-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JB6TVypa1HUFq++567McCfkL5eSHHoKmdlBnB8WYk56+UKWUADe+B+V4KXcJ4hxQ TbWtOQQ0KwwLPhCn32E6sQ== 0001005794-02-000053.txt : 20020430 0001005794-02-000053.hdr.sgml : 20020430 ACCESSION NUMBER: 0001005794-02-000053 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020202 FILED AS OF DATE: 20020429 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FREDS INC CENTRAL INDEX KEY: 0000724571 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-VARIETY STORES [5331] IRS NUMBER: 620634010 STATE OF INCORPORATION: TN FISCAL YEAR END: 0127 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-14565 FILM NUMBER: 02623625 BUSINESS ADDRESS: STREET 1: 4300 NEW GETWELL RD CITY: MEMPHIS STATE: TN ZIP: 38118 BUSINESS PHONE: 9013658880 MAIL ADDRESS: STREET 1: 4300 NEW GETWELL ROAD CITY: MEMPHIS STATE: TN ZIP: 38118 FORMER COMPANY: FORMER CONFORMED NAME: BADDOUR INC DATE OF NAME CHANGE: 19910620 10-K 1 freds10k04-02.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 2, 2002 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 19, 2002, there were 25,405,002 shares outstanding of the Registrant's Class A no par value voting common stock. Based on the last reported sale price of $36.95 per share on the NASDAQ Stock Market on April 19, 2002, the aggregate market value of the Registrant's Common Stock held by those persons deemed by the Registrant to be non-affiliates was $938,714,824. As of April 19, 2002, 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 2001 Annual Report to Shareholders for the year ended February 2, 2002 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 for the 2002 annual shareholders meeting 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, government regulations and other factors affecting business beyond the Company's control. Consequently, all of the forward-looking statements are qualified by this cautionary statement 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 353 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). Two hundred and two 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 14,517 square feet and had average sales of $2,702,763 in fiscal 2001. No single store accounted for more than 1.0% of sales during fiscal 2001. 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 202 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 30% 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 type of 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 opened 33 stores in 2001, and anticipates a net increase of fifty-five to sixty new stores in 2002. 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 13 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. During 2001, the Company converted six Xpress locations to full size Fred's locations. During 2002 the Company anticipates opening three to five new Xpress locations. It is the Company's intent to expand these locations into a full size Fred's location as market conditions dictate. A significant growth area for the Company has been its pharmaceuticals business. In 2001, the Company added a net 4 new pharmacies. During 2002, the Company anticipates adding at least 30 additional pharmacies. Approximately 57% of Fred's stores contain a pharmacy and sell prescription drugs. The Company's primary mechanism for obtaining customers for 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:
1997 1998 1999 2000 2001 --------------------------------------------------- Stores open at beginning of period 213 261 283 293 320 Stores opened/acquired during period 49 29 20 31 33 Stores closed during period (1) (7) (10) (4) (0) --------------------------------------------------- Stores open at end of period 261 283 293 320 353 =================================================== Number of stores with Pharmacies at End of period 141 180 182 198 202 =================================================== Square feet of selling space at end of period (in thousands) 3,362 3,680 3,968 4,346 4,892 =================================================== Average square feet of selling space per store 13,875 13,925 14,015 14,690 14,517 =================================================== Franchise stores at end of period 31 29 26 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-five years of operation by the Company and its predecessors, enables the Company to compete effectively in its region. 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 2001, all of the Company's prescription drugs were purchased by its pharmacies individually and shipped direct from a pharmaceutical wholesaler. In November 1999, the Company entered into a supply agreement with Bergen Brunswig Drug Company (Bergen). Under this agreement, Bergen is Fred's new primary pharmaceutical wholesaler and provides substantially all of the Company's prescription drugs. During 2001, approximately 30% of the Company's total purchases were made from Bergen. 