10-K 1 freds10k01.txt ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended February 3, 2001 Commission File Number 000-19288 FRED'S, INC. (Exact Name of Registrant as Specified in its Charter) TENNESSEE 62-0634010 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification Number) 4300 New Getwell Road MEMPHIS, TENNESSEE 38118 (Address of Principal Executive Offices) Registrant's telephone number, including area code (901) 365-8880 Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Title of Each Class ------------------- Class A Common Stock, no par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [X]. As of April 20, 2001, there were 12,087,329 shares outstanding of the Registrant's Class A no par value voting common stock. Based on the last reported sale price of $23.50 per share on the NASDAQ Stock Market on April 20, 2001, the aggregate market value of the Registrant's Common Stock held by those persons deemed by the Registrant to be non-affiliates was $284,052,232. As of April 20, 2001, there were no shares outstanding of the Registrant's Class B no par value non-voting common stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Shareholders for the year ended February 3, 2001 are incorporated by reference into Part II, Items 5, 6, 7 and 8, and into Part IV, Item 14. Portions of the Company's Proxy Statement are incorporated by reference into Part III, Items 11, 12 and 13. Portions of the Company's Registration Statement on Form S-1 (file no. 33-45637) are incorporated as exhibits into Part IV. With the exception of those portions that are specifically incorporated herein by reference, the aforesaid documents are not to be deemed filed as part of this report. Cautionary Statement Regarding Forward-looking Information Statements, other than those based on historical facts that the Company expects or anticipates may occur in the future are forward-looking statements which are based upon a number of assumptions concerning future conditions that may ultimately prove to be inaccurate. Actual events and results may materially differ from anticipated results described in such statements. The Company's ability to achieve such results is subject to certain risks and uncertainties, including, but not limited to, economic and weather conditions which affect buying patterns of the Company's customers, changes in consumer spending and the Company's ability to anticipate buying patterns and implement appropriate inventory strategies, continued availability of capital and financing, competitive factors, changes in reimbursement practices for pharmaceuticals, governmental regulation, and other factors affecting business beyond the Company's control. Consequently, all of the forward-looking statements are qualified by these cautionary statements and there can be no assurance that the results or developments anticipated by the Company will be realized or that they will have the expected effects on the Company or its business or operations. PART I Item 1: Business General Fred's, Inc. ("Fred's" or the "Company"), founded in 1947, operates 320 discount general merchandise stores in eleven states in the southeastern United States. Fred's stores generally serve low, middle and fixed income families located in small to medium sized towns (approximately 65% of Fred's stores are in markets with populations of 15,000 or fewer people). One hundred and ninety-eight of the Company's stores have full service pharmacies. The Company also markets goods and services to 26 franchised "Fred's" stores. Fred's stores stock over 12,000 frequently purchased items which address the everyday needs of its customers, including nationally recognized brand name products, proprietary "Fred's" label products and lower priced off-brand products. Fred's management believes its customers shop Fred's stores as a result of the stores' convenient location and size, everyday low prices on key products and regularly advertised departmental promotions and seasonal specials. Fred's stores have average selling space of 14,690 square feet and had average sales of $2,440,000 in fiscal 2000. No single store accounted for more than 1.0% of sales during fiscal 2000. Business Strategy The Company's strategy is to meet the general merchandise and pharmacy needs of the small to medium sized towns it serves by offering a wider variety of quality merchandise and a more attractive price-to-value relationship than either drug stores or smaller variety/dollar stores and a shopper-friendly format which is more convenient than larger sized discount merchandise stores. The major elements of this strategy include: Wide variety of frequently purchased, basic merchandise -Fred's combines everyday basic merchandise with certain specialty items to offer its customers a wide selection of general merchandise. The selection of merchandise is supplemented by seasonal specials, private label products, and the inclusion of pharmacies in 198 of its stores. Discount prices - The Company provides value and low prices to its customers (i.e., a good "price-to-value relationship") through a coordinated discount strategy and an Everyday Low Pricing program that focuses on strong values day in and day out, while minimizing the Company's reliance on promotional activities. As part of this strategy, Fred's maintains low opening price points and competitive prices on key products across all departments, and regularly offers seasonal specials and departmental promotions supported by direct mail, television, radio and newspaper advertising. Convenient shopper-friendly environment - Fred's stores are typically located in convenient shopping and/or residential areas. Approximately 31% of the Company's stores are freestanding as opposed to being located in strip shopping center sites. Freestanding sites allow for easier access and shorter distances to the store entrance, and will be the primary site growth in the future. Fred's stores are of a manageable size and have an understandable store layout, wide aisles and fast checkouts. Expansion Strategy The Company expects that expansion will occur primarily within its present geographic area and will be focused in small to medium sized towns. The Company may also enter larger metropolitan and urban markets where it already has a market presence in the surrounding area. Fred's added a net 27 stores in 2000, and anticipates a net increase of twenty-five to thirty new stores in 2001. The Company's new store prototype has 14,000 square feet of space. Opening a new store currently costs between $320,000 and $420,000 for inventory, furniture, fixtures, equipment and leasehold improvements. The Company has 19 stand-alone Xpress locations which sell pharmaceuticals and other health and beauty related items. These locations range in size from 1,000 to 6,000 square feet, and enable the Company to enter a new market with an initial investment of under $200,000. It is the Company's intent to expand these locations into a full size Fred's location as market conditions dictate. During 2000, the Company converted two Xpress locations to full size Fred's locations and anticipates converting up to six more Xpress locations during 2001. A significant growth area for the Company has been its pharmaceuticals business. In 2000, the Company added a net 16 new pharmacies. During 2001, the Company anticipates adding at least 20 additional pharmacies. Approximately 62% of Fred's stores contain a pharmacy and sell prescription drugs. The Company's primary mechanism for adding new pharmacies is through the acquisition of prescription files from independent pharmacies. These acquisitions provide an immediate sales benefit, and in many cases, the independent pharmacist will move to Fred's, thereby providing continuity in the pharmacist-patient relationship. The following tables set forth certain information with respect to stores and pharmacies for each of the last five years:
1996 1997 1998 1999 2000 -------------------------------------------------------------------------------------------------------- Stores open at beginning of period 206 213 261 283 293 Stores opened/acquired during period 13 49 29 20 31 Stores closed during period (6) (1) (7) (10) (4) ------------------------------------------------- Stores open at end of period 213 261 283 293 320 ================================================= Number of stores with Pharmacies at End of period 101 141 180 182 198 ================================================= Square feet of selling space at end of period (in thousands) 2,828 3,362 3,680 3,966 4,353 ================================================= Average square feet of selling space per store 13,277 13,875 13,925 14,015 14,690 ================================================= Franchise stores at end of period 32 31 29 26 26 =================================================
Merchandising and Marketing The business in which the Company is engaged is highly competitive. The principal competitive factors include location of stores, price and quality of merchandise, in-stock consistency, merchandise assortment and presentation, and customer service. The Company competes for sales and store locations in varying degrees with national, regional and local retailing establishments, including department stores, discount stores, variety stores, dollar stores, discount clothing stores, drug stores, grocery stores, outlet stores, warehouse stores and other stores. Many of the largest retail merchandising companies in the nation have stores in areas in which the Company operates. Management believes that Fred's has a distinctive niche in that it offers a wider variety of merchandise at a more attractive price-to-value relationship than either a drug store or smaller variety/dollar store and is more shopper-convenient than a larger discount store. The variety and depth of merchandise offered at Fred's stores in high traffic departments, such as health and beauty aids and paper and cleaning supplies, are comparable to those of larger discount retailers. Management believes that its knowledge of regional and local consumer preferences, developed in over fifty years of operation by the Company and its predecessors, enables the Company to compete effectively in its region. Purchasing Purchasing The Company's primary non-prescription drug buying activities are directed from the corporate office by three Vice Presidents-Merchandising who are supported by a staff of 19 buyers and assistants. The buyers and assistants are participants in an incentive compensation program, which is based upon various factors primarily relating to gross margin returns on inventory controlled by each individual buyer. The Company believes that adequate alternative sources of products are available for these categories of merchandise. During 2000, all of the Company's prescription drugs were purchased individually by its pharmacies and shipped direct from a pharmaceutical wholesaler. On November 24, 1999, the Company entered into a supply agreement with Bergen Brunswig Drug Company to be Fred's new primary pharmaceutical wholesaler and to provide substantially all of the Company's prescription drugs. During 2000, approximately 30% of the Company's total purchases were made from its pharmaceutical wholesalers. Although there are alternative wholesalers that supply pharmaceutical products, the Company operates under a purchase and supply contract with one supplier as its primary wholesaler. Accordingly, the unplanned loss of this particular supplier could have a short-term gross margin impact on the Company's business until