UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the quarterly period ended November 1, 2014.
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. |
For the transition period from _______ to _______.
Commission file number 001-14565
FRED'S, INC.
(Exact name of registrant as specified in its charter)
TENNESSEE | 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)
(901) 365-8880
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes x No ¨.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer x |
Non-accelerated filer ¨ | Smaller reporting company ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x.
The registrant had 36,915,375 shares of Class A voting, no par value common stock outstanding as of December 5, 2014.
FRED'S, INC.
INDEX
2 |
Part I – FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except for number of shares)
November 1, 2014 | February 1, | |||||||
(unaudited) | 2014 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 7,595 | $ | 6,725 | ||||
Receivables, less allowance for doubtful accounts of $2,394 and $2,097, respectively | 41,452 | 35,161 | ||||||
Inventories | 352,323 | 361,993 | ||||||
Other non-trade receivables | 48,956 | 39,108 | ||||||
Prepaid expenses and other current assets | 13,202 | 13,245 | ||||||
Total current assets | 463,528 | 456,232 | ||||||
Property and equipment, at depreciated cost | 145,734 | 153,363 | ||||||
Equipment under capital leases, less accumulated amortization of $5,138 and $5,111, respectively | 2 | 29 | ||||||
Intangibles | 74,047 | 54,580 | ||||||
Other noncurrent assets, net | 12,153 | 3,582 | ||||||
Total assets | $ | 695,464 | $ | 667,786 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 160,184 | $ | 125,925 | ||||
Current portion of indebtedness | 1,430 | 1,640 | ||||||
Accrued expenses and other | 52,706 | 46,236 | ||||||
Deferred income taxes | 24,185 | 24,446 | ||||||
Total current liabilities | 238,505 | 198,247 | ||||||
Long-term portion of indebtedness | 2,205 | 3,578 | ||||||
Other noncurrent liabilities | 27,795 | 14,413 | ||||||
Total liabilities | 268,505 | 216,238 | ||||||
Commitments and Contingencies (See Note 9 - Legal Contingencies) | ||||||||
Shareholders’ equity: | ||||||||
Preferred stock, nonvoting, no par value, 10,000,000 shares authorized, none outstanding | - | - | ||||||
Preferred stock, Series A junior participating nonvoting, no par value, 224,594 shares authorized, none outstanding | - | - | ||||||
Common stock, Class A voting, no par value, 60,000,000 shares authorized, 36,915,375 and 36,791,279 shares issued and outstanding, respectively | 105,317 | 102,524 | ||||||
Common stock, Class B nonvoting, no par value, 11,500,000 shares authorized, none outstanding | - | - | ||||||
Retained earnings | 320,939 | 348,321 | ||||||
Accumulated other comprehensive income | 703 | 703 | ||||||
Total shareholders’ equity | 426,959 | 451,548 | ||||||
Total liabilities and shareholders’ equity | $ | 695,464 | $ | 667,786 |
See accompanying notes to condensed consolidated financial statements.
3 |
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
Thirteen Weeks Ended | Thirty-Nine Weeks Ended | |||||||||||||||
November 1, | November 2, | November 1, | November 2, | |||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net sales | $ | 476,175 | $ | 460,542 | $ | 1,465,624 | $ | 1,444,213 | ||||||||
Cost of goods sold | 352,686 | 320,305 | 1,085,992 | 1,016,972 | ||||||||||||
Gross profit | 123,489 | 140,237 | 379,632 | 427,241 | ||||||||||||
Depreciation and amortization | 10,259 | 10,631 | 30,308 | 31,459 | ||||||||||||
Selling, general and administrative expenses | 129,809 | 118,970 | 382,015 | 362,149 | ||||||||||||
Operating income (loss) | (16,579 | ) | 10,636 | (32,691 | ) | 33,633 | ||||||||||
Interest expense | 107 | 113 | 405 | 377 | ||||||||||||
Income (loss) before income taxes | (16,686 | ) | 10,523 | (33,096 | ) | 33,256 | ||||||||||
Provision (benefit) for income taxes | (6,252 | ) | 3,215 | (12,346 | ) | 11,207 | ||||||||||
Net income (loss) | $ | (10,434 | ) | $ | 7,308 | $ | (20,750 | ) | $ | 22,049 | ||||||
Net income (loss) per share | ||||||||||||||||
Basic | $ | (0.28 | ) | $ | 0.20 | $ | (0.57 | ) | $ | 0.60 | ||||||
Diluted | $ | (0.28 | ) | $ | 0.20 | $ | (0.56 | ) | $ | 0.60 | ||||||
Weighted average shares outstanding | ||||||||||||||||
Basic | 36,691 | 36,558 | 36,650 | 36,532 | ||||||||||||
Effect of dilutive stock options | 122 | 165 | 166 | 147 | ||||||||||||
Diluted | 36,813 | 36,723 | 36,816 | 36,679 | ||||||||||||
Dividends per common share | $ | 0.06 | $ | 0.06 | $ | 0.18 | $ | 0.18 |
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(in thousands)
Thirteen Weeks Ended | Thirty-Nine Weeks Ended | |||||||||||||||
November 1, | November 2, | November 1, | November 2, | |||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Net income (loss) | $ | (10,434 | ) | $ | 7,308 | $ | (20,750 | ) | $ | 22,049 | ||||||
Other comprehensive income (expense), net of tax postretirement plan adjustment | - | - | - | - | ||||||||||||
Comprehensive income | $ | (10,434 | ) | $ | 7,308 | $ | (20,750 | ) | $ | 22,049 |
See accompanying notes to condensed consolidated financial statements.
4 |
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Thirty-Nine Weeks Ended | ||||||||
November 1, 2014 | November 2, 2013 | |||||||
Cash flows from operating activities: | ||||||||
Net income (loss) | $ | (20,750 | ) | $ | 22,049 | |||
Adjustments to reconcile net income to net cash flows from operating activities: | ||||||||
Depreciation and amortization | 30,308 | 31,459 | ||||||
Net gain on asset disposition | (3,125 | ) | (1,446 | ) | ||||
Provision (benefit) for store closures and asset impairment | 14,177 | (45 | ) | |||||
Stock-based compensation | 1,962 | 1,944 | ||||||
Provision for uncollectible receivables | 297 | 636 | ||||||
LIFO reserve increase | 2,368 | 1,904 | ||||||
Deferred income tax benefit | (8,991 | ) | (2,970 | ) | ||||
Income tax (charge) benefit upon exercise of stock options | (68 | ) | 20 | |||||
Changes in operating assets and liabilities: | ||||||||
(Increase) decrease in operating assets: | ||||||||
Trade and non-trade receivables | (4,836 | ) | (1,612 | ) | ||||
Insurance receivables | (16 | ) | 298 | |||||
Inventories | (4,173 | ) | (34,144 | ) | ||||
Other assets | 43 | (2,308 | ) | |||||
Increase (decrease) in operating liabilities: | ||||||||
Accounts payable and accrued expenses | 39,914 | 38,188 | ||||||
Income taxes payable | (10,495 | ) | (586 | ) | ||||
Other noncurrent liabilities | 13,336 | 4,122 | ||||||
Net cash provided by operating activities | 49,951 | 57,509 | ||||||
Cash flows from investing activities: | ||||||||
Capital expenditures | (17,885 | ) | (20,582 | ) | ||||
Proceeds from asset dispositions | 4,510 | 3,258 | ||||||
Insurance recoveries for replacement assets | - | 176 | ||||||
Asset acquisition, net (primarily intangibles) | (28,322 | ) | (13,053 | ) | ||||
Net cash used in investing activities | (41,697 | ) | (30,201 | ) | ||||
Cash flows provided by (used in) financing activities: | ||||||||
Payments of indebtedness and capital lease obligations | (1,583 | ) | (1,229 | ) | ||||
Proceeds from revolving line of credit | 383,568 | 192,661 | ||||||
Payments on revolving line of credit | (383,568 | ) | (199,647 | ) | ||||
Excess tax charges from stock-based compensation | 68 | (20 | ) | |||||
Proceeds from exercise of stock options and employee stock purchase plan | 762 | 1,004 | ||||||
Cash dividends paid | (6,631 | ) | (6,621 | ) | ||||
Net cash used in financing activities | (7,384 | ) | (13,852 | ) | ||||
Increase (decrease) in cash and cash equivalents | 870 | 13,456 | ||||||
Cash and cash equivalents: | ||||||||
Beginning of year | 6,725 | 8,129 | ||||||
End of period | $ | 7,595 | $ | 21,585 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Interest paid | $ | 405 | $ | 377 | ||||
Income taxes paid | $ | 8,044 | $ | 14,784 |
See accompanying notes to consolidated financial statements.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 1: BASIS OF PRESENTATION
Fred's, Inc. and subsidiaries ("Fred's", “We”, “Our”, “Us” or “Company”) operates, as of November 1, 2014, 703 discount general merchandise stores, including 21 franchised Fred's stores, in 15 states in the southeastern United States. There are 362 full service pharmacy departments located within our discount general merchandise stores.
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and are presented in accordance with the requirements of Form 10-Q, and therefore, do not include all information and notes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with GAAP. The statements reflect all adjustments (consisting of only normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of financial position in conformity with GAAP. The statements should be read in conjunction with the Notes to the Consolidated Financial Statements for the fiscal year ended February 1, 2014 incorporated into Our Annual Report on Form 10-K.