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 2001 was as follows: Pharmaceuticals...................................................34.4% Household Goods...................................................22.4% Apparel and Linens................................................12.3% Food and Tobacco Products..........................................9.5% Health and Beauty Aids.............................................9.4% Paper and Cleaning Supplies........................................8.3% Sales to Franchised Fred's Stores..................................3.7% 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 2001 the average customer transaction size was approximately $16.25, and the number of customer transactions totaled approximately 54 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 3% of total sales in 2001. 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 $33,452,000 in 2001, $34,281,000 in 2000,and $32,850,000 in 1999, representing 3.7%, 4.4%, and 4.9% of total revenue, respectively. Franchise and other fees earned totaled $1,764,000 in 2001, $1,806,000 in 2000, and $1,761,000 in 1999. 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 2001. 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 most stores are open seven days a week (other than pharmacy). 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 twenty district managers supervise the management and operation of Fred's stores. Fred's operates 202 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). Approximately 56% of the merchandise received by Fred's stores in 2001 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. On March 22, 2002, the Company announced plans to construct a new distribution center in Dublin, Laurens County, Georgia, pending the completion of final documentation and the receipt of all required governmental approvals. The $25 million, 600,000 square-foot distribution center will augment the capacity provided by the Company's original Memphis center. Construction of the Dublin distribution center is expected to begin promptly and it is estimated that the facility will be fully operational by March 2003. 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 2, 2002, the Company had approximately 7,850 full-time and part-time employees, comprising 750 corporate and distribution center employees and 7,100 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 2, 2002, the geographical distribution of the Company's 353 locations was as follows: State Number of Stores -------------------------------------------------- Mississippi 87 Tennessee 73 Arkansas 64 Alabama 45 Louisiana 28 Georgia 27 Missouri 10 Kentucky 10 Illinois 6 North Carolina 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 288 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 forty-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 2, 2002. PART II Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters The information required by this item is incorporated herein by reference to "Stock Market Information"(inside back cover) of the 2001 Annual Report to Shareholders for the year ended February 2, 2002 (the "Annual Report to Shareholders"). The Company has paid cash dividends of $0.05 per share (not adjusted for stock splits) in each of the last four fiscal years. During the fiscal year 2001, the Company paid cash dividends of $0.05 per share (not adjusted for stock splits) for the first quarter and $0.04 per share (not adjusted for stock split) for all subsequent quarters. Item 6: Selected Financial Data The selected financial data for the five years ended February 2, 2002, are incorporated herein by reference to the 2001 Annual Report to Shareholders under the caption "Selected Financial Data". 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 are incorporated herein by reference to the 2001 Annual Report to Shareholders under the caption "Management's Discussion and Analysis". Item 7a: Quantitative and Qualitative Disclosure about Market Risk The Company has no holdings of derivative financial or commodity instruments as of February 2, 2002. 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 are incorporated herein by reference to the 2001 Annual Report to Shareholders. 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) 60 Director, Managing Director (2), Chief Executive Officer John R. Eisenman(1) 60 Director Roger T. Knox(1) 64 Director John Reier(1) 62 President and Director Thomas H. Tashjian(1) 47 Director John A. Casey 55 Executive Vice President - Pharmacy Operations Jerry A Shore 49 Executive Vice President and Chief Financial Officer Charles S. Vail 59 Corporate Secretary, Vice President - Legal Services and General Counsel (1) Five 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 Director is the chief executive officer of the Company and has 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. 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 has served as Executive Vice President - Pharmacy Operations since February 1997. 