an alternative wholesaler arrangement could be implemented. Sales Mix Sales of merchandise through Company owned stores and to franchised Fred's locations are the only significant industry segment of which the Company is a part. The Company's sales mix by major category during 2000 was as follows: Pharmaceuticals..................................................32.7% Household Goods..................................................20.4% Apparel and Linens...............................................13.8% Health and Beauty Aids...........................................11.0% Food and Tobacco Products.........................................9.4% Paper and Cleaning Supplies.......................................8.3% Sales to Franchised Fred's Stores.................................4.4% The sales mix varies from store to store depending upon local consumer preferences and whether the stores include pharmacies and/or a full-line of apparel. In 2000 the average customer transaction size was approximately $15.25, and the number of customer transactions totaled approximately 48 million. The private label program, includes household cleaning supplies, health and beauty aids, disposable diapers, pet foods, paper products and a variety of beverage and other products. Private label products sold constituted approximately 5% of non-pharmaceutical sales in 2000. Private label products afford the Company higher than average gross margins while providing the customer with lower priced products that are of a quality comparable to that of competing branded products. An independent laboratory testing program is used for substantially all of the Company's private label products. The Company sells merchandise to its 26 franchised "Fred's" stores. These sales during the last three years totaled $34,281,000 in 2000, $32,850,000 in 1999,and $35,766,000 in 1998, representing 4.4%, 4.9%, and 6.0% of total revenue, respectively. Franchise and other fees earned totaled $1,806,000 in 2000, $1,761,000 in 1999,and $1,957,000 in 1998. These fees represent a reimbursement for use of the Fred's name and other administrative cost incurred on behalf of the franchised stores. The Company does not intend on expanding its franchise network, and therefore, expects that this category will continue to decrease as a percentage of the Company's total revenues. Advertising and Promotions Advertising and promotion costs represented 1.3% of net sales in 2000. The Company uses direct mail, television, radio and newspaper advertising to promote its merchandise, special promotional events and a discount retail image. During 1999, the Company eliminated the distribution of two major circulars, and now distributes thirteen major advertising circulars per year. The Company's buyers have discretion to mark down slow moving items. The Company runs regular clearances of seasonal merchandise and conducts sales and promotions of particular items. The Company also encourages its store managers to create in-store advertising displays and signage in order to increase customer traffic and impulse purchases. The store managers, with corporate approval, are permitted to tailor the price structure at their particular store to meet competitive conditions within each store's marketing area. Store Operations All Fred's stores are open six days a week (Monday through Saturday), and many stores are open seven days a week. Store hours are generally from 9:00 a.m. to 9:00 p.m.; however, certain stores are open only until 6:00 p.m. Each Fred's store is managed by a full-time store manager and those stores with a pharmacy employ a full-time pharmacist. The Company's seventeen district managers supervise the management and operation of Fred's stores. Fred's operates 198 in-store pharmacies, which offer brand name and generic pharmaceuticals and are staffed by licensed pharmacists. The addition of acquired pharmacies in the Company's stores has resulted in increased store sales and sales per selling square foot. Management believes that in-store pharmacies increase customer traffic and repeat visits and are an integral part of the store's operation. The Company has an incentive compensation plan for store managers, pharmacists and district managers based on meeting or exceeding targeted profit percentage contributions. Various factors included in determining profit percentage contribution are gross profits and controllable expenses at the store level. Management believes that this incentive compensation plan, together with the Company's store management training program, are instrumental in maximizing store performance. Inventory Control and Distribution Inventory Control The Company's computerized central management information system (known as "AURORA," which stands for Automation Utilizing Replenishment Ordering and Receiving Accuracy) maintains a daily SKU level inventory and current and historical sales information for each store and the distribution center. This system is supported by in-store point-of-sale ("POS") cash registers, which capture SKU and other data at the time of sale for daily transmission to the Company's central data processing center. Data received from the stores is used to automatically replenish frequently purchased merchandise on a weekly basis and to assist the Company's buyers in their decision making process. Distribution The Company has an 850,000 square foot centralized distribution center in Memphis, Tennessee (see "Properties" below). During 1998, the Company completed a $12 million project to modernize and automate its distribution center. This project, including implementation of a new warehouse management computer system, has increased the center's capacity sufficiently to accommodate the Company's store expansion plans for the next several years. Approximately 60% of the merchandise received by Fred's stores in 2000 was shipped through the distribution center, with the remainder (primarily pharmaceuticals, certain snack food items, greeting cards, beverages and tobacco products) being shipped directly to the stores by suppliers. For distribution, the Company uses owned and leased trailers and tractors, as well as common carriers. Seasonality The Company's business is somewhat seasonal. Generally, the highest volume of sales and net income occurs in the fourth fiscal quarter and the lowest volume occurs during the second fiscal quarter. Employees At February 3, 2001, the Company had approximately 7,620 full-time and part-time employees, comprising 725 corporate and distribution center employees and 6,895 store employees. The number of employees varies during the year, reaching a peak during the Christmas selling season. The Company's labor force is not subject to a collective bargaining agreement. Management believes it has good relationships with its employees. Item 2: Properties As of February 3, 2001, the geographical distribution of the Company's 320 locations was as follows: State Number of Stores -------------------------------------------------- Mississippi 85 Tennessee 69 Arkansas 61 Alabama 36 Louisiana 27 Georgia 25 Missouri 8 Kentucky 4 North Carolina 2 Illinois 2 Florida 1 The Company owns the real estate and the buildings for 60 locations, and owns the buildings at 5 locations which are subject to ground leases. The Company leases the remaining 255 locations from third parties pursuant to leases that provide for monthly rental payments primarily at fixed rates (although a number of leases provide for additional rent based on sales). Store locations range in size from 1,000 square feet to 27,000 square feet. Two hundred and twenty-seven of the locations are in strip centers or adjoined with a downtown-shopping district, with the remainder being freestanding. It is anticipated that existing buildings and buildings to be developed by others will be available for lease to satisfy the Company's expansion program in the near term. It is management's intention to enter into leases of relatively moderate length with renewal options, rather than entering into long-term leases. The Company will thus have maximum relocation flexibility in the future, since continued availability of existing buildings is anticipated in the Company's market areas. The Company owns its distribution center and corporate headquarters situated on a 60 acre site in Memphis, Tennessee. The site contains the distribution center with approximately 850,000 square feet of space, and 250,000 square feet of office and retail space. Presently, the Company utilizes 90,000 square feet of office space and 22,000 square feet of retail space at the site. The retail space is operated as a Fred's store and is used to test new products, merchandising ideas and technology. Item 3: Legal Proceedings The Company is party to several pending legal proceedings and claims. Although the outcome of the proceedings and claims cannot be determined with certainty, management of the Company is of the opinion that it is unlikely that these proceedings and claims will have a material effect on the results of operations, cash flows, or the financial condition of the Company. Item 4: Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended February 3, 2001. PART II Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters Information required by this item is incorporated herein by reference to Page 33 (inside back cover) of the Annual Report to Shareholders for the year ended February 3, 2001 (the "Annual Report to Shareholders"). The Company has paid cash dividends of $0.20 per share for each of the last five fiscal years. Item 6: Selected Financial Data The selected financial data for the five years ended February 3, 2001, which appears on page 10 of the Annual Report to Shareholders is incorporated herein by reference. Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of financial condition and results of operations appearing on pages 11 through 15 of the Annual Report to Shareholders is incorporated herein by reference. Item 7a: Quantitative and Qualitative Disclosure about Market Risk The Company has no holdings of derivative financial or commodity instruments as of February 3, 2001. The Company is exposed to financial market risks, including changes in interest rates. All borrowings under the Company's Revolving 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 the Company's income. All of the Company's business is transacted in U.S. dollars and, accordingly, foreign exchange rate fluctuations have never had a significant impact on the Company, and they are not expected to in the foreseeable future. Item 8: Financial Statements and Supplementary Data The consolidated financial statements appearing on pages 16 through 31 of the Annual Report to Shareholders are incorporated herein by reference. Item 9: Changes In and Disagreements With Accountants on Accounting and Financial Disclosure None. PART III Item 10: Directors and Executive Officers of the Registrant The following information is furnished with respect to each of the directors and executive officers of the Registrant:
Name Age Positions and Offices ---- --- --------------------- Michael J. Hayes(1) 59 Director, Managing Director (2), Chief Executive Officer David A. Gardner(1) 53 Director and Managing Director (2) John R. Eisenman(1) 59 Director Roger T. Knox(1) 63 Director John Reier (1) 61 President and Director Thomas H. Tashjian (1) 46 Director John A. Casey 54 Executive Vice President - Pharmacy Operations Jerry A Shore 48 Executive Vice President and Chief Financial Officer Charles S. Vail 58 Corporate Secretary, Vice President - Legal Services and General Counsel
