement providing
third party credit support to Lessor relating to any Lease or Unit.

(f) This Agreement, the Schedules, any approval letter by Lessor in relation
hereto and any replacement or successor letter thereto (together, the "Approval
Letter") and the Related Agreements, constitute the entire agreement between the
parties with respect to the leasing of the Units. Any amendment to such
documents must be made in writing and signed by the parties hereto or thereto.
Such documents may be executed in one or more counterparts. Where multiple
counterpart originals of any Schedule exist, only the counterpart marked
"Lessor's Copy" shall be deemed chattel paper and evidence a monetary obligation
of Lessee.




(g) All demands, notices, requests, consents, waivers and other communications
under this Agreement, any Lease, any Approval Letter or any Related Agreement
shall be in writing and shall be deemed to have been duly given when received,
personally delivered or three business days after being deposited in the mail,
first class postage prepaid, or the business day after delivery to an express
carrier, charges prepaid, or when sent by facsimile transmission or electronic
mail (with electronic confirmation of receipt), addressed to each party at the
address, electronic mail address or fax number set forth below the signature of
such party on the signature page, or at such other address or fax number as may
hereafter be furnished in writing by such party to the other.

(h) (i) To secure the payment and performance of its obligations under the Lease
relating to such Unit and the repayment of any advances, with interest and fees,
made by Lessor on account of the Unit, and (ii) as a separate grant of security,
to secure the payment and performance of its obligations under all other Leases
and all other lease, loan or other obligations owing by Lessee to Lessor, in
each case, now existing or hereafter arising, Lessee hereby grants to Lessor a
security interest in all of Lessee's right, title and interest in and to each
Unit, together with (A) all attachments, accessories and accessions to,
substitutions and replacements for, and products of, the Unit, (B) all rights to
chattel paper arising from the Unit, (C) all insurance, warranty and other
claims against third parties with respect to the Unit (including claims for rent
upon any lease of the Unit), (D) all software and other intellectual property
rights used or useful in connection therewith, (E) all proceeds of any of the
foregoing, including insurance proceeds, and (F) all books and records regarding
the foregoing, in each case, now existing or hereafter arising.

(i) To the extent permitted by applicable law, this is a "finance lease" under
the Article of the Uniform Commercial Code governing personal property leases.
Lessee waives any right (i) to cancel or repudiate any Lease, (ii) to reject or
revoke acceptance of any Unit, and (iii) to recover from Lessor any general or
consequential damages, for any reason whatsoever.

(j) To the extent specified in any Approval Letter, Lessee shall reimburse
Lessor upon demand for costs and expenses incurred by Lessor in connection with
the execution and delivery of this Agreement and the other documents
contemplated hereby. Lessee shall reimburse Lessor on demand for all costs and
expenses, including Attorney Costs, incurred in connection with any amendment of
any Lease or related document requested by Lessee, or any waiver.

(k) THIS AGREEMENT, EACH SCHEDULE AND (UNLESS OTHERWISE SPECIFIED THEREIN) THE
RELATED AGREEMENTS SHALL BE GOVERNED BY AND CONSTRUED ACCORDING TO THE INTERNAL
LAWS OF THE STATE OF GEORGIA, TO THE NON-EXCLUSIVE JURISDICTION OF THE COURTS OF
WHICH, AND THE FEDERAL COURTS LOCATED THEREIN, THE PARTIES HERETO SUBMIT.

(l) LESSOR AND LESSEE EACH WAIVE TRIAL BY JURY IN ANY ACTION, PROCEEDING OR
COUNTERCLAIM BROUGHT BY EITHER AGAINST THE OTHER ON ANY MATTER HOWEVER ARISING
OUT OF OR IN ANY WAY CONNECTED WITH ANY LEASE OR THE UNITS.

IN WITNESS WHEREOF, Lessor and Lessee have executed this Agreement as of the
date first above written.

Banc of America Leasing & Capital,            Fred's Stores of Tennessee,
LLC (Lessor)                                  Inc. (Lessee)

By:      /s/ Carol Jones                      By:      /s/ Jerry A Shore
    ------------------------------------          ------------------------------
Printed Name: Carol Jones                     Printed Name: Jerry A Shore
Title: Vice-President                         Title: Vice-President
Address: 2059 Northlake Parkway, 4 South      Address: 4300 New Getwell Road
             Tucker, Georgia 30084                     Memphis, Tennessee 38118
Facsimile: (770)270-8454                      Facsimile: (901) 365-6815

EX-31.1

                                                                    Exhibit 31.1

                    CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Michael J. Hayes, certify that:

      1.    I have reviewed this quarterly report on Form 10-Q of Fred's, Inc.;

      2.    Based on my knowledge, this report does not contain any untrue
            statement of a material fact or omit to state a material fact
            necessary to make the statements made, in light of the circumstances
            under which such statements were made, not misleading with respect
            to the period covered by this report;

      3.    Based on my knowledge, the financial statements, and other financial
            information included in this report, fairly present in all material
            respects the financial condition, results of operations and cash
            flows of the registrant as of, and for, the periods presented in
            this report;