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 to the Company's 2002 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 to the Company's 2002 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 16 through 31 of the 2001 Annual Report to Shareholders for the year ended February 2, 2002. Report of Independent Accountants. Consolidated Statements of Income for the years ended February 2, 2002, February 3, 2001, and January 29, 2000. Consolidated Balance Sheets as of February 2, 2002, and February 3, 2001. Consolidated Statements of Changes in Shareholders' Equity for the years ended February 2, 2002, February 3, 2001, and January 29, 2000. Consolidated Statements of Cash Flows for the years ended February 2, 2002, February 3, 2001, and January 29, 2000. 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 2, 2002. 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]. 3.3 Articles of Amendment to the Charter of Fred's, Inc., dated September 6, 2001, as filed with the Secretary of the State of Tennessee. [incorporated by reference to exhibit 3.3 of amendment No. 1 to our Registration Statement on Form S-3 filed on September 10, 2001.] 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]. 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 2, 2002 (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 January 15, 2002 (filed on March 6, 2002) announcing a three-for-two stock split. Current report on Form 8-K dated March 22, 2002 (filed on March 22, 2002) announcing plans to construct a new distribution center. * Management Compensatory Plan ** Filed herewith 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 19th day of April, 2002. 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 19th day of April, 2002. Signature Title --------- ----- /s/ Michael J. Hayes Director, Managing Director, - -------------------------- Michael J. Hayes Chief Executive Officer, President /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 Report of Independent Accountants on Financial Statement Schedules Our audits of the consolidated financial statements referred to in our report dated March 15, 2002 in the 2001 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 March 15, 2002 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 29, 2000 644 80 (272) 452 Year ended February 3, 2001 452 194 (130) 516 Year ended February 2, 2002 516 809 (668) 657
EXHIBIT 13.1 Fred's, Inc. Consolidated Financial Statements February 2, 2002 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 2, 2002 and February 3, 2001, and the results of their operations and their cash flows for each of the three years in the period ended February 2, 2002, 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. PricewaterhouseCoopers LLP Memphis, Tennessee March 15, 2002 Fred's, Inc. Consolidated Balance Sheets (in thousands, except for number of shares) - --------------------------------------------------------------------------------
February 2, February 3, 2002 2001 -------------------- ------------------- ASSETS Current assets: Cash and cash equivalents $ 15,906 $ 2,569 Receivables, less allowance for doubtful accounts of $657 ($516 at February 3, 2001) 15,705 15,430 Inventories 163,560 149,602 Deferred income taxes 1,790 2,022 Other current assets 2,499 2,306 -------------------- ------------------- Total current assets 199,460 171,929 Property and equipment, at depreciated cost 78,225 76,360 Equipment under capital leases, less accumulated amortization of $1,849 ($1,305 at February 3, 2001) 1,533 1,387 Deferred income taxes - 98 Other noncurrent assets, net 4,841 5,021 -------------------- ------------------- Total assets $ 284,059 $ 254,795 ==================== =================== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 43,747 $ 40,432 Current portion of indebtedness 562 2,175 Current portion of capital lease obligations 678 503 Accrued liabilities 14,228 14,012 Income taxes payable 1,866 4,278 -------------------- ------------------- Total current liabilities 61,081 61,400 Long-term portion of indebtedness 141 30,475 Deferred tax liability 696 - Capital lease obligations 1,179 1,230 Other noncurrent liabilities 2,055 2,003 -------------------- ------------------- Total liabilities 65,152 95,108 -------------------- ------------------- Commitments and contingencies (Notes 6 and 10) Shareholders' equity: Common stock, Class A voting, no par value, 25,361,112 shares issued and outstanding (22,628,471 shares at February 3, 2001) 110,508 68,557 Retained earnings 108,462 91,342 Deferred compensation on restricted stock incentive plan (63) (212) -------------------- ------------------- Total shareholders' equity 218,907 159,687 -------------------- ------------------- Total liabilities and shareholders' equity $ 284,059 $ 254,795 ==================== ===================
See accompanying notes to consolidated financial statements. Fred's, Inc. Consolidated Statements of Income (in thousands, except share and per share amounts) - --------------------------------------------------------------------------------