(1) Six directors, constituting the entire Board of Directors, are to be elected at the Annual Meeting to serve one year or until their successors are elected. (2) According to the By-laws of the Company, the Managing Directors (Messrs. Hayes and Gardner) are the chief executive officers of the Company and have general supervisory responsibility for the business of the Company. Michael J. Hayes was elected a director of the Company in January 1987 and has been a Managing Director of the Company since October 1989. Mr. Hayes has been Chief Executive Officer since October 1989. He was previously employed by Oppenheimer & Company, Inc. in various capacities from 1976 to 1985, including Managing Director and Executive Vice President - Corporate Finance and Financial Services. David A. Gardner was elected a director of the Company in January 1987 and has been a Managing Director of the Company since October 1989. Mr. Gardner has been President of Gardner Capital Corporation, a real estate and venture capital investment firm since April 1980. Additionally, Mr. Gardner is a director of Organogenesis, Inc., Wynd Communications Corporation, NumeriX, LLC and Joyce International, Inc. John R. Eisenman is involved in real estate investment and development with REMAX Island Realty, Inc., located in Hilton Head Island, South Carolina. Mr. Eisenman has been engaged in commercial and industrial real estate brokerage and development since 1983. Previously, he founded and served as President of Sally's, a chain of fast food restaurants from 1976 to 1983, and prior thereto held various management positions in manufacturing and in securities brokerage. Roger T. Knox has served the Memphis Zoological Society as its President and Chief Executive Officer since January 1989. Mr. Knox was the President and Chief Operating Officer of Goldsmith's Department Stores, Inc. (a full-line department store in Memphis and Jackson, Tennessee) from 1983 to 1989 and its Chairman of the Board and Chief Executive Officer from 1987 to 1989. Prior thereto, Mr. Knox was with Foley's Department Stores in Houston, Texas for 20 years. Additionally, Mr. Knox is a Director of Hancock Fabrics, Inc. John D. Reier is President and a Director. Mr. Reier joined the Company in May of 1999 as President and was elected a director of the Company in August 2000. Prior to joining the company, Mr. Reier was President and Chief Executive Officer of Sunny's Great Outdoors Stores, Inc. from 1997 to 1999, and was President, Chief Operating Officer, Senior Vice President of Merchandising, and General Merchandise Manager at Family Dollar Stores, Inc. from 1987 to 1997. Thomas H. Tashjian was elected a director of the Company in March 2001. Mr. Tashjian is a private investor. Mr. Tashjian has served as a managing director and consumer group leader at Banc of America Montgomery Securities in San Francisco. Prior to that, Mr. Tashjian held similar positions at First Manhattan Company, Seidler Companies, and Prudential Securities. Mr. Tashjian's earlier retail operating experience was in discount retailing at the Ayrway Stores, which were acquired by Target , and in the restaurant business at Noble Roman's. John A. Casey is Executive Vice President - Pharmacy Operations. Mr. Casey joined the Company in 1979 and has served in various positions in Pharmacy Operations. Mr. Casey is a registered Pharmacist. Jerry A. Shore joined the Company in April 2000 as Executive Vice President and Chief Financial Officer. Prior to joining the Company, Mr. Shore was employed by Wang's International, a major importing and wholesale distribution company as Chief Financial Officer from 1989 to 2000, and in various financial management capacities with IPS Corp., and Caterpillar, Inc. from 1975 to 1989. Charles S. Vail has served the Company as General Counsel since 1973, as Corporate Secretary since 1975, and as Vice President - Legal since 1984. Mr. Vail joined the Company in 1968. Item 11: Executive Compensation Information regarding executive compensation is incorporated herein by reference from the information on pages 7 through 9 of the Company's Proxy Statement, which will be filed within 120 days of the registrant's fiscal year end. Item 12: Security Ownership of Certain Beneficial Owners and Management Information regarding security ownership of certain beneficial owners and management is incorporated herein by reference from pages 2 and 3 of the Company's Proxy Statement, which will be filed within 120 days of the Registrant's fiscal year end. Item 13: Certain Relationships and Related Transactions This information is incorporated herein by reference from the information under the caption "Compensation Committee Interlocks and Insider Participation" on page 11 of the Company's Proxy Statement, which will be filed within 120 days of the Registrant's fiscal year end. PART IV Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K (a)(1) Consolidated Financial Statements The following consolidated financial statements are incorporated herein by reference from pages 14 through 26 of the Annual Report to Shareholders for the year ended February 3, 2001. Report of Independent Accountants. Consolidated Statements of Income for the years ended February 3, 2001, January 29, 2000,and January 30, 1999. Consolidated Balance Sheets as of February 3, 2001, and January 29, 2000. Consolidated Statements of Changes in Shareholders' Equity for the years ended February 3, 2001, January 29, 2000,and January 30, 1999. Consolidated Statements of Cash Flows for the years ended February 3, 2001, January 29, 2000, and January 30, 1999. Notes to Consolidated Financial Statements. (a)(2) Financial Statement Schedules Report of Independent Accountants on Financial Statement Schedules for each of the three years for the period ended February 3, 2001. II Valuation and qualifying accounts (a)(3) Those exhibits required to be filed as Exhibits to this Annual Report on Form 10-K pursuant to Item 601 of Regulation S-K are as follows: 2.1 Asset Purchase Agreement between CVS Revco D.S., Inc., Fred's Stores of Tennessee, Inc., CVS Corporation and Fred's, Inc., dated as of October 10, 1997 [incorporated herein by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K dated December 1, 1997]. 2.2 Letter Agreement between CVS Revco D.S., Inc., Fred's Stores of Tennessee, Inc., CVS Corporation and Fred's, Inc. dated as of November 1, 1997 [incorporated herein by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K dated December 1, 1997]. 3.1 Certificate of Incorporation, as amended [incorporated herein by reference to Exhibit 3.1 to the Form S-1 as filed with the Securities and Exchange Commission February 7, 1992 (SEC File No. 33-45637) (the "Form S-1")]. 3.2 By-laws, as amended [incorporated herein by reference to Exhibit 3.2 to the Form S-1]. 4.1 Specimen Common Stock Certificate [incorporated herein by reference to Exhibit 4.2 to Pre-Effective Amendment No. 3 to the Form S-1]. 4.2 Preferred Share Purchase Plan [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended October 31, 1998]. 9.1 Baddour, Inc. (Registrant changed its name to "Fred's, Inc." in 1991) Shareholders Agreement dated as of June 28, 1986 [incorporated herein by reference to Exhibit C, pages C-1 through C-42 to Baddour, Inc.'s Report on Form 8-K dated July 1, 1986] 10.1 Form of Fred's, Inc. Franchise Agreement [incorporated herein by reference to Exhibit 10.8 to the Form S-1]. 10.2 401(k) Plan dated as of May 13, 1991 [incorporated herein by reference to Exhibit 10.9 to the Form S-1]. 10.3 Employee Stock Ownership Plan (ESOP) dated as of January 1, 1987 [incorporated herein by reference to Exhibit 10.10 to the Form S-1]. *10.4 Incentive Stock Option Plan dated as of December 22, 1986 [incorporated herein by reference to Exhibit 10.11 to the Form S-1]. 10.5 Lease Agreement by and between Hogan Motor Leasing, Inc. and Fred's, Inc. dated February 5, 1992 for the lease of truck tractors to Fred's, Inc. and the servicing of those vehicles and other equipment of Fred's, Inc. [incorporated herein by reference to Exhibit 10.15 to Pre-Effective Amendment No. 1 to the Form S-1]. 10.6 Revolving Loan and Credit Agreement between Fred's, Inc. and Union Planters National Bank dated as of May 15, 1992 [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended May 2, 1992]. *10.7 1993 Long Term Incentive Plan dated as of January 21, 1993 [Incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 31, 1993]. *Management Compensatory Plan 10.8 Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of May 31, 1995 (modifies the Revolving Loan and Credit Agreement included as Exhibit 10.7) [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 29, 1995]. 10.9 Second Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of July 31, 1995 (modifies the Revolving Loan and Credit Agreement included as Exhibit 10.7) [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 29, 1995]. 10.10 Seasonal Overline Revolving Credit Agreement between Fred's, Inc. and Union Planters National Bank dated as of July 23, 1996 [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended August 3, 1996]. 10.11 Addendum to Leasing Agreement and form of schedules 2 through 6 of Schedule A by and between Hogan Motor Leasing, Inc. and Fred's, Inc. dated December 19, 1996 (modifies the Lease Agreement included as Exhibit 10.6) [incorporated herein by reference to the Company's report on Form 10-K for the year ended February 1, 1997]. 10.12 Third Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of February 28, 1997 (modifies the Revolving Loan and Credit Agreement included as Exhibit 10.7) [incorporated herein by reference to the Company's report on Form 10-K for the year ended February 1, 1997]. 10.13 Term Loan Agreement between Fred's, Inc. and Union Planters National Bank dated as of May 5, 1998 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended May 2, 1998]. 10.14 Fourth Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of September 1998 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended August 1, 1998]. 10.15 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated as of February 3, 1999 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended May 1, 1999]. 10.16 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated s of May 12, 1999 [incorporated herein by reference to the Company's Report on From 10-Q for the quarter ended May 1, 1999]. 10.17 Term Loan Agreement between Fred's, Inc. and First American National Bank dated as of April 23, 1999 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended May 1, 1999]. 10.18 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated as of August 3, 1999 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended July 31, 1999]. 10.19 Prime Vendor Agreement between Fred's Stores of Tennessee, Inc. and Bergen Brunswig Drug Company, dated as of November 24, 1999 [incorporated herein by reference to Company's Report on Form 10-Q for the quarter ended October 31, 1999]. 10.20 Addendum to Leasing Agreement and Form of Schedules 7 through 8 of Schedule A, by and between Hogan Motor Leasing, Inc. and Fred's, Inc dated September 20, 1999 (modifies the Lease Agreement included as Exhibit 10.6) [incorporated herein by reference to the Company's report on Form 10-K for the year ended January 29, 2000]. 10.21 Revolving Loan Agreement between Fred's, Inc. and Union Planters Bank, NA and Suntrust Bank dated April 3, 2000 [incorporated herein by reference to the Company's report on form 10-K for year ended January 29, 2000]. 10.22 Loan modification agreement dated May 26, 2000 (modifies the Revolving Loan Agreement included as Exhibit 10.23) [Incorporated herein by reference to the Company's report on Form 10-K for the year ended January 29, 2000]. 10.23 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated as of October 11, 2000 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended October 28, 2000]. **13.1 Annual report to shareholders for the year ended February 3, 2001 (to the extent incorporated herein by reference). **21.1 Subsidiaries of Registrant **23.1 Consent of PricewaterhouseCoopers LLP (b) Reports on Form 8-K Current report on Form 8-K dated March 19, 2001 (filed on March 29, 2001) reporting under item 5 of Form 8-K, other events, information related to the Company's announcing the appointment of Thomas H. Tashjian to its Board of Directors. ** Filed herewith Report of Independent Accountants on Financial Statement Schedules Our audits of the consolidated financial statements referred to in our report dated April 4, 2001 in the 2000 Annual Report to Shareholders of Fred's, Inc. and subsidiaries (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP Memphis,Tennessee April 4, 2001