Certain prior year amounts have been reclassified to conform to the 2014 presentation (for changes in the balance sheet for state and franchise tax receivables in accrued expenses).
The results of operations for the thirteen week and thirty-nine week periods ended November 1, 2014 are not necessarily indicative of the results to be expected for the full fiscal year.
NOTE 2: INVENTORIES
Merchandise inventories are valued at the lower of cost or market using the retail first-in, first-out (FIFO) method for goods in our stores and the cost FIFO method for goods in our distribution centers. The retail inventory method is a reverse mark-up, averaging method which has been widely used in the retail industry for many years. This method calculates a cost-to-retail ratio that is applied to the retail value of inventory to determine the cost value of inventory and the resulting cost of goods sold and gross margin. The assumptions that the retail inventory method provides for valuation at lower of cost or market and the inherent uncertainties therein are discussed in the following paragraphs. In order to assure valuation at the lower of cost or market, the retail value of our inventory is adjusted on a consistent basis to reflect current market conditions. These adjustments include increases to the retail value of inventory for initial markups to set the selling price of goods or additional markups to adjust pricing for inflation and decreases to the retail value of inventory for markdowns associated with promotional, seasonal or other declines in the market value. Because these adjustments are made on a consistent basis and are based on current prevailing market conditions, they approximate the carrying value of the inventory at net realizable value (market value). Therefore, after applying the cost to retail ratio, the cost value of our inventory is stated at the lower of cost or market as is prescribed by GAAP.
Because the approximation of net realizable value (market value) under the retail inventory method is based on estimates such as markups, markdowns and inventory losses (shrink), there exists an inherent uncertainty in the final determination of inventory cost and gross margin. In order to mitigate that uncertainty, the Company has a formal review by product class which considers such variables as current market trends, seasonality, weather patterns and age of merchandise to ensure that markdowns are taken currently, or a markdown reserve is established to cover future anticipated markdowns. This review also considers current pricing trends and inflation to ensure that markups are taken if necessary. The estimation of inventory losses (shrink) is a significant element in approximating the carrying value of inventory at net realizable value, and as such the following paragraph describes our estimation method as well as the steps we take to mitigate the risk of this estimate in the determination of the cost value of inventory.
The Company calculates inventory losses (shrink) based on actual inventory losses occurring as a result of physical inventory counts during each fiscal period and estimated inventory losses occurring between yearly physical inventory counts. The estimate for shrink occurring in the interim period between physical counts is calculated on a store-specific basis and is based on history, as well as performance on the most recent physical count. It is calculated by multiplying each store’s shrink rate, which is based on the previously mentioned factors, by the interim period’s sales for each store. Additionally, the overall estimate for shrink is adjusted at the corporate level to a three-year historical average to ensure that the overall shrink estimate is the most accurate approximation of shrink based on the Company’s overall history of shrink. The three-year historical estimate is calculated by dividing the “book to physical” inventory adjustments for the trailing 36 months by the related sales for the same period. In order to reduce the uncertainty inherent in the shrink calculation, the Company first performs the calculation at the lowest practical level (by store) using the most current performance indicators. This ensures a more reliable number, as opposed to using a higher level aggregation or percentage method. The second portion of the calculation ensures that the extreme negative or positive performance of any particular store or group of stores does not skew the overall estimation of shrink. This portion of the calculation removes additional uncertainty by eliminating short-term peaks and valleys that could otherwise cause the underlying carrying cost of inventory to fluctuate unnecessarily. The methodology that we have applied in estimating shrink has resulted in variability that is not material to our financial statements.
6 |
Management believes that the Company’s retail inventory method provides an inventory valuation which reasonably approximates cost and results in carrying inventory at the lower of cost or market. For pharmacy inventories, which were approximately $41.2 million and $40.4 million at November 1, 2014 and February 1, 2014, respectively, cost was determined using the retail last-in, first-out (LIFO) method in which inventory cost is maintained using the retail inventory method, then adjusted by application of the Producer Price Index published by the U.S. Department of Labor for the cumulative annual periods. The current cost of inventories exceeded the LIFO cost by approximately $37.6 million at November 1, 2014 and $35.2 million at February 1, 2014.
The Company has historically included an estimate of inbound freight and certain general and administrative costs in merchandise inventory as prescribed by GAAP. These costs include activities surrounding the procurement and storage of merchandise inventory such as merchandise planning and buying, warehousing, accounting, information technology and human resources, as well as inbound freight. The total amount of procurement and storage costs and inbound freight, inclusive of the accelerated recognition of freight capitalization expense, included in merchandise inventory at November 1, 2014 is $20.0 million, with the corresponding amount of $21.6 million at February 1, 2014.
In the second quarter of 2014, the Company established a reserve for inventory clearance of product that management identified as low-productive and does not fit our go-forward convenient and pharmacy healthcare services model. The Company recorded a below-cost inventory adjustment in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 330, "Inventory," of approximately $11.6 million (including $1.6 million, for the accelerated recognition of freight capitalization expense) in cost of goods sold to value inventory at the lower of cost or market on inventory identified as low-productive, which the Company will be liquidating in accordance with our new strategy. To date, the Company has utilized $2.7 million of the reserve associated with goods sold in 2014.
The following table illustrates the inventory markdown reserve activity related to the low-productive inventory discussed in the previous paragraph (in millions):
Balance at February 1, 2014 | Additions | Utilization | Ending Balance November 1, 2014 | |||||||||||||
Inventory markdown on low-productive inventory | $ | - | $ | 10.0 | $ | (2.3 | ) | $ | 7.7 | |||||||
Inventory provision for freight capitalization expense | $ | - | $ | 1.6 | $ | (0.4 | ) | $ | 1.2 | |||||||
Total | $ | - | $ | 11.6 | $ | (2.7 | ) | $ | 8.9 |
NOTE 3: STOCK-BASED COMPENSATION
The Company accounts for its stock-based compensation plans in accordance with the FASB ASC 718 “Compensation – Stock Compensation.” Under FASB ASC 718, stock-based compensation expense is based on awards ultimately expected to vest, and therefore has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant based on the Company’s historical forfeiture experience and will be revised in subsequent periods if actual forfeitures differ from those estimates.
7 |
FASB ASC 718 also requires the benefits of income tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required prior to FASB ASC 718. A summary of the Company’s stock-based compensation (a component of selling, general and administrative expenses) and related income tax benefit is as follows (in thousands):
Thirteen Weeks Ended | Thirty-Nine Weeks Ended | |||||||||||||||
November 1, 2014 | November 2, 2013 | November 1, 2014 | November 2, 2013 | |||||||||||||
Stock option expense | $ | 201 | $ | 147 | $ | 662 | $ | 464 | ||||||||
Restricted stock expense | 342 | 531 | 1,135 | 1,324 | ||||||||||||
ESPP expense | 55 | 52 | 165 | 156 | ||||||||||||
Total stock-based compensation | $ | 598 | $ | 730 | $ | 1,962 | $ | 1,944 | ||||||||
Income tax benefit on stock-based compensation | $ | 149 | $ | 218 | $ | 508 | $ | 560 |
The fair value of each option granted during the thirteen and thirty-nine week periods ended November 1, 2014 and November 2, 2013 is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
Thirteen Weeks Ended | Thirty-Nine Weeks Ended | |||||||||||||||
November 1, 2014 | November 2, 2013 | November 1, 2014 | November 2, 2013 | |||||||||||||
Stock Options | ||||||||||||||||
Expected volatility | 35.9 | % | 38.4 | % | 36.2 | % | 38.9 | % | ||||||||
Risk-free interest rate | 2.0 | % | 1.2 | % | 1.9 | % | 1.0 | % | ||||||||
Expected option life (in years) | 5.84 | 5.84 | 5.84 | 5.84 | ||||||||||||
Expected dividend yield | 1.61 | % | 1.41 | % | 1.59 | % | 1.30 | % | ||||||||
Weighted average fair value at grant date | $ | 4.73 | $ | 4.81 | $ | 4.96 | $ | 4.64 | ||||||||
Employee Stock Purchase Plan | ||||||||||||||||
Expected volatility | 29.1 | % | 29.5 | % | 34.2 | % | 29.4 | % | ||||||||
Risk-free interest rate | 0.2 | % | 0.2 | % | 0.2 | % | 0.2 | % | ||||||||
Expected option life (in years) | 0.75 | 0.75 | 0.5 | 0.5 | ||||||||||||
Expected dividend yield | 1.35 | % | 1.35 | % | 0.90 | % | 0.90 | % | ||||||||
Weighted average fair value at grant date | $ | 4.35 | $ | 3.42 | $ | 4.30 | $ | 3.15 |
The following is a summary of the methodology applied to develop each assumption:
Expected Volatility - This is a measure of the amount by which a price has fluctuated or is expected to fluctuate. The Company uses actual historical changes in the market value of our stock to calculate expected price volatility because management believes that this is the best indicator of future volatility. The Company calculates weekly market value changes from the date of grant over a past period representative of the expected life of the options to determine volatility. An increase in the expected volatility will increase compensation expense.
Risk-free Interest Rate - This is the yield of a U.S. Treasury zero-coupon bond issue effective at the grant date with a remaining term equal to the expected life of the option. An increase in the risk-free interest rate will increase compensation expense.