For the Years Ended -------------------------------------------------------------------- February 2, February 3, January 29, 2002 2001 2000 -------------------------------------------------------------------- Net sales $ 910,831 $ 781,249 $ 665,777 Cost of goods sold 661,110 566,115 478,138 --------------------- ------------------ ----------------------- Gross profit 249,721 215,134 187,639 Selling, general and administrative expenses 217,970 189,414 168,696 --------------------- ------------------ ----------------------- Operating income 31,751 25,720 18,943 Interest expense, net 1,611 3,226 2,504 --------------------- ------------------ ----------------------- Income before taxes 30,140 22,494 16,439 Income taxes 10,511 7,645 5,737 --------------------- ------------------ ----------------------- Net income $ 19,629 $ 14,849 $ 10,702 ===================== ================== ======================= Net income per share Basic $ .83 $ .66 $ .48 ===================== ================== ======================= Diluted $ .81 $ .65 $ .47 ===================== ================== ======================= Weighted average shares outstanding Basic 23,553 22,382 22,176 ===================== ================== ======================= Diluted 24,197 22,869 22,635 ===================== ================== =======================
See accompanying notes to consolidated financial statements. 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 30, 1999 11,946,772 $ 66,951 $ 70,596 $ (564) $ 136,983 Stock split - (Note 7) 2,986,693 Stock split - (Note 7) 7,466,732 Cash dividends paid ($.11 per share) (2,396) (2,396) Issuance of restricted stock 18,562 124 (124) Cancellation of restricted stock (10,687) (118) 118 Other issuances 3,213 30 30 Exercises of stock options 66,732 296 296 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 22,478,017 $ 67,326 $ 78,902 $ (315) $ 145,913 Cash dividends paid ($.11 per share) (2,409) (2,409) Issuance of restricted stock 7,125 57 (57) - Cancellation of restricted stock (54,510) (218) 15 (203) Exercises of stock options 197,839 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 22,628,471 $ 68,557 $ 91,342 $ (212) $ 159,687 Proceeds from public offering 2,377,500 $ 38,156 38,156 Cash dividends paid ($.12 per share) (2,509) (2,509) Cancellation of restricted stock (15,185) (63) 12 (51) Other issuances 55,980 937 937 Exercises of stock options 314,346 2,165 2,165 Amortization of deferred compensation on restricted stock incentive plan 137 137 Tax benefit on exercise of stock options 756 756 Net income 19,629 19,629 ---------- -------- --------- ----------- ----------- Balance, February 2, 2002 25,361,112 $110,508 $ 108,462 $ (63) $ 218,907 ---------- -------- --------- ----------- -----------
See accompanying notes to consolidated financial statements. Fred's, Inc. Consolidated Statements of Cash Flows (in thousands) - --------------------------------------------------------------------------------
For the Years Ended ------------------- February 2, February 3, January 29, 2002 2001 2000 ---- ---- ---- Cash flows from operating activities: Net income $ 19,629 $ 14,849 $ 10,702 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization 17,846 14,277 11,830 Provision for uncollectible receivables 142 64 80 LIFO Reserve 642 753 100 Deferred income taxes 1,026 1,747 2,513 Amortization of deferred compensation on restricted stock incentive plan 137 145 255 Issuance (net of cancellation) of restricted stock (52) (203) - Tax benefit upon exercise of stock options 756 313 43 Gain on sale of fixed assets - - (41) (Increase) decrease in assets: Receivables (416) (4,583) (2,060) Inventories (14,291) (8,743) (15,135) Other assets (194) (444) (847) Increase (decrease) in liabilities: Accounts payable and accrued liabilities 3,532 5,110 (8,210) Income taxes payable (2,411) 3,628 (176) Other noncurrent liabilities 52 174 159 --------- ---------- ----------- Net cash provided by (used in) operating activities 26,398 27,087 (787) ========= ========== =========== Cash flows from investing activities: Capital expenditures (17,372) (15,801) (14,043) Proceeds from dispositions of property and equipment - 493 215 Asset acquisition, net of cash acquired (primarily intangibles) (986) (2,807) (805) --------- ---------- ----------- Net cash used in investing activities (18,358) (18,115) (14,633) ========= ========== =========== Cash flows from financing activities: Reduction of indebtedness and capital lease obligations (9,892) (2,495) (2,139) Proceeds from revolving line of credit, net of payments (22,623) (5,617) 18,040 Proceeds from term loan - - 2,249 Proceeds from public offering, net of expenses 38,156 Proceeds from exercise of options 2,165 1,079 296 Payment of cash for dividends and fractional shares (2,509) (2,406) (2,396) --------- ---------- ----------- Net cash provided by (used in) financing activities 5,297 (9,439) 16,050 ========= ========== =========== Increase (decrease) in cash and cash equivalents 13,337 (467) 630 Cash and cash equivalents: Beginning of year 2,569 3,036 2,406 --------- ---------- ----------- End of year $ 15,906 $ 2,569 $ 3,036 ========= ========== =========== Supplemental disclosures of cash flow information: Interest paid $ 1,775 $ 3,332 $ 2,399 Income taxes paid $ 11,000 $ 2,000 $ 3,810 Non cash investing and financing activities: Assets acquired through capital lease obligations $ 691 $ - $ 612 Common stock issued for acquisition $ 937 $ - $ 30