Schedule II - Valuation and Qualifying Accounts Balance at Charged to Balance at Beginning Costs and Deductions End of Period Expenses Write-offs of Period Allowance for doubtful Accounts: Year ended January 30, 1999 766 124 (246) 644 Year ended January 29, 2000 644 80 (272) 452 Year ended February 3, 2001 452 194 (130) 516
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on this 20th day of April, 2001. FRED'S, INC. By: /s/ Michael J. Hayes -------------------- Michael J. Hayes, Chief Executive Officer By: /s/ Jerry A. Shore ------------------ Jerry A. Shore, Executive Vice President and Chief Financial Officer (Principal Accounting and Financial Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 20th day of April, 2001. Signature Title /s/ Michael J. Hayes Director, Managing Director, -------------------------- Michael J. Hayes Chief Executive Officer, President /s/ David A. Gardner Director and Managing Director -------------------------- David A. Gardner /s/ Roger T. Knox Director -------------------------- Roger T. Knox /s/ John R. Eisenman Director -------------------------- John R. Eisenman /s/ John D. Reier Director -------------------------- John D. Reier /s/ Thomas H. Tashjian Director -------------------------- Thomas H. Tashjian EXHIBIT 13.1 ------------ Selected Financial Data (dollars in thousands, except per share amounts)
2000(1) 1999 1998(2) 1997 1996 ------- ---- ------- ---- ---- Statement of Income Data: Net sales $781,249 $665,777 $600,902 $492,236 $418,297 Operating income 25,720 18,943 14,711 15,511 6,779(3) Income before income taxes 22,494 16,439 13,605 15,660 6,508 Provision for income taxes 7,645 5,737 4,775 5,873 702 Net income 14,849 10,702 8,830 9,787 5,806 Net income per share: Basic 1.24 .90 .75 .84 .50 Diluted 1.22 .89 .73 .83 .50 Selected Operating Data: Operating income as a percentage of sales 3.3% 2.9% 2.4% 3.2% 1.6%(3) Increase in comparable store sales (4) 9.2%(5) 5.2% 5.6% 8.3% 2.2% Stores open at end of period 320 293 283 261 213 Balance Sheet Data (at period end): Total assets $254,795 $240,222 $220,757 $195,407 $161,148 Short-term debt (including capital leases) 2,678 30,736 11,914 214 1,641 Long-term debt (including capital leases) 31,705 11,761 11,821 1,368 138 Shareholders' equity 159,687 145,913 136,983 129,359 119,579
(1) Results for 2000 include 53 weeks. (2) Results for 1998 include the effect of the 1998 adoption of LIFO for pharmacy inventories. (3) After $3,289 of restructuring and other charges. (4) A store is first included in the comparable store sales calculation after the end of the twelfth month following the store's grand opening month. (5) The increase in comparable store sales for 2000 is computed on the same 53 week period for 1999. -10- Management's Discussion and Analysis Fiscal 2000 Compared to Fiscal 1999 Sales Net sales increased 17.3% ($115 million) in 2000. Approximately $57 million of the increase was attributable to the addition of 31 new or upgraded stores, and 16 pharmacies during 2000, together with the sales of 20 store locations and 2 pharmacies that were opened or upgraded during 1999 and contributed a full year of sales in 2000. During 2000, the Company also closed 4 store locations. Comparable store sales based on a 53-week comparison, consisting of sales from stores that have been open for more than one year, increased 9.2% in 2000. The Company's front store (non-pharmacy) sales increased approximately 15% over 1999 front store sales. Front store sales growth benefited from the above mentioned store additions, and solid performances in categories such as home furnishings, floor coverings, bath, small appliances, giftware, ladies intimate, ladies accessories, men's and boy's apparel, ethnic products, beverages, food and snacks, and tobacco. Lawn and garden sales decreased due to reduced emphasis of large lawn and garden equipment that carried lower margins and required additional labor outside the stores. Fred's pharmacy sales grew to 33% of total sales in 2000 from 31% of total sales in 1999 and continues to rank as the largest sales category within the Company. The total sales in this department, including the Company's mail order operation, increased 25% over 1999, with third party prescription sales representing approximately 83% of total pharmacy sales, compared with 77% of total pharmacy sales in 1999. The Company's pharmacy sales growth continued to benefit from an ongoing program of purchasing prescription files from independent pharmacies, the addition of pharmacy departments in existing store locations, and inflation caused by drug manufacturer increases. Sales to Fred's 26 franchised locations increased approximately $1 million in 2000 and represented 4% of the Company's total sales, as compared to 5% in 1999. It is anticipated that this category of business will decline as a percentage of total Company sales since the Company has not added and does not intend to add any additional franchisees. Gross Margin Gross margin as a percentage of sales was 27.5% in 2000 compared to 28.2% in 1999. The decrease in gross margin is primarily attributed to the changes in sales mix and promotional activities to increase customer traffic. -11- Selling, General and Administrative Expenses Selling, general and administrative expenses were 24.2% of net sales in 2000 compared with 25.3% of net sales in 1999. Labor expenses improved in the stores and pharmacies as a result of the strong sales coupled with store productivity initiatives. Advertising expense improved as a percentage of sales by reducing the cost of advertising circulars while maintaining the same number of circulars issued during the year. Other expenses such as store supplies and distribution center equipment rental also improved as a result of cost control efforts. Operating Income Operating income increased approximately $6.8 million or 35.8% to $25.7 million in 2000 from $18.9 million in 1999. Operating income as a percentage of sales increased to 3.3% in 2000 from 2.9% in 1999, due to the above-mentioned reasons. Interest Expense, Net Interest expense for 2000 totaled $3.2 million compared to net interest expense of $2.5 million in 1999. The interest expense for 2000 reflects higher average revolver borrowings for inventory purchases, caused by significantly improved in-stock positions over 1999 and inventory for the new stores opened throughout the year. Higher interest rates during 2000 were also a factor in the higher expense. Income Taxes The effective income tax rate decreased to 34.0% in 2000 from 34.9% in 1999, due to changes made in the Company's organizational structure during the fourth quarter of 1998 and the implementation of a federal program to generate employment related tax credits, which resulted in a reduction in the Company's liability for taxes. At February 3, 2001, the Company had certain net operating loss carryforwards which were acquired in reorganizations and certain purchase transactions and are available to reduce income taxes, subject to usage limitations. These carryforwards total approximately $43.8 million for state income tax purposes, which expire during the period 2002 through 2022. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of carryforwards which can be utilized. Net Income Net income for 2000 was $14.8 million (or $1.22 per diluted share) or approximately 39% higher than the $10.7 million (or $.89 per diluted share) reported in 1999. -12- Fiscal 1999 Compared to Fiscal 1998 (No change from last year's annual report) Liquidity and Capital Resources Fred's primary sources of working capital are cash flow from operations and borrowings under its current facility. The Company had working capital of $110.5 million, $79.7 million and $72.8 million at year end 2000, 1999 and 1998, respectively. Working capital fluctuates in relation to profitability, seasonal inventory levels, net of trade accounts payable, and the level of store openings and closings. On April 3, 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement to replace the existing $15 million unsecured revolving credit commitment that has generally been used to finance inventory levels at specified periods. The expanded credit capacity is necessary to accommodate the Company's continued growth and shifting seasonal inventory needs. This $40 million credit commitment was supplemented with a $5 million seasonal overline, for a total revolving borrowing capacity of $45 million. The credit commitment expires on April 3, 2003 and bears interest at 1.5% below prime rate or a LIBOR-based rate (weighted average interest rate of 7.4% on 2000 outstanding borrowings). All other provisions of the new agreement are essentially the same as the prior agreement. At February 3, 2001, approximately $22.6 million of inventories were financed with outstanding borrowings under the Company's revolver. The reduction in borrowings from the prior year results from the Company's focus on inventory management and the accelerated payment made in the prior year as explained below. At January 29, 2000, approximately $28.2 million of inventories were financed with outstanding borrowings under the Company's revolver. Higher year-end revolver borrowings resulted from significantly improved in-stock positions compared to 1998, duplicate inventories in several re-merchandised inventory categories, and the accelerated repayment of approximately $7.5 million in accounts payable, originally due in February, as a result of a change made in the Company's pharmacy drug wholesaler in December 1999. In May 1998, the Company entered into a seven-year unsecured term loan of $12 million to finance the modernization and automation of the Company's distribution center and corporate facilities. The Loan Agreement bears interest of 6.82% per annum and matures on November 1, 2005. At year-end 2000, the outstanding principal balance on the term loan was approximately $8.8 million compared with $10.3 million at year-end 1999. In April 1999, the Company entered into a four-year unsecured term loan of $2.3 million to finance the replacement of the Company's mainframe computer system. The Loan Agreement bears interest at 6.15% per annum and matures on April 15, 2003. At year-end 2000, the outstanding principal balance on the term loan was approximately $1.3 million compared with $1.8 million at year-end 1999. Cash provided by operations was $27.1 million in 2000 compared to cash used in