Expected Lives - This is the period of time over which the options granted are expected to remain outstanding and is based on historical experience. Options granted have a maximum term of seven and one-half years. An increase in the expected life will increase compensation expense.
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Dividend Yield – This is based on the historical yield for a period equivalent to the expected life of the option. An increase in the dividend yield will decrease compensation expense.
Forfeiture Rate - This is the estimated percentage of options granted that are expected to be forfeited or cancelled before becoming fully vested. This estimate is based on historical experience. An increase in the forfeiture rate will decrease compensation expense.
Employee Stock Purchase Plan
The 2004 Employee Stock Purchase Plan (the “2004 Plan”), which was approved by Fred’s shareholders, permits eligible employees to purchase shares of our common stock through payroll deductions at the lower of 85% of the fair market value of the stock at the time of grant or 85% of the fair market value at the time of exercise. There were 41,726 shares issued during the thirty-nine weeks ended November 1, 2014. There are 1,410,928 shares approved to be issued under the 2004 Plan and as of November 1, 2014, there were 816,839 shares available.
Stock Options
The following table summarizes stock option activity during the thirty-nine weeks ended November 1, 2014:
Options | Weighted Average Exercise Price | Weighted Average Remaining Contractual Life (Years) | Aggregate Intrinsic Value (Thousands) | |||||||||||||
Outstanding at February 1, 2014 | 1,142,429 | $ | 12.63 | 3.0 | $ | 5,539 | ||||||||||
Granted | 96,500 | $ | 15.81 | |||||||||||||
Forfeited / Cancelled | (25,510 | ) | $ | 12.78 | ||||||||||||
Exercised | (34,622 | ) | $ | 11.63 | ||||||||||||
Outstanding at November 1, 2014 | 1,178,797 | $ | 12.92 | 2.6 | $ | 3,433 | ||||||||||
Exercisable at November 1, 2014 | 483,914 | $ | 10.79 | 0.9 | $ | 2,380 |
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between Fred’s closing stock price on the last trading day of the period ended November 1, 2014 and the exercise price of the option multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on that date. As of November 1, 2014, total unrecognized stock-based compensation expense net of estimated forfeitures related to non-vested stock options was approximately $1.3 million, which is expected to be recognized over a weighted average period of approximately 2.8 years. The total fair value of options vested during the thirty-nine weeks ended November 1, 2014 was $268.2 thousand.
Restricted Stock
The following table summarizes restricted stock activity during the thirty-nine weeks ended November 1, 2014:
Number of Shares | Weighted Average Grant Date Fair Value | |||||||
Non-vested Restricted Stock at February 1, 2014 | 551,013 | $ | 13.53 | |||||
Granted | 136,272 | $ | 17.35 | |||||
Forfeited / Cancelled | (78,510 | ) | $ | 13.72 | ||||
Vested | (32,223 | ) | $ | 12.94 | ||||
Non-vested Restricted Stock at November 1, 2014 | 576,552 | $ | 14.41 |
9 |
The aggregate pre-tax intrinsic value of restricted stock outstanding as of November 1, 2014 is $9.1 million with a weighted average remaining contractual life of 5.8 years. The unrecognized compensation expense net of estimated forfeitures, related to the outstanding stock is approximately $4.9 million, which is expected to be recognized over a weighted average period of approximately 7.1 years. The total fair value of restricted stock awards that vested during the thirty-nine weeks ended November 1, 2014 was $425.8 thousand.
NOTE 4 — FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy, as defined below, gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.
· | Level 1, defined as quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date. |
· | Level 2, defined as inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. |
· | Level 3, defined as unobservable inputs for the asset or liability. |
Due to their short-term nature, the Company’s financial instruments, which include cash and cash equivalents, receivables and accounts payable, are presented on the Condensed Consolidated Balance Sheets at a reasonable estimate of their fair value as of November 1, 2014 and February 1, 2014. No borrowings on the revolving line of credit existed at the balance sheet date. The fair value of our mortgage loans are estimated using Level 2 inputs based on the Company's current incremental borrowing rate for comparable borrowing arrangements.
The table below details the fair value and carrying values for the mortgage loans as of the following dates:
November 1, 2014 | February 1, 2014 | |||||||||||||||
(in thousands) | Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||
Mortgage loans on land & buildings | 3,711 | 4,512 | 5,319 | 5,581 |
NOTE 5: PROPERTY AND EQUIPMENT
Property and Equipment are carried at cost. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets. Improvements to leased premises are amortized using the straight-line method over the shorter of the initial term of the lease or the useful life of the improvement. Leasehold improvements added late in the lease term are amortized over the shorter of the remaining term of the lease (including the upcoming renewal option, if the renewal is reasonably assured) or the useful life of the improvement. Assets under capital leases are amortized in accordance with the Company’s normal depreciation policy for owned assets or over the lease term (regardless of renewal options), if shorter, and the charge to earnings is included in depreciation expense in the consolidated financial statements. Gains or losses on the sale of assets are recorded as a component of selling, general and administrative expenses.
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The following illustrates the breakdown of the major categories within Property and Equipment (in thousands):
November 1, 2014 | February 1, 2014 | |||||||
Property and equipment, at cost: | ||||||||
Buildings and building improvements | $ | 116,494 | $ | 114,688 | ||||
Leasehold improvements | 79,933 | 78,101 | ||||||
Automobiles and vehicles | 5,714 | 5,459 | ||||||
Airplane | 4,697 | 4,697 | ||||||
Furniture, fixtures and equipment | 272,117 | 268,771 | ||||||
478,955 | 471,716 | |||||||
Less: Accumulated depreciation and amortization | (345,933 | ) | (328,686 | ) | ||||
133,022 | 143,030 | |||||||
Construction in progress | 4,108 | 1,729 | ||||||
Land | 8,604 | 8,604 | ||||||
Total Property and equipment, at depreciated cost | $ | 145,734 | $ | 153,363 |
NOTE 6: EXIT AND DISPOSAL ACTIVITIES
Fixed Assets
The Company’s policy is to review the carrying value of all long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We measure impairment losses of fixed assets and leasehold improvements as the amount by which the carrying amount of a long-lived asset exceeds its fair value as prescribed by FASB ASC 360, "Impairment or Disposal of Long-Lived Assets." If a long-lived asset is found to be impaired, the amount recognized for impairment is equal to the difference between the carrying value and the asset’s fair value. The fair value is based on estimated market values for similar assets or other reasonable estimates of fair market value based upon using a discounted cash flow model.
During the second quarter of 2014, in association with the planned closure of stores not meeting the Company's operational performance targets, we recorded a charge of $2.9 million in selling, general and administrative expense for the impairment of fixed assets and leasehold improvements. Five stores were closed in the third quarter, and approximately 47 stores will close in the fourth quarter of 2014. In the third quarter of 2014, the Company utilized $0.2 million of the reserve associated with fixed assets and leasehold improvements for the five stores that closed leaving $2.7 million remaining in the reserve as of November 1, 2014.
Inventory
As discussed in Note 2 - Inventories, we adjust inventory values on a consistent basis to reflect current market conditions. In accordance with FASB ASC 330, "Inventories," we write down inventory to net realizable value in the period in which conditions giving rise to the write-downs are first recognized.
In the fourth quarter of 2013, a reserve in the amount of $1.7 million, was established for the discontinuance of product categories that the Company has decided to exit in line with the strategies that are part of the Company's reconfiguration plan. Product categories the Company has decided to exit are furniture, electronics, and footwear. During the first nine months of 2014, the Company recorded an additional markdown reserve to cost of goods sold for the discontinuance of the exit categories of $0.7 million, including $0.3 million for the accelerated recognition of freight capitalization expense, while utilizing $1.4 million of the reserve associated with goods sold in 2014.
In the third quarter of 2014, we recorded a below-cost inventory adjustment of approximately $3.3 million (including $1.3 million for the accelerated recognition of freight capitalization expense) to value inventory at the lower of cost or market on inventory in approximately 47 stores that are planned for closure in the fourth quarter of fiscal 2014. The adjustment was recorded to cost of goods sold in the Consolidated Statements of Income for the thirteen and thirty-nine week periods ended November 1, 2014.
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Lease Termination
For lease obligations related to closed stores, we record the estimated future liability associated with the rental obligation on the cease use date (when the stores were closed). The lease obligations are established at the cease use date for the present value of any remaining operating lease obligations, net of estimated sublease income, and at the communication date for severance and other exit costs, as prescribed by FASB ASC 420, “Exit or Disposal Cost Obligations.” Key assumptions in calculating the liability include the timeframe expected to terminate lease agreements, estimates related to the sublease potential of closed locations, and estimates of other related exit costs. If actual timing and potential termination costs or realization of sublease income differ from our estimates, the resulting liabilities could vary from recorded amounts. These liabilities are reviewed periodically and adjusted when necessary.
A lease obligation still exists for some store closures that occurred in 2008. During the first nine months of fiscal 2014, we utilized and added less than $0.1 million of the remaining lease liability for the fiscal 2008 store closures, leaving $0.1 million in the reserve at November 1, 2014.