See accompanying notes to consolidated financial statements. 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 353 retail discount stores located in eleven states 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 2001, 2000 and 1999, as used herein, refer to the years ended February 2, 2002, February 3, 2001, and January 29, 2000, 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 20% and 19% of the retail inventories at February 2, 2002 and February 3, 2001, respectively, cost was determined using the LIFO (last-in, first-out) method. The current cost of inventories exceeded the LIFO cost by approximately $4,603,000 at February 2, 2002 and $3,961,000 at February 3, 2001. 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 2, 2002 and February 3, 2001, no material adjustments to the carrying value of such assets were necessary. Selling, general and administrative expenses. The Company includes buying, warehousing, distribution, depreciation 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 2001, 2000, and 1999 was $12,079,000, $10,166,000, and $8,926,000 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 and are therefore netted against selling, general and administrative expenses. Total franchise income for 2001, 2000, and 1999 was $1,764,000, $1,806,000, and $1,761,000 respectively. 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. During the year ended February 2, 2002, the Company issued 55,980 (split-adjusted) shares for pharmacy acquisitions. These intangibles, net of accumulated amortization, totaled $4,778,000 at February 2, 2002, and $4,945,000 at February 3, 2001. Accumulated amortization for 2001 and 2000 totaled $5,272,000 and $3,490,000, respectively. Amortization expense for 2001, 2000, and 1999 was $1,795,000, $1,421,000, and $1,307,000, respectively. Cash and cash equivalents. Cash on hand and in banks, together with other highly liquid investments which are subject to market fluctuations and 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 for which there was no excess amounts at February 2, 2002 and $5,823,000 at February 3, 2001. Financial instruments. At February 2, 2002, 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. Insurance reserves. The Company is largely self-insured for workers compensation, general liability and medical insurance. The Company's liability for self-insurance is determined based on known claims and estimates for incurred but not reported claims. 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. 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 2001 presentation. Recent Accounting Pronouncements. In June 2001, the FASB issued SFAS No. 141, Business Combinations. SFAS No. 141 supercedes Accounting Principles Board Opinion ("APB") No. 16, Business Combinations, and SFAS No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The Company does not expect the adoption of SFAS No. 141 to have a material impact on its financial statements. In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 supercedes APB No. 17, Intangible Assets, and its provisions are effective for fiscal years beginning after December 15, 2001. SFAS No. 142 requires that: 1) goodwill and indefinite lived intangible assets will no longer be amortized; 2) goodwill will be tested for impairment at least annually at the reporting unit level (reporting unit levels to be determined upon adoption); 3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually; and 4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. As of February 2, 2002, the Company has intangible assets, net of accumulated amortization, of $4.8 million and has recognized amortization expense of approximately $1.8 million during the year February 2, 2002. The Company will continue to amortize intangible assets in accordance with its existing policy and accordingly does not anticipate a material impact on adoption of SFAS No. 142. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, effective for years beginning after December 15, 2001. This Statement supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets to Be Disposed of, but retains the fundamental provision of SFAS 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be held for sale. The statement requires that whenever events or changes in circumstances indicate that a long-lived asset's carrying value may not be recoverable, the asset should be tested for recoverability. The statement also requires that a long-lived asset classified as held for sale should be carried at the lower of its carrying value or fair value, less cost to sell. The Company is evaluating the potential impact the provisions of SFAS 144 could have on it's financial statements but does not believe there will be a material effect on the financial statements upon adoption. NOTE 2 - PROPERTY AND EQUIPMENT