operations of ($.8) million in 1999 and cash provided by operations of $.7 million in 1998. Year-end 2000 inventory levels were better managed to improve turnover and reduce duplicate inventories in several product categories. Also, income taxes payable increased as a result of tax strategies put in place in prior years that had a favorable effect in 2000. Year-end 1999 inventory levels were impacted by improved in-stock positions and duplicate inventories compared to 1998, and accounts payable were impacted by the accelerated repayment of $7.5 million of payables. Year-end 1998 accounts payable levels were adversely impacted as a result of merchandise processing delays, and were supplemented with short-term borrowings at year-end. -14- Capital expenditures in 2000 totaled $15.8 million compared with $14.0 million in 1999 and $21.3 million in 1998. The 2000 capital expenditures included approximately $12.2 million of expenditures associated with upgraded or new stores and pharmacies. Approximately $3.6 million in expenditures related to technology upgrades, distribution center equipment, freight equipment, and capital maintenance. The 1999 capital expenditures included approximately $2.3 million of expenditures associated with replacement of the Company's mainframe computer system, and approximately $11.7 million of expenditures associated with new stores and pharmacies, store and pharmacy upgrades, distribution center equipment and annual capital maintenance. The 1998 capital expenditures included $12.0 million of expenditures associated with the Company's modernization and automation of its distribution center, $4.7 million of expenditures associated with new stores and pharmacies, and $4.6 million for store and pharmacy upgrades and annual capital maintenance. Cash used for investing activities also includes $2.8 million in 2000, $.8 million in 1999, and $2.0 million in 1998 for the acquisition of customer lists and other pharmacy related items. The Company believes that sufficient capital resources are available in both the short-term and long-term through currently available cash, cash generated from future operations and, if necessary, the ability to obtain additional financing. Recent Accounting Pronouncements In June 1999, the FASB issued SFAS no. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the effective date of FASB Statement No. 133, which deferred the effective date provisions of SFAS No. 133 for the company to the first quarter of 2001. The Company does not believe this new standard will have an impact on its financial statements since it currently has no derivative instruments. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 identifies various revenue recognition issues, several of which are common within the retail industry including treatment of revenue recognition on layaway sales. In the fourth quarter of 2000, the Company revised its revenue recognition for layaway sales to defer revenue recognition until all terms of the sale have been satisfied and the customer takes delivery of the merchandise. Under the prior method of accounting, net sales were recognized at the time the customer put the merchandise into layaway. The effects of this change on prior quarters in 2000 and the proforma effects on 1999 are reflected in Note 12. The effects of this change on the fourth quarter of 2000 was an increase in net sales, gross profit, net income and net income per share (basic and diluted) of $1,932, $482, $318 and $.02 respectively. Annual financial results were not affected. Cautionary Statement Regarding Forward-looking Information Statements, other than those based on historical facts that the Company expects or anticipates may occur in the future are forward-looking statements which are based upon a number of assumptions concerning future conditions that may ultimately prove to be inaccurate. Actual events and results may materially differ from anticipated results described in such statements. The Company's ability to achieve such results is subject to certain risks and uncertainties, including, but not limited to, economic and weather conditions which affect buying patterns of the Company's customers, changes in consumer spending and the Company's ability to anticipate buying patterns and implement appropriate inventory strategies, continued availability of capital and financing, competitive factors, changes in reimbursement practices for pharmaceuticals, governmental regulation, and other factors affecting business beyond the Company's control. Consequently, all of the forward-looking statements are qualified by these cautionary statements and there can be no assurance that the results or developments anticipated by the Company will be realized or that they will have the expected effects on the Company or its business or operations. -15- Fred's, Inc. Consolidated Statements of Income (in thousands, except share and per share amounts)
For the Years Ended ----------------------------------------------- February 3, January 29, January 30, 2001 2000 1999 --------- ----------- --------- Net sales $ 781,249 $ 665,777 $ 600,902 Cost of goods sold 566,115 478,138 436,523 --------- ----------- --------- Gross profit 215,134 187,639 164,379 Selling, general and administrative expenses 189,414 168,696 149,668 --------- ----------- --------- Operating income 25,720 18,943 14,711 Interest expense, net 3,226 2,504 1,106 --------- ----------- --------- Income before taxes 22,494 16,439 13,605 Income taxes 7,645 5,737 4,775 --------- ----------- --------- Net income $ 14,849 $ 10,702 $ 8,830 ========= =========== ========= Net income per share Basic $ 1.24 $ .90 $ .75 =========== =========== ============= Diluted $ 1.22 $ .89 $ .73 =========== =========== ============= Weighted average shares outstanding Basic 11,937 11,827 11,798 =========== =========== ============= Diluted 12,197 12,072 12,078 =========== =========== =============
See accompanying notes to consolidated financial statements. -16- Fred's, Inc. Consolidated Balance Sheets (in thousands, except for number of shares) --------------------------------------------------------------------------------
February 3, January 29, 2001 2000 ---- ---- ASSETS Current assets: Cash and cash equivalents $ 2,569 $ 3,036 Receivables, less allowance for doubtful accounts of $516 ($452 at January 29, 2000) 15,430 10,911 Inventories 149,602 141,612 Deferred income taxes 2,022 3,002 Other current assets 2,306 1,865 ------------ ------------- Total current assets 171,929 160,426 Property and equipment, at depreciated cost 76,360 73,459 Equipment under capital leases, less accumulated amortization of $1,305 ($856 at January 29, 2000) 1,387 1,835 Deferred income taxes 98 866 Other noncurrent assets, net 5,021 3,636 ------------ ------------- Total assets $ 254,795 $ 240,222 ============ ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 40,432 $ 39,653 Current portion of indebtedness 2,175 30,306 Current portion of capital lease obligations 503 430 Accrued liabilities 14,012 9,680 Income taxes payable 4,278 650 ------------ ------------- Total current liabilities 61,400 80,719 Long-term portion of indebtedness 30,475 10,027 Capital lease obligations 1,230 1,734 Other noncurrent liabilities 2,003 1,829 ------------ ------------- Total liabilities 95,108 94,309 ------------ ------------- Commitments and contingencies (Notes 6 and 10) Shareholders' equity: Common stock, Class A voting, no par value, 12,068,518 shares issued and outstanding (11,988,276 shares at January 29, 2000) 68,557 67,326 Retained earnings 91,342 78,902 Deferred compensation on restricted stock incentive plan (212) (315) ------------ ------------- Total shareholders' equity 159,687 145,913 ------------ ------------- $ 254,795 $ 240,222 ============ =============
See accompanying notes to consolidated financial statements. -17- Fred's, Inc. Consolidated Statements of Changes in Shareholders' Equity (in thousands, except share data)
Common Stock Retained Deferred --------------------------- Shares Amount Earnings Compensation Total ------ ------ -------- ------------ ----- Balance, January 31, 1998 11,866,789 $65,700 $ 64,147 $ (488) $ 129,359 Cash dividends paid ($.20 per share) (2,381) (2,381) Repurchase of shares (30) - Issuance of restricted stock 46,182 752 (362) 390 Cancellation of restricted stock (5,500) (38) 38 - Exercises of stock options 39,331 329 329 Amortization of deferred compensation on restricted stock incentive plan 248 248 Tax benefit on exercise of stock options 208 208 Net income 8,830 8,830 ---------- ------- --------- ----------- ----------- Balance, January 30, 1999 11,946,772 $66,951 $ 70,596 $ (564) $ 136,983 Cash dividends paid ($.20 per share) (2,396) (2,396) Issuance of restricted stock 9,900 124 (124) Cancellation of restricted stock (5,700) (118) 118 Other issuances 1,714 30 30 Exercises of stock options 35,590 296 296 Amortization of deferred compensation on restricted stock incentive plan 255 255 Tax benefit on exercise of stock options 43 43 Net income 10,702 10,702 ---------- ------- --------- ----------- ----------- Balance, January 29, 2000 11,988,276 $67,326 $ 78,902 $ (315) $ 145,913 Cash dividends paid ($.20 per share) (2,409) (2,406) Issuance of restricted stock 3,800 57 (57) Cancellation of restricted stock (29,072) (218) 15 (203) Exercises of stock options 105,514 1,079 1,079 Amortization of deferred compensation on restricted stock incentive plan 145 145 Tax benefit on exercise of stock options 313 313 Net income 14,849 14,849 ---------- ------- --------- ----------- ----------- Balance, February 3, 2001 12,068,518 $68,557 $ 91,342 $ (212) $ 159,690 ========== ======= ========= =========== ===========
See accompanying notes to consolidated financial statements. -18- Fred's, Inc. Consolidated Statements of Cash Flows (in thousands)
For the Years Ended February 3, January 29, January 30, 2001 2000 1999 ------- ------- ------- Cash flows from operating activities: Net income $14,849 $10,702 $ 8,830 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization 14,277 11,830 8,939 Provision for uncollectible receivables 64 80 124 LIFO Reserve 753 100 3,108 Deferred income taxes 1,747 2,513 2,344 Amortization of deferred compensation on restricted stock incentive plan 145 255 248 Issuance (net of cancellation) of restricted stock (203) - 390 Tax benefit upon exercise of stock options 313 43 208 Gain on sale of fixed assets - (41) - (Increase) decrease in assets: Receivables (4,583) (2,060) (1,969) Inventories (8,743) (15,135) (14,664) Other assets (444) (847) (2,354) Increase (decrease) in liabilities: Accounts payable and accrued liabilities 5,110 (8,210) (3,712) Income taxes payable 3,628 (176) (890) Other noncurrent liabilities 174 159 175 ------- ------- ------- Net cash (used in) provided by operating activities 27,087 (787) 777 ======= ======= ======= Cash flows from investing activities: Capital expenditures (15,801) (14,043) (21,273) Proceeds from dispositions of property and equipment 493 215 - Asset acquisition, net of cash acquired (primarily intangibles) (2,807) (805) (1,993) ------- ------- ------- Net cash used in investing activities (18,115) (14,633) (23,266) ======= ======= ======= Cash flows from financing activities: Reduction of indebtedness and capital lease obligations (2,495) (2,139) (556) Proceeds from revolving line of credit, net of payments (5,617) 18,040 10,200 Proceeds from term loan - 2,249 12,000 Proceeds from exercise of options 1,079 296 329 Payment of cash for dividends and fractional shares (2,406) (2,396) (2,381) ------- ------- ------- Net cash provided by (used in) financing activities (9,439) 16,050 19,592 ======= ======= ======= Increase (decrease) in cash and cash equivalents (467) 630 (2,897) Cash and cash equivalents: Beginning of year 3,036 2,406 5,303 ------- ------- ------- End of year $ 2,569 $ 3,036 $ 2,406 ======= ======= ======= Supplemental disclosures of cash flow information: Interest paid $ 3,332 $ 2,399 $ 1,239 Income taxes paid $ 2,000 $ 3,810 $ 2,828 Non cash investing and financing activities: Assets acquired through capital lease obligations $ - $ 612 $ 509 Common stock issued for acquisition $ - $ 30 $ -