The following table illustrates the exit and disposal reserves related to the store closures and strategic initiatives discussed in the previous paragraphs (in millions):
Balance at February 1, 2014 | Additions | Utilization | Ending Balance November 1, 2014 | |||||||||||||
Inventory markdowns for discontinuance of exit categories | $ | 1.7 | $ | 0.4 | $ | (1.2 | ) | $ | 0.9 | |||||||
Inventory provision for freight capitalization expense, exit categories | $ | - | $ | 0.3 | $ | (0.2 | ) | $ | 0.1 | |||||||
Inventory markdowns for 2014 planned closures | $ | - | $ | 2.0 | $ | - | $ | 2.0 | ||||||||
Inventory provision for freight capitalization expense, 2014 planned closures | $ | - | $ | 1.3 | $ | - | $ | 1.3 | ||||||||
Lease contract termination liability, 2008 closures | $ | 0.1 | $ | - | $ | - | $ | 0.1 | ||||||||
Total | $ | 1.8 | $ | 4.0 | $ | (1.4 | ) | $ | 4.4 |
We expect to record the lease termination costs related to the planned closure of approximately 47 stores in the fourth quarter of 2014. Charges associated with lease terminations are expected to be in the range of $0.3 million to $0.6 million. Additional one-time charges to selling, general and administrative expenses associated with going out of business activities are anticipated to be in the range of $2.5 million to $3.5 million.
NOTE 7: ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive income consists of two components, net income and other comprehensive income (loss). Other comprehensive income (loss) refers to gains and losses that under GAAP are recorded as an element of shareholders’ equity but are excluded from net income. The Company’s accumulated other comprehensive income includes the unrecognized prior service costs, transition obligations and actuarial gains/losses associated with our postretirement benefit plan.
The following table illustrates the activity in accumulated other comprehensive income:
Thirteen Weeks Ended | Year Ended | |||||||||||
(in thousands) | November 1, 2014 | November 2, 2013 | February 1, 2014 | |||||||||
Accumulated other comprehensive income | $ | 703 | $ | 794 | $ | 794 | ||||||
Amortization of postretirement benefit | - | - | (91 | ) | ||||||||
Ending balance | $ | 703 | $ | 794 | $ | 703 |
NOTE 8: RELATED PARTY TRANSACTIONS
Atlantic Retail Investors, LLC, which is partially owned by Michael J. Hayes, a director of the Company and Chairman of the Board, owns the land and buildings occupied by three Fred’s stores. The terms and conditions regarding the leases on these locations are consistent in all material respects with other stores leases of the Company with unrelated landlords. The total rental payments related to related party leases were $234.6 thousand and $225.7 thousand for the thirty-nine weeks ended November 1, 2014 and November 2, 2013, respectively.
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NOTE 9: LEGAL CONTINGENCIES
In July 2008, a lawsuit styled Jessica Chapman, on behalf of herself and others similarly situated, v. Fred's Stores of Tennessee, Inc. was filed in the United States District Court for the Northern District of Alabama, Southern Division, in which the plaintiff alleges that she and other female assistant store managers are paid less than comparable males and seeks compensable damages, liquidated damages, attorney fees and court costs. The plaintiff filed a motion seeking collective action. On or about March 15, 2013, the Magistrate Judge issued a Report and Recommendation that the case be conditionally certified as a collective action, which the District Court Judge affirmed. As a result, notice of a collective action was sent to the appropriate class as required by the Court. One hundred ninety four plaintiffs opted into the suit, and approximately one hundred seventy plaintiffs currently remain in the suit. The Company believes that all of its assistant managers have been properly paid and that the matter is not appropriate for collective action treatment. The Company is and will continue to vigorously defend this matter; however, it is not possible to predict whether Chapman will ultimately be able to proceed collectively and no assurances can be given that the Company will be successful in the defense of the action on the merits or otherwise. In accordance with FASB ASC 450, “Contingencies,” the Company does not believe at this time that a loss in this matter is probable. For these reasons, the Company is unable to estimate any potential loss or range of loss in the matter. The Company has tendered the matter to its Employment Practices Liability Insurance (“EPLI”) carrier for coverage under its EPLI policy. At this time, the Company expects that the EPLI carrier will participate in the defense or resolution of part or all of the potential claims.
In addition to the matters disclosed above, the Company is party to several pending legal proceedings and claims arising 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 these proceedings and claims should not have a material adverse effect on the financial statements as a whole. However, litigation involves an element of uncertainty. Future developments could cause these actions or claims, individually or in aggregate, to have a material adverse effect on the financial statements as a whole.
NOTE 10: CUMULATIVE EFFECT OF A CORRECTION OF AN ERROR IN THE CASH FLOW STATEMENT
In the second quarter of 2013, the Condensed Consolidated Statements of Cash Flows (Cash Flows Statement) was changed to correct the presentation of proceeds received and net gain resulting from the sale of pharmacy department prescription files. From time-to-time, the Company closes an underperforming pharmacy department and sells the related prescription files. In previous filings, the proceeds received and gain resulting from the sale of pharmacy department prescription files were neither presented on the face of the Cash Flows Statement as an addition to cash flows provided by investing activities nor as a reduction to cash flows provided by operating activities. Going forward, the proceeds received from the sale of pharmacy prescription files will be shown on the face of the Cash Flows Statement as part of proceeds from asset dispositions in investing activities, and the net gain from the sale will be presented as a part of net loss (gain) on asset disposition in operating activities.
In accordance with Staff Accounting Bulletin 99, quantifying the impact of the corrected presentation on our Cash Flows Statement, we have determined that the quantitative impact on the Cash Flows Statement was immaterial to both the net cash provided by operating activities and the net cash used by investing activities. In addition, qualitatively, this misstatement had no effect on the Consolidated Income Statements or Consolidated Balance Sheets presented in our filed Form 10-Qs or Form 10-Ks from fiscal year 2011 through the first quarter of 2013. Additionally, there was no impact on our debt covenant requirements or our previous Liquidity and Capital Resources disclosures.
NOTE 11: NEW PRIME VENDOR AGREEMENT WITH PRIMARY PHARMACEUTICAL WHOLESALER
On August 6, 2014, the Company entered into a Prime Vendor Agreement (the “Agreement”) with Cardinal Health, Inc., one of the nation’s largest healthcare services companies. Cardinal Health will serve as Fred’s new primary wholesale supplier for branded and generic pharmaceuticals under a multi-year agreement that began on October 1, 2014. The agreement with Cardinal Health replaced the Prime Vendor Agreement the Company had with AmerisourceBergen Drug Corporation, which expired in accordance with the contract on September 30, 2014.
Under the Agreement, Fred’s and Cardinal Health established a mutually beneficial strategic alliance designed to support Fred’s key initiative of rapid pharmacy growth, and build on a foundation of premier supply chain and asset management tools. The initial term of the Agreement commenced on October 1, 2014 and shall continue through the longer of 1) March 31, 2018 or 2) the date upon which the Company’s net aggregate generic purchases reach a certain purchase requirement, provided that date is not before September 30, 2017.
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Management's Discussion and Analysis of Financial
Condition and Results of Operations
GENERAL
Executive Overview
Fred's, Inc. and subsidiaries ("Fred's", “We”, “Our”, “Us” or “Company”) operates, as of November 1, 2014, 703 discount general merchandise stores, including 21 franchised Fred's stores, in 15 states in the southeastern United States. There are currently 362 full service pharmacies in our stores. Our mission is to be the hometown pharmacy and discount store that provides a fast, fun and friendly low-price place to shop. Approximately 84% of our stores are located in markets with populations of 15,000 or less, where Fred’s provides often the only, or one of only two, pharmacies in town.
Fred’s is a unique combination of pharmacy, dollar store and mass merchant. We offer a broader assortment than traditional dollar stores and pharmacies with greater convenience than big box retailers. We offer different product categories to drive shopping frequency (including consumables such as tobacco, food and beverage, prescription pharmaceuticals, paper and cleaning supplies, pet supplies, health and beauty aids) and to drive higher profitability (including discretionary products such as home décor, seasonal merchandise, auto and hardware and lawn and garden). Our general merchandise selection includes a diverse array of brand name and private label staple and discretionary products at value prices. We operate in the discount retail variety sector and approximately 90% of the products offered in our stores retail between $1 and $10.
In the first quarter of 2013, the Company announced the launch of our three-year reconfiguration plan to regain the momentum we had in the prior three years in driving toward our 4% operating margin goal. In 2009, 2010 and 2011, our operating income as a percent of sales was 2.1%, 2.5% and 2.7%, respectively. The main focus of our reconfiguration plan is to improve our overall store productivity and space efficiency while enhancing the product selection in stores with pharmacies. The plan has two fundamental principles: to aggressively accelerate our pharmacy department presence and to improve our general merchandise space efficiency and productivity.
In our first quarter press release filed Thursday, May 29, 2014, the Company announced updates to our reconfiguration plan in fiscal 2014. We confirmed through extensive research that customers use Fred’s for their "need it now" convenience trips. We see this as an opportunity to further leverage non-consumable, higher margin "immediate need" convenience departments which include Bed, Bath, Kitchen, Home Improvement (which includes Hardware), Seasonal and Pet.