Property and equipment, at cost, consist of the following (in thousands): 2001 2000 ------------------- -------------------- Buildings and improvements $ 69,217 $ 67,068 Furniture, fixtures and equipment 103,889 89,152 ------------------- -------------------- 173,106 156,220 Less accumulated depreciation and amortization (99,121) (84,100) ------------------- -------------------- 73,985 72,120 Land 4,240 4,240 ------------------- -------------------- Total property and equipment, at depreciated cost $ 78,225 $ 76,360 =================== ==================== Depreciation expense totaled $15,507,000, $12,407,000, and $10,168,000 for 2001, 2000 and 1999, respectively. NOTE 3 - ACCRUED LIABILITIES The components of accrued liabilities are as follows (in thousands): 2001 2000 ------------------- -------------------- Payroll and benefits $ 6,727 $ 5,136 Sales and use taxes 2,694 2,000 Insurance 1,753 2,497 Other 3,054 4,379 ------------------- -------------------- Total accrued liabilities $ 14,228 $ 14,012 =================== ====================
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 a 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 no borrowings outstanding under the Agreement at February 2, 2002 and the borrowings outstanding under the Agreement at February 3, 2001 totaled $22,623,000. 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 $703,000 and $1,265,500 borrowings outstanding under the Agreement at February 2, 2002 and February 3, 2001, respectively. The principal maturity under this Agreement for debt outstanding at February 2, 2002 is as follows: $562,500 in fiscal 2002 and $140,500 in fiscal 2003. 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 bore interest of 6.82% per annum and would have matured on November 1, 2005. The Company used the proceeds of the public offering to pay off the Agreement and the borrowings outstanding under the Agreement at February 3, 2001 totaled $8,762,000. Interest expense for 2001, 2000, and 1999 totaled $1,611,000, $3,226,000, and $2,504,000, 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): 2001 2000 1999 ---------------- ---------------- ---------------- Current Federal $ 9,485 $ 5,642 $ 3,224 State - - - ---------------- ---------------- ---------------- 9,485 5,642 3,224 ---------------- ---------------- ---------------- Deferred Federal 907 1,679 2,116 State 119 324 397 ---------------- ---------------- ---------------- 1,026 2,003 2,513 ---------------- ---------------- ---------------- $ 10,511 $ 7,645 $ 5,737 ---------------- ---------------- ----------------
Deferred tax assets (liabilities) are comprised of the following(in thousands): 2001 2000 ---------------- ---------------- Current deferred tax assets: Inventory valuation methods $ 530 $ 627 Accrual for inventory shrinkage 1,060 768 Allowance for doubtful accounts 357 310 Insurance accruals 933 1,200 Other 76 26 ---------------- ---------------- Gross current deferred tax assets 2,956 2,931 Deferred tax asset valuation allowance (289) (289) ---------------- ---------------- 2,667 2,642 Current deferred tax liabilities (877) (620) ---------------- ---------------- Net current deferred tax asset $ 1,790 $ 2,022 ---------------- ---------------- Noncurrent deferred tax assets: Net operating loss carryforwards $ 1,532 $ 1,685 Postretirement benefits other than pensions 799 760 Restructuring costs 73 82 Other 1,768 1,769 ---------------- ---------------- Gross noncurrent deferred tax assets 4,172 4,296 Deferred tax asset valuation allowance (1,243) (1,267) ---------------- ---------------- 2,929 3,029 Noncurrent deferred tax liabilities: Depreciation (3,598) (2,904) Other (27) (27) ---------------- ---------------- Gross noncurrent deferred tax liabilities (3,625) (2,931) ---------------- ---------------- Net noncurrent deferred tax (liability) asset $ (696) $ 98 ---------------- ----------------
The ultimate realization of the current deferred tax liability 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 2001 the valuation allowance decreased ($24,000) and during 2000 the valuation allowance increased $135,000. The Company was able to use net operating loss carryforwards in certain states during 2001 as compared to the Company generating additional net operating loss carryforwards in certain states during 2000. At February 2, 2002, 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 $43,939,000 for state income tax purposes, and expire at various times during the period 2003 through 2023. 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:
2001 2000 1999 ------------------ ------------------ -------------- Income tax provision at statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal benefit 0.1 0.9 1.6 Surtax Exemptions - (1.0) (1.0) Other (0.2) (0.9) (0.7) ------------------ ------------------ -------------- 34.9% 34.0% 34.9% ------------------ ------------------ --------------