See accompanying notes to consolidated financial statements. -19- Fred's, Inc. Notes to Consolidated Financial Statements NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description of business. The primary business of Fred's, Inc. and subsidiaries (the "Company") is the sale of general merchandise through its 320 retail discount stores located in the southeastern United States. In addition, the Company sells general merchandise to its 26 franchisees. Consolidated financial statements. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions are eliminated. Fiscal year. The Company utilizes a 52 - 53 week accounting period which ends on the Saturday closest to January 31. Fiscal years 2000, 1999 and 1998, as used herein, refer to the years ended February 3, 2001, January 29, 2000, and January 30, 1999, respectively. Use of estimates. The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Inventories. Wholesale 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. For pharmacy inventories, which comprise approximately 19% and 18% of the retail inventories at February 3, 2001 and January 29, 2000, respectively, cost was determined using the LIFO (last-in, first-out) method. The current cost of inventories exceeded the LIFO cost by approximately $3,961,000 at February 3, 2001 and $3,208,000 at January 29, 2000. Property and equipment. Buildings, furniture, fixtures and equipment are stated at cost and depreciation is computed using the straight-line method over their estimated useful lives. Leasehold costs and improvements are amortized over the lesser of their estimated useful lives or the remaining lease terms. Average useful lives are as follows: buildings and improvements - 8 to 30 years; furniture and fixtures - 5 to 10 years; and equipment - 3 to 10 years. Amortization on equipment under capital leases is computed on a straight-line basis over the terms of the leases. Gains or losses on the sale of assets are recorded at disposal. Long lived assets. The Company's policy is to review the recoverability of all long-lived assets annually and whenever events or changes indicate that the carrying amount of an asset may not be recoverable. Based upon the Company's review as of February 3, 2001 and January 29, 2000, no material adjustments to the carrying value of such assets were necessary. Selling, general and administrative expenses. The Company includes buying, warehousing, transportation and occupancy costs in selling, general and administrative expenses. Advertising. The Company charges advertising, including production costs, to expense on the first day of the advertising period. Advertising expense for 2000, 1999, and 1998 was $10,166,000, $8,926,000, and $9,621,000 respectively. Preopening costs. The Company charges to expense the preopening costs of new stores as incurred. These costs are primarily labor to stock the store, preopening advertising, store supplies and other expendable items. Revenue Recognition. The Company markets goods and services through Company owned stores and 26 franchised stores. Net sales includes sales of merchandise from Company owned stores, net of returns and exclusive of sales taxes. Sales to franchised stores are recorded when the merchandise is shipped from the Company's warehouse. Revenues resulting from layaway sales are recorded upon delivery of the merchandise to the customer. In addition, the Company charges the franchised stores a fee based on a percentage of their purchases from the Company. These fees represent a reimbursement for use of the Fred's name and other administrative costs incurred on behalf of the franchised stores. Total franchise income for 2000, 1999 and 1998 was $1,809,000, $1,761,000 and $1,957,000 respectively. -20- Other intangible assets. Other identifiable intangible assets which are included in other noncurrent assets primarily represent amounts associated with acquired pharmacies and are being amortized on a straight line basis over five years. These intangibles, net of accumulated amortization, totaled $4,945,000 at February 3, 2001, and $3,559,000 at January 29, 2000. Accumulated amortization for 2000 and 1999 totaled $3,964,000 and $2,543,000, respectively. Amortization expense for 2000, 1999 and 1998 was $1,421,000, $1,307,000 and $1,214,000 respectively. Cash and cash equivalents. Cash on hand and in banks, together with other highly liquid investments having original maturities of three months or less, are classified as cash equivalents. Included in accounts payable are outstanding checks in excess of funds on deposit which totaled $5,823,000 at February 3, 2001 and $14,089,000 at January 29, 2000. Financial instruments. At February 3, 2001, the Company did not have any outstanding derivative instruments. The recorded value of the Company's financial instruments, which include cash and cash equivalents, receivables, accounts payable and indebtedness, approximates fair value. The following methods and assumptions were used to estimate fair value of each class of financial instrument: (1) the carrying amounts of current assets and liabilities approximate fair value because of the short maturity of those instruments and (2) the fair value of the Company's indebtedness is estimated based on the current borrowing rates available to the Company for bank loans with similar terms and average maturities. Business segments. The Company's only reportable operating segment is its sale of merchandise through its Company owned stores and to franchised Fred's locations, which are organized around the products sold and markets served. Comprehensive income. Comprehensive income does not differ from the consolidated net income presented in the consolidated statements of income. Reclassifications. Certain prior year amounts have been reclassified to conform to the 2000 presentation. Recent Accounting Pronouncements. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 identifies various revenue recognition issues, several of which are common within the retail industry including treatment of revenue recognition on layaway sales. In the fourth quarter of 2000, the Company revised its revenue recognition for layaway sales to defer revenue recognition until all terms of the sale have been satisfied and the customer takes delivery of the merchandise. Under the prior method of accounting, net sales were recognized at the time the customer put the merchandise into layaway. The effects of this change on prior quarters in 2000 and the proforma effects on 1999 are reflected in Note 12. The effects of this change on the fourth quarter of 2000 was an increase in net sales, gross profit, net income and net income per share (basic and diluted) of $1,932, $482, $318 and $.02 respectively. Annual financial results were not affected. In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the effective date of FASB Statement No. 133, which deferred the effective date provisions of SFAS No. 133 for the company to the first quarter of 2001. The Company does not believe this new standard will have an impact on its financial statements since it currently has no derivative instruments. -21- NOTE 2 - PROPERTY AND EQUIPMENT Property and equipment, at cost, consist of the following (in thousands):
2000 1999 ------------------ ------------------- Buildings and improvements $ 67,068 $ 65,660 Furniture, fixtures and equipment 89,152 81,424 ------------------ ------------------- 156,220 147,084 Less accumulated depreciation and amortization (84,100) (78,018) ------------------ ------------------- 72,120 69,066 Land 4,240 4,393 ------------------ ------------------- $ 76,360 $ 73,459 ------------------ -------------------
Depreciation expense totaled $12,407,000, $10,168,000 and $7,442,000 for 2000, 1999 and 1998, respectively. NOTE 3 - ACCRUED LIABILITIES The components of accrued liabilities are as follows (in thousands):
2000 1999 ------------------ ------------------- Payroll and benefits $ 5,136 $ 2,992 Sales and use taxes 2,000 1,726 Insurance 2,497 2,904 Other 4,379 2,058 ------------------ ------------------- $ 14,012 $ 9,680 ------------------ -------------------
NOTE 4 - INDEBTEDNESS On April 3, 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement (the "Agreement") to replace the May 15, 1992 Revolving Loan and Credit Agreement, as amended. The Agreement provides the Company with an unsecured revolving line of credit commitment of up to $40 million and bears interest at 1.5% below prime rate or a LIBOR-based rate. Under the most restrictive covenants of the Agreement, the Company is required to maintain specified shareholders' equity and net income levels. The Company is required to pay a commitment fee to the bank at a rate per annum equal to .18% on the unutilized portion of the revolving line commitment over the term of the Agreement. The term of the Agreement extends to April 3, 2003. There were $22,623,000 and $28,240,000 of borrowings outstanding under the Agreement at February 3, 2001 and January 29, 2000, respectively. On April 23, 1999, the Company and a bank entered into a Loan Agreement (the "Loan Agreement"). The Loan Agreement provided the Company with a four-year unsecured term loan of $2.3 million to finance the replacement of the Company's mainframe computer system. The Loan Agreement bears interest of 6.15% per annum and matures on April 15, 2003. Under the most restrictive covenants of the Loan Agreement, the Company is required to maintain specified debt service levels. There were $1,265,500 and $1,828,000 borrowings outstanding under the Agreement at February 3, 2001 and January 29, 2000, respectively. The principal maturity under this Agreement for debt outstanding at February 3, 2001 is as follows: $562,500 in fiscal 2001; $562,500 in fiscal 2002 and $140,500 in fiscal 2003. -22- On May 5, 1998, the Company and a bank entered into a Loan Agreement (the "Term Loan Agreement"). The Term Loan Agreement provided the Company with an unsecured term loan of $12 million to finance the modernization and automation of the Company's distribution center and corporate facilities. The Term Loan Agreement bears interest of 6.82% per annum and matures on November 1, 2005. Under the most restrictive covenants of the Term Loan Agreement, the Company is required to maintain specified shareholders' equity and net income levels. Borrowings outstanding under this Term Loan Agreement totaled $8,762,000 at February 3, 2001 and $10,265,000 at January 29, 2000. The principal maturity under this Agreement for debt outstanding at February 3, 2001 is as follows: $1,612,742 in fiscal 2001; $1,727,860 in fiscal 2002; $1,851,199 in fiscal 2003; $1,983,338 in fiscal 2004 and $1,586,503 in fiscal 2005. Interest expense for 2000, 1999 and 1998 totaled $3,226,000, $2,504,000 and $1,206,000, respectively. NOTE 5 - INCOME TAXES Deferred income taxes are provided for the tax effects of temporary differences between the financial reporting basis and income tax basis of the Company's assets and liabilities. The provision for income taxes consists of the following (in thousands):