Also as an outcome of the extensive research performed in the first half of the year, during the second quarter of 2014, the Company embarked on a promotional program to reduce low-productive inventory that does not fit the go-forward convenient and pharmacy healthcare services model and its gross margin return-on-investment (GMROI) objectives. An $11.9 million lower of cost or market write-down of this promotional inventory was recorded in the second quarter. The Company incurred $2.3 million of above-cost markdowns from sales of this inventory during the third quarter of 2014. The reduction of these SKUs will make way for our improved convenient and pharmacy healthcare services model.
In line with the reconfiguration plan, the Company closed five under-performing stores in the third quarter of 2014 and has announced it will close 47 additional stores by the end of the fourth quarter of 2014. As a result, a write-down of the fixed assets in these closed stores was recorded in the second quarter, which totaled $2.9 million, and a $3.3 million lower of cost or market write down of the closed store inventory was recorded in the third quarter. In the fourth quarter of 2014, the Company will record the closed stores’ lease liability and additional one-time charges associated with closing the stores in the range of $7.2 million to $10.2 million. The stores selected for closure contribute less than the Company’s average return on invested capital and do not have pharmacy departments. Capital previously spent to operate these locations will be used to invest in pharmacy acquisitions.
To further help drive the store performance, the Company is collectively focused on those initiatives that will drive the success of Fred’s into 2015 and beyond. The first principle includes building the talent at Fred’s that will drive profitability and growth. Toward that effort, the Company announced October 24, 2014, the promotion of Craig Barnes from Senior Vice President, Global Sourcing and Hardlines to Executive Vice President, General Merchandise Manager and anticipate filling the President and Chief Operating Officer position by the end of fiscal 2014.
The second principle is to implement the structure, processes and disciplines that coordinate efforts throughout the organization. We have taken significant steps this year to reinstill disciplines, processes and structure into our organization and will leverage this progress to improve the level of execution in our stores. A few of the major processes that will drive successful performance include our business and line review in all our product categories, life-cycle management of our seasonal inventory and our in-store marketing initiatives.
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The third principle is to refine the store and pharmacy model that showcases Fred’s competitive advantages of convenience, friendliness and pharmacy service offerings. While internet purchases will continue to increase, convenience will drive traffic in the future. We are now piloting a revamped front-end store model in five of our stores. Early indications show that comparable store sales have increased double-digits in the revamped stores. We will continue to refine our model using key performance indicators such as traffic, sales mix, gross margin return on investment and inventory turn. We plan to roll out the new model in 20 of our stores each month for the first six months of 2015.
Fred’s stores with pharmacy departments outperform our retail locations without pharmacy departments. Our pharmacy department is a key differentiating factor from other small-box discount retailers. Pharmacy department penetration was 50% at the end of 2012, as compared to 53% at the end of the third quarter of 2014. Under the reconfiguration plan, we are increasing pharmacy department penetration to between 65% to 70% by the end of 2015. To achieve this goal, we will concentrate on adding pharmacies to existing stores without pharmacy departments, opening all new stores with a pharmacy department and making opportunistic acquisitions that will operate as Xpress pharmacy locations until they become a future full-service location. Our pharmacy departments should continue to benefit from the aging U.S. population, an expected increase in patient prescription compliance and customers who are newly insured under the Affordable Care Act. Pharmacy department penetration is projected to be in the range of 58% to 59% by the end of 2014.
This growth in pharmacy department locations positions us to expand our other pharmacy offerings such as our specialty pharmacy program, our customer-centric clinical services offerings and an improved over-the-counter offering in health and beauty aids. Specialty pharmacy is the fastest-growing segment of the pharmacy industry. During 2012, we entered into an agreement with Diplomat Specialty Pharmacy to provide clinical and patient administration services necessary to manage our patients who are receiving specialty medications. Specialty medications are high cost drugs that are used to treat chronic or rare conditions such as hepatitis, cancer, multiple sclerosis, rheumatoid arthritis and other complex diseases. We recently anniversaried the opening of EIRIS Health Services and continue to be pleased with the initial progress surrounding the execution of our specialty pharmacy initiative, including the on-going relationship with Diplomat Specialty and the opportunities to expand our presence in the specialty pharmacy market. Fred’s clinical services offerings are focused on driving increased immunizations, assisting our customers with medication therapy management, rolling out “Time My Meds”, which is focused on prescription adherence, and expanding our disease management services, beginning with diabetes management.
In the second quarter of 2014, the Company announced the execution of a new prime vendor multi-year agreement with pharmacy wholesaler Cardinal Health to serve as Fred’s new primary wholesale supplier for branded and generic pharmaceuticals beginning on October 1, 2014. Under the prime vendor agreement, Fred’s and Cardinal Health have established a mutually beneficial strategic alliance designed to support Fred’s key initiative of rapid pharmacy growth, and build on a foundation of premier supply chain and asset management tools.
Beginning in the second quarter, we implemented marketing and branding changes to emphasize those “need it now” trips and drive customer traffic. We began relaying our stores with a new front-end configuration for a faster checkout and a realignment of category adjacencies to highlight and brand our in-store convenience centers. The front end of our stores will be re-laid with power displays and pallets, along with a faster check-out configuration, all focused on ease of shopping and designed to become the convenient, small-box store of choice.
Third Quarter 2014 Financial Results
As reported in our earnings release published on November 25, 2014, sales in the third quarter of 2014 increased 3% to $476.2 million from $460.5 million in the third quarter of 2013. Comparable store sales for the quarter increased 0.3% on top of an increase of 1.4% in the same quarter last year. For the first nine months of 2014, sales increased 2% to $1.466 billion from $1.444 billion in the year earlier period. Comparable store sales for the first nine months of the year decreased 0.5% as compared to an increase of 1.1% in the year earlier period. As a percent of sales, pharmacy department sales increased to 44.1% of total sales in the third quarter and 40.1% of sales at the same time last year, continuing to rank as the top department in our stores.
Fred's gross profit for the third quarter of 2014 decreased 12% to $123.5 million from $140.2 million in the prior-year period. Gross margin for the quarter decreased to 25.9% from 30.5% in the same quarter last year. Excluding the impact of the inventory reserves recorded in the second and third quarters and the non-recurring tax charges recorded in the third quarter, gross margin was 27.1%, 340 basis points below last year. Gross profit for the first nine months of 2014 decreased 11% to $379.6 million from $427.2 million in the prior-year period. Gross margin for the nine-month period decreased to 25.9% compared with 29.6% in the prior-year period. Excluding the impact of the inventory reserves recorded in the second and third quarters and the non-recurring tax charges recorded in the third quarter, gross margin was 27.1%, 250 basis points below last year. The deleveraging in gross profit in both the quarter and year-to-date periods was driven by continuing pressure on pharmacy initial markup driven by historically large generic inflation coupled with the maturing reimbursement rates on prior brand-to-generic conversions, sales mix changes in general merchandise toward other consumable product departments, and aggressive promotional activity throughout general merchandise departments.
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For the third quarter ended November 1, 2014, Fred's net loss totaled $10.4 million or ($0.28) per share compared with net income of $7.3 million or $0.20 per share for the third quarter ended November 2, 2013. Fred's net loss for the first nine months of fiscal 2014 was $20.8 million or ($0.56) per diluted share versus net income of $22.0 million or $0.60 per share in the year-earlier period. Excluding the impact of the inventory reserves recorded in the second and third quarters and the non-recurring tax charges recorded in the third quarter, net loss for the third quarter was $6.2 million or ($0.16) per share and $7.2 million or ($0.19) per diluted share for the first nine months of the year.
Although earnings this year have been affected by many factors, we have made significant progress in improving the infrastructure, strengthening the balance sheet and improving cash flow. By clearing less productive merchandise, we generated positive working capital during the quarter and have no borrowings under our revolving line of credit. We expect the investments and changes made in 2014 will bring stronger financial performance in 2015 and beyond, while allowing us to continue our growth.
At November 1, 2014, cash and cash equivalents were $7.6 million, down from $21.6 million at the same time last year, reflecting our on-going investments in pharmacy acquisitions. The inventory balance at the end of the third quarter decreased 8.6% to $352.3 million from $385.6 million at the same time last year, the result of clearing low-productive inventory in our stores. At the end of the third quarter of 2014, there were no borrowings under our revolving line of credit and total indebtedness related to mortgage liabilities totaled $3.6 million as compared to $5.2 million at the end of the third quarter of 2013.
In our sales release dated January 9, 2014, the Company announced that we have engaged financial advisors Bank of America Merrill Lynch and Peter J. Solomon to review strategic opportunities to enhance shareholder value. The Board of Directors, with the assistance of its financial advisors, was considering a range of options, which could include a sale or merger of the Company, a strategic alliance with another company, a recapitalization of the Company or none of the foregoing. In our Form 8-K dated November 26, 2014, Fred's, Inc. stated that after a comprehensive and diligent process, the Company did not receive indications of interest that were satisfactory to the Board of Directors for a sale of the Company. The Company continues to explore both acquisitions and the recapitalization of the Company. The Company does not intend to comment further regarding this process until such time as its Board of Directors has determined the outcome of the process or otherwise determined that disclosure is required or appropriate.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s condensed financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The critical accounting matters that are particularly important to the portrayal of the Company’s financial condition and results of operations, and require some of management’s most difficult, subjective and complex judgments, are described in detail in the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2014. The preparation of condensed financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to inventories, income taxes, insurance reserves, contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
In the second quarter of 2014, the Company made a refinement to its revenue recognition policy concerning gift card breakage. The Company sells gift cards for which the revenue is recognized at time of redemption. The Company has stated in our Form 10-K, filed April 17, 2014, that we will begin to recognize aged liabilities as revenue when the likelihood of the gift card being redeemed is remote ("gift card breakage") and that the Company had not recognized any revenue from gift card breakage since the inception of the program in 2004 and did not intend to record any gift card breakage revenue until there was more certainty regarding our ability to retain such amounts in light of current consumer protection and state escheatment laws.