NOTE 6 - LONG-TERM LEASES The Company leases certain of its store locations under noncancelable operating leases that require monthly rental payments primarily at fixed rates (although a number of the leases provide for additional rent based upon sales) 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 $22,207,000, $17,465,000, and $15,329,000 for 2001, 2000, and 1999, respectively. Amortization expense on assets under capital lease for 2001, 2000, and 1999 was $544,000, $449,000, and $355,000, respectively. Future minimum rental payments under all operating and capital leases as of February 2, 2002 are as follows:
Operating Capital Leases Leases - ----------------------------------------------------------------------------------------------------------------------- 2002 $ 20,611 $ 914 2003 18,112 536 2004 15,072 428 2005 12,280 315 2006 8,869 173 Thereafter 12,789 28 ------------------ ----------------- Total minimum lease payments $ 87,733 2,394 ================== Imputed interest (537) ----------------- Present value of net minimum lease payments, including ----------------- $678 classified as current portion of capital lease obligations $ 1,857 =================
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 (a "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. On May 24, 2001, the Company announced a five-for-four stock split of its common stock, Class A voting, no par value. The new shares, one additional share for each four shares held by stockholders, were distributed on June 18, 2001 to stockholders of record on June 4, 2001. All share and per share amounts included in the accompanying financial statements have been adjusted to reflect this stock split. In October 2001, the company completed a secondary stock offering of 1,585,000 company shares (unadjusted for 3-for-2 stock split completed on February 1, 2002) raising net proceeds to the Company of $38.2 million dollars. On January 15, 2002, the Company announced a three-for-two stock split of its common stock, Class A voting, no par value. The new shares, one additional share for each two shares held by stockholders, were distributed on February 1, 2002 to stockholders of record on January 25, 2002. All share and per share amounts included in the accompanying financial statements have been adjusted to reflect this stock split. NOTE 8 - EMPLOYEE BENEFIT PLANS Incentive stock option plan. The Company has a long-term incentive plan under which an aggregate of 2,191,409 shares may be granted. These options expire five years from the date of grant. Options outstanding at February 2, 2002 expire in 2002 through 2006.
A summary of activity in the plan follows: 2001 2000 1999 -------------------------------- --------------------------------- ------------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price -------------------------------- --------------------------------- ------------------------ Outstanding at beginning of year 1,242,415 $ 8.16 1,056,475 $ 7.01 919,009 $ 7.15 Granted 288,219 9.39 647,824 8.03 256,405 6.31 Forfeited/ canceled (292,253) 9.22 (264,046) 5.88 (48,939) 7.89 Expired - - (3,270) 6.05 Exercised (314,346) 6.82 (197,838) 4.63 (66,730) 4.47 ------------- ---------- ------------ Outstanding at end of year 924,035 8.65 1,242,415 8.16 1,056,475 7.01 ============= ========== ============ Exercisable at end of year 356,068 8.32 288,871 5.67 317,461 4.86 ============= ========== ============
The weighted average remaining contractual life of all outstanding options was 2.8 years at February 2, 2002. The following table summarizes information about stock options outstanding at February 2, 2002:
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 2, 2002 (in Years) Price February 2, 2002 Price --------------- ---------------- ---------- ----- ---------------- ----- $3.15 to $3.84 37,068 0.8 $ 3.76 33,429 $ 3.75 $6.14 to $8.64 743,474 2.4 $ 7.57 243,858 $ 6.90 $10.67 to $18.53 143,493 2.2 $ 13.62 78,781 $ 13.61 ---------------- --------------- 924,035 356,068 ---------------- ---------------
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 2001, 2000, and 1999 consistent with the method prescribed by SFAS No. 123, Accounting for Stock-Based Compensation, the Company's operating results for 2001, 2000, and 1999 would have been reduced to the pro forma amounts indicated below:
(in thousands, except per share data) 2001 2000 1999 ------------- --------------- -------------- Net income As reported $19,629 $14,849 $10,702 Pro forma 19,245 14,260 10,363 Basic earnings per share As reported 0.83 0.66 0.48 Pro forma 0.82 0.63 0.47 Diluted earnings per share As reported 0.81 0.65 0.47 Pro forma 0.80 0.62 0.46