      4.    The registrant's other certifying officer and I are responsible for
            establishing and maintaining disclosure controls and procedures (as
            defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
            control over financial reporting (as defined in Exchange Act Rules
            13a-15(f) and 15d-15(f)) for the registrant and have:

                  a)    Designed such disclosure controls and procedures, or
                        caused such disclosure controls and procedures to be
                        designed under our supervision, to ensure that material
                        information relating to the registrant, including its
                        consolidated subsidiaries, is made known to us by others
                        within those entities, particularly during the period in
                        which this report is being prepared;

                  b)    Designed such internal control over financial reporting,
                        or caused such internal control over financial reporting
                        to be designed under our supervision, to provide
                        reasonable assurance regarding the reliability of
                        financial reporting and the preparation of financial
                        statements for external purposes in accordance with
                        generally accepted accounting principles;

                  c)    Evaluated the effectiveness of the registrant's
                        disclosure controls and procedures and presented in this
                        report our conclusions about the effectiveness of the
                        disclosure controls and procedures, as of the end of the
                        period covered by this report based on such evaluation;
                        and

                  d)    Disclosed in this report any change in the registrant's
                        internal control over financial reporting that occurred
                        during the registrant's most recent fiscal quarter that
                        has materially affected, or is reasonably likely to
                        materially affect, the registrant's internal control
                        over financial reporting; and

      5.    The registrant's other certifying officer and I have disclosed,
            based on our most recent evaluation of internal control over
            financial reporting, to the registrant's auditors and the audit
            committee of registrant's board of directors:

                  a)    All significant deficiencies and material weaknesses in
                        the design or operation of internal control over
                        financial reporting which are reasonably likely to
                        adversely affect the registrant's ability to record,
                        process, summarize and report financial information; and

                  b)    Any fraud, whether or not material, that involves
                        management or other employees who have a significant
                        role in the registrant's internal control over financial
                        reporting.

Date: December 7, 2005                       /s/ Michael J. Hayes
                                             ----------------------------------
                                             Michael J. Hayes
                                             Chief Executive Officer

EX-31.2

                                                                    Exhibit 31.2

                    CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Jerry A. Shore, certify that:

      1.    I have reviewed this quarterly report on Form 10-Q of Fred's, Inc.

      2.    Based on my knowledge, this report does not contain any untrue
            statement of a material fact or omit to state a material fact
            necessary to make the statements made, in light of the circumstances
            under which such statements were made, not misleading with respect
            to the period covered by this report;

      3.    Based on my knowledge, the financial statements, and other financial
            information included in report, fairly present in all material
            respects the financial condition, results of operations and cash
            flows of the registrant as of, and for, the periods presented in
            this report;

      4.    The registrant's other certifying officer and I are responsible for
            establishing and maintaining disclosure controls and procedures (as
            defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
            control over financial reporting (as defined in Exchange Act Rules
            13a-15(f) and 15d-15(f)) for the registrant and have:

            a)    Designed such disclosure controls and procedures, or caused
                  such disclosure controls and procedures to be designed under
                  our supervision, to ensure that material information relating
                  to the registrant, including its consolidated subsidiaries, is
                  made known to us by others within those entities, particularly
                  during the period in which this report is being prepared;

            b)    Designed such internal control over financial reporting, or
                  caused such internal control over financial reporting to be
                  designed under our supervision, to provide reasonable
                  assurance regarding the reliability of financial reporting and
                  the preparation of financial statements for external purposes
                  in accordance with generally accepted accounting principles;

            c)    Evaluated the effectiveness of the registrant's disclosure
                  controls and procedures and presented in this report our
                  conclusions about the effectiveness of the disclosure controls
                  and procedures, as of the end of the period covered by this
                  report based on such evaluation; and

            d)    Disclosed in this report any changes in the registrant's
                  internal control over financial reporting that occurred during
                  the registrant's most recent fiscal quarter that has
                  materially affected, or is reasonably likely to materially
                  affect, the registrant's internal control over financial
                  reporting; and

      5.    The registrant's other certifying officer and I have disclosed,
            based on our most recent evaluation of internal control over
            financial reporting, to the registrant's auditors and the audit
            committee of registrant's board of directors:

            a)    All significant deficiencies and material weaknesses in the
                  design or operation of internal control over financial
                  reporting which are reasonably likely to adversely affect the
                  registrant's ability to record, process, summarize and report
                  financial information; and

            b)    Any fraud, whether or not material, that involves management
                  or other employees who have a significant role in the
                  registrant's internal control over financial reporting.

Date: December 7, 2005                       /s/ Jerry A. Shore
                                             ----------------------------------
                                             Jerry A. Shore
                                             Executive Vice President and
                                             Chief Financial Officer

EX-32

                                                                      Exhibit 32

      CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO RULE 13 A OR 15 (d) UNDER THE SECURITIES EXCHANGE ACT OF 1934 AND 18
                               U.S.C. SECTION 1350

Each of the undersigned hereby certifies that to his knowledge the Quarterly
Report on Form 10-Q for the fiscal quarter ended October 29, 2005 of Fred's, Inc
(the "Company") filed with the Securities and Exchange Commission on the date
hereof fully complies with the requirements of Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and that the information contained in such
report fairly presents, in all material respects, the financial condition and
results of operation of the Company.

Date: December 7, 2005                       /s/ Michael J. Hayes
                                             ----------------------------------
                                             Michael J. Hayes
                                             Chief Executive Officer

                                             /s/ Jerry A Shore
                                             ----------------------------------
                                             Jerry A Shore
                                             Executive Vice President and Chief
                                             Financial Officer