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Utilizing 10 years of gift card data provided by third party vendor Bank of America during Q2, a clear redemption and breakage trend emerged. Fred’s gift cards hit their redemption peak of approximately 87% by the end of third year of activation, resulting in a 13% breakage trend. In addition, Fred’s gift card liability is governed by Tennessee’s escheat laws which state that gift cards issued after 1998 are not considered abandoned property. Therefore, the Company revised the estimate of gift card breakage revenue during the second quarter of 2014. In the first nine months of 2014, the Company has recognized $0.9 million of gift card revenue, or $0.02 per share. Going forward, the balance on gift cards activated at least 36 months will be considered to represent gift card breakage and the liability balance on those cards will be recognized as part of revenue.
RESULTS OF OPERATIONS
Thirteen Weeks Ended November 1, 2014 and November 2, 2013
Sales
Net sales for the third quarter of 2014 increased to $476.2 million from $460.5 million in 2013, a year-over-year increase of $15.7 million or 3.4%. On a comparable store basis, sales increased 0.3% on top of a 1.4% increase in the same period last year.
General merchandise (non-pharmacy) sales decreased 2.8% to $258.3 million from $265.8 million in 2013. We experienced sales decreases in departments such as toys, food, cleaning supplies and home furnishings which were partially offset by sales increases in ladies apparel and accessories and hardware.
The Company’s pharmacy department sales were 44.2% of total sales ($210.5 million) in 2014 compared to 40.5% of total sales ($186.5 million) in the prior year and continue to rank as the largest department within the Company. The total sales in this department increased 12.8% over 2013 with third party prescription sales representing approximately 92% of total pharmacy sales, 1% above the prior year. The Company’s pharmacy department continues to benefit from an ongoing program of purchasing prescription files from independent pharmacies as well as the addition of EIRIS Specialty Pharmacy and pharmacy departments in existing store locations.
During the quarter, there were no changes to the franchised locations, with 21 franchised locations at November 1, 2014 and November 2, 2013. Sales to our franchised locations during 2014 were $7.4 million (1.5% of sales) compared to $8.2 million (1.8% of sales) in the prior year. The Company does not intend to expand its franchise network.
The following table illustrates the sales mix, unadjusted for deferred layaway sales:
Thirteen Weeks Ended | ||||||||
November 1, 2014 | November 2, 2013 | |||||||
Pharmaceuticals | 44.1 | % | 40.1 | % | ||||
Household Goods | 18.3 | % | 19.4 | % | ||||
Food and Tobacco | 17.2 | % | 17.8 | % | ||||
Paper and Cleaning Supplies | 8.2 | % | 8.8 | % | ||||
Health and Beauty Aids | 6.7 | % | 7.0 | % | ||||
Apparel and Linens | 4.0 | % | 5.2 | % | ||||
Franchise | 1.5 | % | 1.7 | % | ||||
100.0 | % | 100.0 | % |
For the quarter, comparable store customer traffic decreased 1.9% over last year while the average customer ticket increased 2.2% to $21.30.
Gross Profit
Gross profit for the third quarter decreased to $123.5 million in 2014 from $140.2 million in 2013, a decrease of $16.7 million or 11.9%. Gross margin, measured as a percentage of sales, was 25.9% in 2014, a decrease of 460 basis points as compared to 30.5% in the same quarter last year. In the quarter, gross margin was negatively affected by a reserve for inventory markdowns on the planned closure of stores, above-cost markdowns such as those to clearance our low-productive (promotional) and exit related inventory, and aggressive promotional activities throughout general merchandise categories. Gross margin deleveraging was also driven by extraordinary generic pharmaceutical inflation coupled with continued pressure on generic pharmaceutical reimbursement rates. The reimbursement adjustments from third parties have not been made at the pace of the manufacturer’s rate of price increases.
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Selling, General and Administrative Expenses
Selling, general and administrative expenses, including depreciation and amortization, increased to $140.1 million (29.4% of sales) in 2014 from $129.6 (28.2% of sales) million in 2013, an increase of $10.5 million. The 120 basis points deleveraging in the third quarter was comprised of increased payroll expense (67 basis points) driven by pharmacy department growth, an increase in occupancy related costs (35 basis points), an increase in insurance expense (27 basis points) and higher advertising expense (18 basis points) associated with our new marketing program that began in late May. The deleveraging was partially offset by lower depreciation and amortization expense (15 basis points), primarily the result of extending the useful life of the pharmacy department intangible script files from five to seven years in the fourth quarter of 2013.
Operating Income (Loss)
Operating loss was ($16.6) million or (3.5%) of sales in 2014 compared to operating income of $10.6 million or 2.3% of sales in 2013. The $27.2 million decrease in operating income is attributable to the $16.7 million decrease in gross profit, driven by inventory reserves, above-cost markdowns on promotional and exit related inventory, aggressive promotional activities throughout general merchandise categories and extraordinary generic pharmaceutical inflation coupled with continued pressure on generic pharmaceutical reimbursement rates. Also decreasing operating income was the $10.5 million increase in selling, general and administrative expenses as detailed in the Selling, General and Administrative Expenses section above.
Interest Expense, Net
Net interest expense for the third quarter totaled $0.1 million or less than 0.1% of sales, unchanged from the prior year.
Income Taxes
The effective income tax rate for the third quarter of 2014 was 37.5% compared to 30.6% in the third quarter of 2013. The increase in the effective income tax rate is primarily the result of the expiration of the federal Work Opportunity Tax Credits (WOTC) at the end of 2013. The federal WOTC are expected to be reinstated in the fourth quarter of 2014. Income tax benefit for the quarter was ($6.3) million compared to income tax expense of $3.2 million in the third quarter of 2013.
Net Income (Loss)
Net loss for the third quarter totaled ($10.4) million or ($0.28) per diluted share in 2014 as compared to net income of $7.3 million or $0.20 per diluted share in 2013, a decrease of $17.7 million. The decrease in net income was due to the $16.7 million decrease in gross profit, driven by inventory reserves, above-cost markdowns on promotional and exit related inventory, aggressive promotional activities throughout general merchandise categories and extraordinary generic pharmaceutical inflation coupled with continued pressure on generic pharmaceutical reimbursement rates. Net income also decreased due to the $10.5 million increase in selling, general and administrative expenses as detailed in the Selling, General and Administrative Expenses section above. The decrease in gross profit was partially offset by a decrease in income tax expense of $9.5 million driven by lower gross profit which more than offset the higher effective tax rate.
Thirty-nine Weeks Ended November 1, 2014 and November 2, 2013
Sales
Net sales for the first nine months of 2014 increased to $1.466 billion from $1.444 billion in 2013, a year-over-year increase of $21.4 million or 1.5%. On a comparable store basis, sales decreased 0.5% ($6.4 million) compared with a 1.1% ($11.3 million) increase in the same period last year.
General merchandise (non-pharmacy) sales decreased 4.9% to $834.1 million in 2014 from $877.0 million in 2013. The decrease resulted primarily from categories such as food, bedding and window, cleaning supplies, toys and beverages which were partially offset by sales increases in ladies apparel and accessories and tobacco.
The Company’s pharmacy department sales were 41.5% of total sales ($608.2 million) in 2014 compared to 37.6% of total sales ($542.6 million) in the prior year and continue to rank as the largest department within the Company. The total sales in this department increased 12.1% over 2013 with third party prescription sales representing approximately 92% of total pharmacy sales, 1% above the prior year. The Company’s pharmacy department continues to benefit from an ongoing program of purchasing prescription files from independent pharmacies as well as the addition of pharmacy departments in existing store locations, in line with our reconfiguration plan.
During the first half of 2014, there were no changes to franchised locations leaving 21 franchised locations as of November 1, 2014 and November 2, 2013. Sales to our franchised locations during 2014 decreased to $23.4 million (1.6% of sales) from $24.7 million (1.7% of sales) in 2013. The Company does not intend to expand its franchise network.
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The following table illustrates the sales mix unadjusted for deferred layaway sales:
Thirty-Nine Weeks Ended | ||||||||
November 1, 2014 | November 2, 2013 | |||||||
Pharmaceuticals | 41.4 | % | 37.4 | % | ||||
Household Goods | 20.5 | % | 21.6 | % | ||||
Food and Tobacco | 17.0 | % | 17.7 | % | ||||
Paper and Cleaning Supplies | 8.2 | % | 8.7 | % | ||||
Health and Beauty Aids | 6.7 | % | 7.1 | % | ||||
Apparel and Linens | 4.6 | % | 5.8 | % | ||||
Franchise | 1.6 | % | 1.7 | % | ||||
100.0 | % | 100.0 | % |
For the first nine months, comparable store customer traffic decreased 2.9% over last year and the average customer ticket increased 2.4% to $21.49.