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 2001, 2000 and 1999, respectively: 2001 2000 1999 --------------- --------------- ------------- Average expected life (years) 3.0 3.0 3.0 Average expected volatility 41.9% 39.0% 43.3% Risk-free interest rates 2.6% 5.6% 4.8% Dividend yield 1.6% 1.3% 1.5% The weighted average grant-date fair value of options granted during 2001, 2000,and 1999 was $6.90, $2.08, and $2.22, respectively. Restricted Stock. During 2001, 2000, and 1999, the Company issued (forfeited/ cancelled) a net of (15,185),(47,385), and 7,875 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 2, 2002, February 3, 2001, and January 29, 2000 were $117,000, $100,000, and $96,000, 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 2, February 3, January 29, 2002 2001 2000 ---- ---- ---- (in thousands) Benefit obligation at beginning of year $ 1,617 $ 1,377 $ 1,252 Service cost 140 132 127 Interest cost 123 116 91 Participant contributions 1 - - Amendments - - - Actuarial (gain) loss (74) 68 (17) Benefits paid (21) (76) (76) ------- ------- ------- Benefit obligation at end of year $ 1,786 $ 1,617 $ 1,377 ======= ======= =======
A reconciliation of the Plan's funded status to accrued benefit cost follows:
February 2, February 3, January 29, 2002 2001 2000 ------------------ ------------------ ------------------ (in thousands) Funded status $ (1,786) $ (1,617) $ (1,377) Unrecognized net actuarial gain (380) (322) (406) Unrecognized prior service cost (5) (5) (6) ------------------ ------------------ ------------------ Accrued benefit costs $ (2,171) $ (1,944) $ (1,789) ------------------ ------------------ ------------------
The medical care cost trend used in determining this obligation is 11.0% effective December 1, 2000, decreasing annually before leveling at 5.5% in 2012. 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 $259,000. The discount rate used in calculating the obligation was 7.25% in 2001, 7.5% in 2000 and 7.75% in 1999. The annual net postretirement cost is as follows:
For the Year Ended ---------------------------------------------------- February 2, February 3, January 29, 2002 2001 2000 -------------- ---------------- ------------------ (in thousands) Service cost $ 140 $ 132 $ 127 Interest cost 123 116 91 Amortization of net gain from prior periods (17) (17) (17) Amortization of unrecognized prior service cost 1 1 1 -------------- ---------------- ------------------ Net periodic postretirement benefit cost $ 247 $ 232 $ 202 ============== ================ ==================
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. A reconciliation of basic earnings per share to diluted earnings per share follows (in thousands, except per share data):
Year Ended -------------------------------------------------------------------------------------------------------------- February 2, 2002 February 3, 2001 January 29, 2000 ------------------------------------ -------------------------------------- ---------------------------------- Per Per Per Share Share Share Income Shares Amount Income Shares Amount Income Shares Amount - ----------------------------------------------------------------------------------------------------------------------------------- Basic EPS $19,629 23,553 $ .83 $14,849 22,382 $ .66 $10,702 22,176 $ .48 Effect of Dilutive Securities Restricted stock 69 146 203 Stock options 575 341 256 ---------- ----------- ----------- ----------- ----------- ----------- ------------- ------------ ----------- Diluted EPS $19,629 24,197 $ .81 $14,849 22,869 $ .65 $10,702 22,635 $ .47 ========== =========== =========== =========== =========== =========== ============= ============ ===========
NOTE 10 - COMMITMENTS AND CONTINGENCIES Commitments. The Company had commitments approximating $9,133,000 at February 2, 2002 and $5,082,000 at February 3, 2001 on issued letters of credit which support purchase orders for merchandise. Additionally, the Company had outstanding letters of credit aggregating $6,838,000 at February 2, 2002 and $2,552,000 at February 3, 2001 utilized as collateral for its 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 - QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth Quarter Quarter Quarter Quarter ---------------- --------------- --------------- --------------- (in thousands, except per share data) Year Ended February 2, 2002 (1) Net sales $ 207,359 $ 210,278 $ 219,242 $ 273,952 Gross profit 57,758 56,781 62,038 73,144 Net income 4,159 2,114 5,128 8,228 Net income per share Basic 0.18 0.09 0.22 0.34 Diluted 0.18 0.09 0.22 0.32 Cash dividends paid per share 0.05 0.04 0.04 0.04 Year Ended February 3, 2001 (1) 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 0.15 0.07 0.17 0.27 Diluted 0.15 0.07 0.17 0.26 Cash dividends paid per share 0.05 0.05 0.05 0.05
(1) Per share data adjusted for stock split (Note 7). 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 INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 33-68478) and Form S-8 (No. 33-48380 and 33-67606) of Fred's, Inc. of our report dated March 15, 2002 relating to the financial statements, which appears in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K. We also consent to the incorporation by reference of our report dated March 15, 2002 relating to the financial statement schedules, which appears in this Form 10-K. PricewaterhouseCoopers LLP Memphis, Tennessee April 26, 2002 -----END PRIVACY-ENHANCED MESSAGE-----