2000 1999 1998 --------------- ---------------- --------------- Current Federal $5,597 $3,224 $2,639 State - - (208) --------------- ---------------- --------------- 5,597 3,224 2,431 --------------- ---------------- --------------- Deferred Federal 1,423 2,116 1,974 State 324 397 370 --------------- ---------------- --------------- 1,747 2,513 2,344 --------------- ---------------- --------------- $7,344 $5,737 $4,775 --------------- ---------------- ---------------
-23- Deferred tax assets (liabilities) are comprised of the following(in thousands):
2000 1999 ---------------- --------------- Current deferred tax assets: Inventory valuation methods $ (465) $ 758 Accrual for inventory shrinkage 768 672 Allowance for doubtful accounts 310 285 Insurance accruals 1,200 990 Other 654 749 ---------------- --------------- Gross current deferred tax assets 2,467 3,454 Deferred tax asset valuation allowance (289) (182) ---------------- --------------- 2,178 3,272 Current deferred tax liabilities (156) (270) ---------------- --------------- Net current deferred tax asset $ 2,022 $ 3,002 ---------------- --------------- Noncurrent deferred tax assets: Net operating loss carryforwards $ 1,685 $ 1,421 Postretirement benefits other than pensions 760 694 Restructuring costs 82 82 Other 1,769 1,583 ---------------- --------------- Gross noncurrent deferred tax assets 4,296 3,780 Deferred tax asset valuation allowance (1,267) (1,239) ---------------- --------------- 3,029 2,541 Noncurrent deferred tax liabilities: Depreciation (2,904) (1,648) Other (27) (27) ---------------- --------------- Gross noncurrent deferred tax liabilities (2,931) (1,675) ---------------- --------------- Net noncurrent deferred tax asset $ 98 $ 866 ---------------- ---------------
The ultimate realization of these assets is dependent upon the generation of future taxable income sufficient to offset the related deductions and loss carryforwards within the applicable carryforward periods as described below. The valuation allowance is based upon management's conclusion that certain tax carryforward items will expire unused. During 2000 and 1999, the valuation allowance increased $264,000 and $393,000, respectively, as the result of the company generating additional net operating loss carryforwards in certain states. At February 3, 2001, the Company has certain net operating loss carryforwards which were acquired in reorganizations and purchase transactions which are available to reduce income taxes, subject to usage limitations. These carryforwards total approximately $43,784,000 for state income tax purposes, and expire at various times during the period 2002 through 2022. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of carryforwards which can be utilized. A reconciliation of the statutory Federal income tax rate to the effective tax rate is as follows:
2000 1999 1998 ----------------- ----------------- ------------- Income tax provision at statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit 0.9 1.6 0.8 Change in valuation allowance - - 0.7 Surtax Exemptions (1.0) (1.0) (1.0) Other (0.9) (0.7) (0.4) ----------------- ----------------- ------------- 34.0% 34.9% 35.1% ----------------- ----------------- -------------
-24- NOTE 6 - LONG-TERM LEASES The Company leases certain of its store locations under noncancelable operating leases expiring at various dates through 2031. Many of these leases contain renewal options and require the Company to pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased properties. In addition, the Company leases various equipment under noncancelable operating leases and certain transportation equipment under capital leases. Total rent expense under operating leases was $17,465,000, $15,329,000 and $13,618,000 for 2000, 1999 and 1998, respectively. Amortization expense on assets under capital lease for 2000, 1999 and 1998 was $449,000, $355,000 and $283,000, respectively. Future minimum rental payments under all operating and capital leases as of February 3, 2001 are as follows:
Operating Capital Leases Leases -------------------------------------------------------------------------------------------------------------------------- 2001 $ 16,055 $ 741 2002 14,189 741 2003 11,505 364 2004 8,491 255 2005 6,121 142 Thereafter 11,426 0 ------------------ ----------------- Total minimum lease payments $ 67,787 2,243 ================== Imputed interest (510) ----------------- Present value of net minimum lease payments, including $503 classified as current portion of capital lease obligations $ 1,733 =================
NOTE 7 - SHAREHOLDERS' EQUITY The Company has 30 million shares of Class A voting common stock authorized. The Company's authorized capital also consists of 11.5 million shares of Class B nonvoting common stock, of which no shares have been issued. In addition, the Company has authorized 10 million shares of preferred stock, of which no shares have been issued. Effective October 12, 1998 the Company adopted a Shareholders Rights Plan which granted a dividend of one preferred share purchase right ("the Right") for each common share outstanding at that date. Each Right represents the right to purchase one-hundredth of a preferred share of stock at a preset price to be exercised when any one individual, firm, corporation or other entity acquires 15% or more of the Company's common stock. The Rights will become dilutive at the time of exercise and will expire, if unexercised, on October 12, 2008. NOTE 8 - EMPLOYEE BENEFIT PLANS Incentive stock option plan. The Company has a long-term incentive plan under which an aggregate of 1,168,750 shares may be granted. These options expire five years from the date of grant. Options outstanding at February 3, 2001 expire in 2001 through 2005. -25- A summary of activity in the plan follows:
2000 1999 1998 --------------------- -------------------- ------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price ------- ----- ------- ----- ------- ----- Outstanding at beginning of year 563,454 $ 13.13 490,139 $ 13.40 411,298 $8.55 Granted 345,507 15.04 136,750 11.82 150,695 25.61 Canceled (140,825) 11.02 (26,101) 14.79 (32,523) 12.46 Expired - (1,744) 11.33 - - Exercised (105,514) 8.67 (35,590) 8.38 (39,331) 8.42 -------- ------- ------- Outstanding at end of year 662,622 15.29 563,454 13.13 490,139 13.40 ======= ======= ======= Exercisable at end of year 154,065 10.62 169,313 9.10 152,483 9.85 ======= ======= =======
The weighted average remaining contractual life of all outstanding options was 3.2 years at February 3, 2001. The following table summarizes information about stock options outstanding at February 3, 2001:
Options Outstanding Options Exercisable ----------------------------------------------- ------------------------------- Weighted Average Remaining Weighted Weighted Number Contractual Average Number Average Range of Outstanding at Life Exercise Exercisable at Exercise Exercise Prices February 3, 2001 (in Years) Price February 3, 2001 Price --------------- ----------------- ---------- ----- ----------------- ----- $5.90 to $7.20 70,634 1.0 $ 7.04 69,084 $ 7.03 $11.50 to $16.19 483,113 3.8 $ 14.19 80,881 $ 12.94 $20.00 to $25.88 108,875 2.1 $ 25.52 4,100 $ 25.50 ----------------- ----------------- 662,622 154,065 ================= =================
The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant date for awards in 2000, 1999, and 1998 consistent with the method prescribed by SFAS No. 123, Accounting for Stock-Based Compensation, the Company's operating results for 2000, 1999, and 1998 would have been reduced to the pro forma amounts indicated below: (in thousands, except per share data) 2000 1999 1998 ----------- ---------- -------- Net income As reported $14,849 $10,702 $8,830 Pro forma 14,260 10,363 8,322 Basic earnings per share As reported 1.24 0.90 0.75 Pro forma 1.19 0.88 0.71 Diluted earnings per share As reported 1.22 0.89 0.73 Pro forma 1.17 0.86 0.69 -26- The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions using grants in 2000, 1999 and 1998, respectively: 2000 1999 1998 --------------- -------------- ------------- Average expected life (years) 3.0 3.0 3.0 Average expected volatility 39.0% 43.3% 41.5% Risk-free interest rates 5.6% 4.8% 5.5% Dividend yield 1.3% 1.5% 1.3% The weighted average grant-date fair value of options granted during 2000, 1999,and 1998 was $3.90, $4.17, and $7.85 respectively. Restricted Stock. During 2000, 1999, and 1998, the Company issued (cancelled) a net of (25,272), 4,200, and 40,682 restricted shares, respectively. Compensation expense related to the shares issued is recognized over the period for which restrictions apply. Employee stock ownership plan. The Company has a non-contributory employee stock ownership plan for the benefit of qualifying employees who have completed one year of service and attained the age of 18. Benefits are fully vested upon completion of seven years of service. The Company has not made any contributions to the plan since 1996. Salary reduction profit sharing plan. The Company has a defined contribution profit sharing plan for the benefit of qualifying employees who have completed one year of service and attained the age of 21. Participants may elect to make contributions to the plan up to a maximum of 15% of their compensation. Company contributions are made at the discretion of the Company's Board of Directors. Participants are 100% vested in their contributions and earnings thereon. Contributions by the Company and earnings thereon are fully vested upon completion of seven years of service. The Company's contributions for the years ended February 3, 2001, January 29, 2000 and January 30, 1999 were $100,000, $96,000 and $83,000, respectively. Postretirement benefits. The Company provides certain health care benefits to its full-time employees that retire between the ages of 58 and 65 with certain specified levels of credited service. Health care coverage options for retirees under the plan are the same as those available to active employees. The Company's change in benefit obligation based upon an actuarial valuation is as follows:
For the Year Ended ------------------ February 3, January 29, January 30, 2001 2000 1999 ---- ---- ---- (in thousands) Benefit obligation at beginning of year $ 1,377 $ 1,252 $ 1,132 Service cost 132 127 103 Interest cost 116 91 85 Participant contributions - - 4 Amendments - - - Actuarial (gain) loss 68 (17) (67) Benefits paid (76) (76) (5) ------- ------- ------- Benefit obligation at end of year $ 1,617 $ 1,377 $ 1,252 ======= ======= =======
-27- A reconciliation of the Plan's funded status to accrued benefit cost follows:
February 3, January 29, January 30, 2001 2000 1999 ----------------- ----------------- ------------------ (in thousands) Funded status $ (1,617) $(1,377) $ (1,252) Unrecognized net actuarial gain (322) (406) (405) Unrecognized prior service cost (5) (6) (6) ----------------- ----------------- ------------------ Accrued benefit costs $ (1,944) $(1,789) $ (1,663) ================= ================= ==================
The medical care cost trend used in determining this obligation is 10.0% effective February 1, 1997, decreasing annually before leveling at 6.0% in 2003. This trend rate has a significant effect on the amounts reported. To illustrate, increasing the health care cost trend by 1% would increase the accumulated postretirement benefit obligation by $238,000. The discount rate used in calculating the obligation was 7.5% in 2000, 7.75% in 1999 and 6.75% in 1998.