Gross Profit
Gross profit for the first nine months of 2014 decreased to $379.6 million from $427.2 million in 2013, a year-over-year decrease of $47.6 million or 11.1%. Gross margin, measured as a percentage of sales was 25.9% in 2014 as compared to 29.6% last year. In the first nine months of 2014, gross margin deleveraging was negatively affected by a reserve for inventory clearance of product that management identified as low-productive, a reserve for inventory markdowns on the discontinuance of product categories that the Company has decided to exit and a reserve for inventory markdowns on the planned closure of stores. Also contributing to the gross margin deleveraging were aggressive promotional activities and additional above-cost markdowns for the clearance of our promotional and exit related categories. The gross margin deleveraging was also driven by extraordinary generic pharmaceutical inflation coupled with continued pressure on generic pharmaceutical reimbursement rates. The reimbursement adjustments from third parties have not been made at the speed of the manufacturer’s rate of price increases.
Selling, General and Administrative Expenses
Selling, general and administrative expenses, including depreciation and amortization was $412.3 million in the first nine months of 2014 (28.1% of sales) as compared to $393.6 million in 2013 (27.3% of sales). The 80 basis points deleveraging in the first nine months of 2014 was driven by increased occupancy related costs (50 basis points), increased payroll expense (32 basis points) driven by the year over year pharmacy department growth and an unfavorable experience in the gain or loss recorded on the disposal of fixed assets (12 basis points) resulting from a reserve for the impairment of fixed assets due to planned store closings in the fourth quarter. The deleveraging was partially offset by lower depreciation and amortization expense (11 basis points), primarily the result of extending the useful life of the pharmacy department intangible script files from five to seven years in the fourth quarter of 2013.
Operating Income (Loss)
Operating loss was ($32.7) million or (2.2%) of sales in 2014 as compared to operating income of $33.6 million or 2.3% of sales in 2013. The year-over-year decrease of $66.3 million is attributable to the $47.6 million decrease in gross profit that was driven by inventory reserves, markdowns from aggressive promotional activities and to clearance our promotional and exit related inventory, and generic pharmaceutical inflation combined with pressure on generic pharmaceutical reimbursement rates. Also decreasing operating income was the $18.7 million increase in selling, general and administrative expenses as detailed in the Selling, General and Administrative Expenses section above.
Interest Expense, Net
Net interest expense for 2014 totaled $0.4 million or less than 0.1% of sales, unchanged from 2013.
Income Taxes
The effective income tax rate for the year-to-date period was 37.3% in 2014 compared to 33.7% in 2013. The increase in the effective income tax rate is primarily the result of the expiration of the federal Work Opportunity Tax Credits (WOTC) at the end of 2013. The federal WOTC are expected to be reinstated in the fourth quarter of 2014. Income tax benefit for the year was ($12.3) million compared to income tax expense of $11.2 million in 2013. The benefit resulting from an operating loss more than offset the higher effective tax rate.
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Net Income (Loss)
Net loss was ($20.8) million or ($0.56) per diluted share in 2014 as compared to net income $22.0 million or $0.60 per diluted share in 2013, a decrease of $42.8 million. The decrease in net income was due to the $47.6 million decrease in gross profit that was driven by inventory reserves, markdowns from aggressive promotional activities and to clearance our promotional and exit related inventory, and generic pharmaceutical inflation combined with pressure on generic pharmaceutical reimbursement rates, and the $18.7 million of increased selling, general and administrative expenses as described in the Selling, General and Administrative section above. These increases more than offset the $23.5 million decrease in income tax expense driven by the operating loss.
LIQUIDITY AND CAPITAL RESOURCES
Due to the seasonality of our business and the increase in the number of stores and pharmacies, inventories are generally lower at year-end than at each quarter-end of the following year.
Net cash flow provided by operating activities totaled $50.0 million during the thirty-nine week period ended November 1, 2014, compared to $57.5 million in the same period of the prior year. Cash generated from operating activities primarily resulted from an increase in operating liabilities of $42.8 million, $30.3 million in depreciation and amortization expense, driven by pharmacy department growth, an increase in our reserves of $14.2 million resulting from our promotional inventory strategy and decision to close stores in the fourth quarter and an increase to the LIFO reserve of $2.4 million. Offsetting the increases to cash were a net loss of $20.8 million, a deferred income tax benefit of $9.0 million driven by our net loss position, an increase in trade and non-trade receivables of $4.8 million related to pharmacy department growth and an increase in inventory, excluding the reserves, of $4.2 million.
Net cash used in investing activities totaled $41.7 million during the thirty-nine week period ended November 1, 2014 compared to $30.2 million in the same period last year. Capital expenditures in the first nine months of 2014 totaled $17.9 million related to existing store and pharmacy expenditures ($11.4 million), technology and other corporate expenditures ($4.5 million) and new store and pharmacy expenditures ($2.0 million). In addition, the Company plans expenditures of approximately $45.9 million in 2014 for the acquisition of prescription lists and other pharmacy related items of which $28.3 million has been spent to date. During the first nine months of 2014, we opened two full-service stores and 13 Xpress pharmacy stores. Fred's also closed 10 full-service stores and six Xpress pharmacy locations during this period. In 2014, the Company is planning capital expenditures, excluding the acquisition of prescription lists, of approximately $28.5 million. Expenditures are planned totaling $21.9 million for new and existing stores and pharmacies. Planned expenditures also include approximately $3.9 million for technology upgrades and approximately $2.7 million for distribution center equipment and other capital maintenance. Technology upgrades in 2014 will be made in the areas of IT software and hardware and mainframe upgrades. To date, the Company has spent $2.7 million towards these improvements.
Net cash used in financing activities totaled $7.4 million during the thirty-nine week period ended November 1, 2014 while net cash used by financing activities was $13.9 million in the same period last year. During the first nine months of 2014, we borrowed and repaid $383.6 on our revolving line of credit, paid cash dividends of $6.6 million and paid $1.6 million on our mortgage debt. There were $3.7 million in borrowings outstanding at November 1, 2014 related to real estate mortgages compared to $5.3 million at February 1, 2014. There were no borrowings under the revolving line of credit at November 1, 2014.
We believe that sufficient capital resources are available in both the short-term and long-term through currently available cash and cash generated from future operations and, if necessary, the ability to obtain additional financing.
FORWARD-LOOKING STATEMENTS
Other than statements based on historical facts, many of the matters discussed in this Form 10-Q relate to events which we expect or anticipate may occur in the future. Such statements are defined as “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), 15 U.S.C. Sections 77z-2 and 78u-5. The Reform Act created a safe harbor to protect companies from securities law liability in connection with forward-looking statements. We intend to qualify both our written and oral forward-looking statements for protection under the Reform Act and any other similar safe harbor provisions.
The words "outlook", "guidance", "may", "should", "could", “believe”, “anticipate”, “project”, “plan”, “expect”, “estimate”, “objective”, “forecast”, “goal”, “intend”, “will likely result”, or “will continue” and similar expressions generally identify forward-looking statements. All forward-looking statements are inherently uncertain, and concern matters that involve risks and other factors that may cause the actual performance of the Company to differ materially from the performance expressed or implied by these statements. Therefore, forward-looking statements should be evaluated in the context of these uncertainties and risks, including but not limited to:
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· | Economic and weather conditions which affect buying patterns of our customers and supply chain efficiency; |
· | Changes in consumer spending and our ability to anticipate buying patterns and implement appropriate inventory strategies; |
· | Continued availability of capital and financing; |
· | Competitive factors, and the ability to recruit and retain employees; |
· | Changes in the merchandise supply chain; |
· | Changes in pharmaceutical inventory costs; |
· | Changes in reimbursement practices for pharmaceuticals; |
· | Governmental regulation; |
· | Increases in insurance costs; |
· | Cyber security risks; |
· | Increases in fuel and utility rates; |
· | Potential adverse results in the litigation described under Legal Proceedings (see Note 9 - Legal Contingencies); |
· | Other factors affecting business beyond our control, including (but not limited to) those discussed under Part 1, ITEM 1A “Risk Factors” of the Company’s Annual Report on Form 10-K for the fiscal year ended February 1, 2014. |
Consequently, all forward-looking statements are qualified by this cautionary statement. Readers should not place undue reliance on any forward-looking statements. We undertake no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We have no holdings of derivative financial or commodity instruments as of November 1, 2014. We are exposed to financial market risks, including changes in interest rates. There were no borrowings at November 1, 2014, and November 2, 2013, under our Revolving Loan and Credit Agreement, which bears interest at our option, on a sliding scale from 1.00% - 1.625% plus LIBOR, or an alternative base rate. An increase in interest rates of 100 basis points would not significantly affect our income. All of our business is transacted in U.S. dollars and, accordingly, foreign exchange rate fluctuations have not had a significant impact on us, and they are not expected to in the foreseeable future.
CONTROLS AND PROCEDURES
(a) Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Accounting Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, the Chief Executive Officer and the Chief Accounting Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Additionally, they concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that the Company is required to file or submit under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and the Chief Accounting Officer, as appropriate to allow timely decisions regarding required disclosures.