The annual net postretirement cost is as follows: For the Year Ended ------------------ February 3, January 29, January 30, 2001 2000 1999 ------------ ----------- ----------- (in thousands) Service cost $ 132 $ 127 $ 103 Interest cost 116 91 85 Amortization of net gain from prior periods (17) (17) (21) Amortization of unrecognized prior service cost 1 1 1 ------------ ----------- ----------- Net periodic postretirement benefit cost $ 232 $ 202 $ 168 ============ =========== ===========
The Company's policy is to fund claims as incurred. NOTE 9 - NET INCOME PER SHARE Basic earnings per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Restricted stock is considered contingently issuable and is excluded from the computation of basic earnings per share. -28- A reconciliation of basic earnings per share to diluted earnings per share follows (in thousands, except per share data):
Year Ended ---------------------------------------------------------------------------------------- February 3, 2001 January 29, 2000 January 31, 1999 ---------------- ---------------- ---------------- Per Per Per Share Share Share Income Shares Amount Income Shares Amount Income Shares Amount -------------------------------------------------------------------------------------------------------------------- Basic EPS $14,849 11,937 $1.24 $10,702 11,827 $ .90 $8,830 11,798 $.75 Effect of Dilutive Securities Restricted stock 78 108 79 Stock options 182 137 201 ------- ------ ----- ------- ------ ----- ------ ------ ---- Diluted EPS $14,849 12,197 $1.22 $10,702 12,072 $ .89 $8,830 12,078 $.73 ======= ====== ===== ======= ====== ===== ====== ====== ====
NOTE 10 - COMMITMENTS AND CONTINGENCIES Commitments. At February 3, 2001, the Company had commitments approximating $5,082,000 on issued letters of credit which support purchase orders for merchandise. Additionally, the Company had outstanding letters of credit aggregating $2,552,000 utilized as collateral for their risk management programs. Litigation. The Company is a party to several pending legal proceedings and claims in the normal course of business. Although the outcome of the proceedings and claims cannot be determined with certainty, management of the Company is of the opinion that it is unlikely that these proceedings and claims will have a material adverse effect on the results of operations, cash flows, or the financial condition of the Company. NOTE 11 - OTHER EXPENSES During the fourth quarter of 1996, the Company recorded a $2,860,000 accrual for the closure of certain underperforming stores and the repositioning of certain merchandise categories. This charge included an accrual for closed facility lease obligations of $1,156,000. The remaining lease obligation at February 3, 2001 represents remaining future base payments required on one location that has been closed. The 2000 activity in this reserve is as follows:
January 30, January 29, February 3, 1999 2000 Payments 2001 ----------------- ----------------- ---------------- ---------------- Lease obligations $ 400 $ 215 $ (129) $ 86
-29- NOTE 12 - QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- (in thousands, except per share data) Year Ended February 3, 2001 - restated (1) (2) Net sales $176,132 $ 180,353 $ 180,141 $ 244,623 Gross profit 48,990 49,060 51,850 65,234 Net income 3,345 1,654 3,829 6,021 Net income per share Basic 0.28 0.14 0.32 0.50 Diluted 0.28 0.14 0.31 0.49 Cash dividends paid per share 0.05 0.05 0.05 0.05 Year Ended January 29, 2000 - proforma (3) Net sales $154,226 $ 155,792 $ 156,741 $ 199,018 Gross profit 44,135 43,775 46,780 52,949 Net income 2,766 920 2,677 4,339 Net income per share Basic 0.23 0.08 0.22 0.37 Diluted 0.23 0.08 0.22 0.36 Cash dividends paid per share 0.05 0.05 0.05 0.05 Year Ended January 29, 2000 - as reported Net sales $154,934 $ 156,498 $ 158,049 $ 196,296 Gross profit 44,319 43,952 47,117 52,251 Net income 2,886 1,037 2,896 3,883 Net income per share Basic 0.24 0.09 0.24 0.33 Diluted 0.24 0.09 0.24 0.32 Cash dividends paid per share 0.05 0.05 0.05 0.05
(1) Based upon a 53 week year. (2) As discussed in "Recent Accounting Prounouncements" in Note 1, the above information has been restated to reflect the impact of the Company implementing the interpetations in SAB 101 related to layaway sales during the fourth quarter of 2000. In the quarters in the year ended February 3, 2001, the effects of this restated on previously reported net sales, gross profit, net income and net income per share (basic & diluted) was a decrease of $528, $132, $87 and $.01 respectively for the 1st quarter; a decrease of $453, $111, $73, and .00 respectively for the 2nd quarter and a decrease of $951, $239, $158 and $.01 respectively for the 3rd quarter. (3) For informational purposes only, 1999 quarterly results have been restated on proforma basis as if the effects of SAB 101 on layaway sales had been applied to the 1999 quarterly reports. -30- Report of Independent Accountants To the Board of Directors and Shareholders of Fred's, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of changes in shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Fred's, Inc. and its subsidiaries at February 3, 2001 and January 29, 2000, and the results of their operations and their cash flows for each of the three years in the period ended February 3, 2001, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion expressed above. PricewaterhouseCoopers Memphis, TN April 4, 2001 -31- Stock Market Information ------------------------ The Company's common stock trades on the Nasdaq Stock Market under the symbol FRED (CUSIP No. 356108-10-0). At April 20, 2001, the Company had an estimated 5,400 shareholders, including beneficial owners holding shares in nominee or street name. The table below sets forth the high and low stock prices, together with cash dividends paid per share, for each fiscal quarter in the past two fiscal years: Dividends High Low Per Share -------------------------------------------------------------------------------- 1999 ---- First $15.00 $9.75 $0.05 Second $17.63 $10.31 $0.05 Third $18.00 $10.69 $0.05 Fourth $17.63 $11.50 $0.05 2000 ---- First $16.00 $14.13 $0.05 Second $21.06 $15.00 $0.05 Third $25.00 $18.75 $0.05 Fourth $23.69 $17.13 $0.05 SIC 5331 -33-(inside back cover) EXHIBIT 21.1 FRED'S, INC. SUBSIDIARIES OF REGISTRANT Fred's, Inc. has the following subsidiaries, all of which are 100% owned: Fred's Stores of Tennessee, Inc. Fred's Capital Management Company Fred's Real Estate and Equipment Management Corporation Fred's Capital Finance, Inc. EXHIBIT 23.1 Consent of PricewaterhouseCoopers LLP We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 33-48380 and 33-67606) of Fred's, Inc. of our report dated April 4, 2001, relating to the financial statements, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on From 10-K. We also consent to the incorporation by reference of our report dated April 4, 2001 relating to the financial statement schedule, which appears in this Form 10-K. PricewaterhouseCoopers LLP Memphis, Tennessee May 2, 2001