(b) Changes in Internal Control over Financial Reporting. There have been no changes during the quarter ended November 1, 2014 in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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In July 2008, a lawsuit styled Jessica Chapman, on behalf of herself and others similarly situated, v. Fred's Stores of Tennessee, Inc. was filed in the United States District Court for the Northern District of Alabama, Southern Division, in which the plaintiff alleges that she and other female assistant store managers are paid less than comparable males and seeks compensable damages, liquidated damages, attorney fees and court costs. The plaintiff filed a motion seeking collective action. On or about March 15, 2013, the Magistrate Judge issued a Report and Recommendation that the case be conditionally certified as a collective action, which the District Court Judge affirmed. As a result, notice of a collective action was sent to the appropriate class as required by the Court. One hundred ninety four plaintiffs opted into the suit, and approximately one hundred seventy plaintiffs currently remain in the suit. The Company believes that all of its assistant managers have been properly paid and that the matter is not appropriate for collective action treatment. The Company is and will continue to vigorously defend this matter; however, it is not possible to predict whether Chapman will ultimately be able to proceed collectively and no assurances can be given that the Company will be successful in the defense of the action on the merits or otherwise. In accordance with FASB ASC 450, “Contingencies,” the Company does not believe that a loss in this matter is probable at this time. For these reasons, the Company is unable to estimate any potential loss or range of loss in the matter. The Company has tendered the matter to its Employment Practices Liability Insurance (“EPLI”) carrier for coverage under its EPLI policy. At this time, the Company expects that the EPLI carrier will participate in the defense or resolution of part or all of the potential claims.
In addition to the matters disclosed above, the Company is party to several pending legal proceedings and claims arising 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 these proceedings and claims should not have a material adverse effect on the financial statements as a whole. However, litigation involves an element of uncertainty. Future developments could cause these actions or claims, individually or in aggregate, to have a material adverse effect on the financial statements as a whole.
The risk factors listed in Part I, “Item 1A. Risk Factors” in the Annual Report on Form 10-K for the fiscal year ended February 1, 2014, should be considered with the information provided elsewhere in this Quarterly Report on Form 10-Q, which could materially adversely affect the business, financial condition or results of operations. There have been no material changes to the risk factors as previously disclosed in such Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On August 27, 2007, the Board of Directors approved a plan that authorized stock repurchases of up to 4.0 million shares of the Company’s common stock. Under the plan, the Company may repurchase its common stock in the open market or through privately negotiated transactions at such times and at such prices as determined to be in the Company’s best interest. On February 16, 2012, Fred's Board authorized the expansion of the Company's existing stock repurchase program by increasing the authorization to repurchase an additional 3.6 million shares or approximately 10% of the current outstanding shares. These repurchases may be commenced or suspended without prior notice depending on then-existing business or market conditions and other factors. No repurchases were made in the first nine months of 2014, leaving 3.0 million shares available for repurchase at November 1, 2014.
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Exhibit Index
Exhibit | Description | Manner of Filing | ||
10.29 | Prime Vendor Agreement between Fred's Stores of Tennessee, Inc. and Cardinal Health 110, LLC and Cardinal Health 410, LLC as of October 1, 2014 (1) | Incorporated by Reference | ||
10.30 | Amendment to Employment Agreement, dated July 30, 2014, between the Company and Bruce A. Efird (2) | Incorporated by Reference | ||
10.31 | Employment Agreement, effective November 3, 2014, between the Company and Jerry A. Shore | Filed Electronically | ||
31.1 | Certification of Chief Executive Officer | Filed Electronically | ||
31.2 | Certification of Executive Vice President and Chief Accounting Officer | Filed Electronically | ||
32 | Certification of Chief Executive Officer and Executive Vice President and Chief Accounting Officer pursuant to rule 13a–14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350 | Filed Electronically | ||
101.INS | XBRL Instance Document | Filed Electronically | ||
101.SCH | XBRL Taxonomy Extension Schema | Filed Electronically | ||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase | Filed Electronically | ||
101.DEF | XBRL Taxonomy Extension Definition Linkbase | Filed Electronically | ||
101.LAB | XBRL Taxonomy Extension Label Linkbase | Filed Electronically | ||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase | Filed Electronically |
(1) | Incorporated by reference to Exhibit 10.29 to the Registrant's Form 10-Q Report filed September 11, 2014. |
(2) | Incorporated by reference to Exhibit 10.30 to the Registrant's Form 10-Q Report filed September 11, 2014. |
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FRED'S, INC. | |
Date: December 11, 2014 |
/s/ Jerry A. Shore |
Jerry A. Shore | |
Chief Executive Officer | |
Date: December 11, 2014 |
/s/ Sherri L. Tagg |
Sherri L. Tagg | |
Executive Vice President and | |
Chief Accounting Officer |
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Exhibit 10.31
MANAGEMENT COMPENSATION AGREEMENT
FOR THE CEO OF FRED’S INC.
JERRY A. SHORE
This Management Compensation Agreement ("Agreement"), is made, and entered into and is effective as of November 3, 2014 by and between Fred’s Inc., a Tennessee corporation, with offices at 4300 New Getwell Road, Memphis, Tennessee 38118 ("Company") and Jerry A. Shore, whose address is 1857 Old Towne Ln, Germantown, TN 38139 ("Executive").
In consideration of the mutual covenants and conditions herein set forth, the parties hereto agree and each of them agrees as follows:
1. Term
Company hereby agrees to employ Executive to serve as its “Chief Executive Officer” for a term commencing from and after November 3, 2014 and ending February 4, 2017 (the "Initial Term"). At the end of the Initial Term and at the end of each successive Additional Term (defined below), the term of this Agreement shall be automatically extended annually for an additional one (1) year term unless either party provides three (3) month’s notice to the other party prior to the end of the term (each an "Additional Term").
2. Position and Duties
Executive agrees to serve as Company's "Chief Executive Officer" during the term of this Agreement. As such, Executive shall have and agrees to assume primary responsibility for the duties of the Chief Executive Officer reporting to the Chairman of the Board and the entire Board of the Company and such other duties assigned by the Chairman. In the performance of such duties, Executive agrees to make available to Company his professional and managerial knowledge and skill and such portion of his time as may be required for the proper fulfillment of his duties. In addition, during the term of this Agreement, Executive agrees to serve as Company’s Chief Executive Officer and in such other offices and capacities to which he may be appointed or elected by the Board of Directors of Company consistent with this Agreement.
3. Compensation and Benefits
(a) Base Salary. As compensation for all of the services to be performed hereunder, Company agrees to pay and Executive agrees to accept an “Annual Base Salary” of $575,000 commencing the date of this Agreement. The Annual Base Salary of Executive during the term of this Agreement shall be reviewed annually and may adjust upward from the aforesaid level at the discretion of the Board of Directors of Company. Executive's compensation will be paid in conformity with Company's practice for payment of its executives' compensation, as such practice may be established or modified from time to time.
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(b) Annual Cash Incentive. Executive shall be eligible to receive a ”Cash Incentive Bonus” under Company’s annual incentive plan of 75% - 150% of Executive's Annual Base Salary. Eligibility to receive a bonus under this paragraph shall be contingent upon Executive remaining in continuous service and in good standing throughout the performance year period and up to the payment date. The amount of any Cash Incentive Bonus above the aforesaid minimum will be based upon the achievement of pre-established performance goals agreed upon by the Board of Directors and the Executive. It is anticipated that bonuses under this section, if any, will be paid on or before April 15 following the applicable performance year.
(c) Annual Stock Incentive. Executive shall be eligible to receive an “Annual Stock Incentive” under Company’s Restricted Stock Leadership in an amount equal to 80% of Executive’s Annual Base Salary payable half in restricted stock of the Company and half in options to purchase stock of the Company. The Annual Stock Incentive award will be based upon the achievement of Company reaching pre-determined annual performance goals agreed upon between the Board of Directors and Executive; these programs may utilize the same or separate goals from the Annual Cash Incentive program. The number of shares and options to be awarded will be determined using the fair market value on the date of grant. Executive, will also be eligible to receive an additional amount equal to 50% of Executive’s Annual Base Salary during each Additional Term, payable in options to purchase stock of the Company for achieving 125% of the mutually agreed upon pre-determined performance goals to qualify for the Annual Stock Incentive.
(d) Restricted Stock and Option Grant. Company shall also provide the following:
(i) Grant to Executive options to purchase the 75,000 shares of Company's common stock on or before December 19, 2014 (which date shall be set at least 2 days prior to the Grant date by Executive). The exercise price shall be set equal to the closing price on the date of grant. Options shall become fully vested upon the expiration and/or termination of this Agreement. Options shall vest ratably on an annual basis over a four year period beginning on the first anniversary of the date of grant.
(ii) As part of Executive’s 2015 annual compensation, issue to Executive 14,000 shares of restricted stock and options to purchase 40,000 shares of stock. The shares shall be granted on April 15, 2015. Options will vest ratably on an annual basis over a four year period beginning on the first anniversary of the date of grant and restrictions, provided that Executive has remained in continuous service and in good standing. Restrictions will lapse upon a Separation of Service, provided that such Separations of Service is not a Termination by the Company for Cause.
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(e) Other Benefits. Company will make available to Executive such benefits on the same terms as are or shall be granted or made available by Company to its other executive employees, to the extent that Executive shall become qualified or eligible for such employee benefits or any of them, including at Company’s discretion (i) be considered for any bonus awards on the same basis as are other executives of Company, and (ii) be considered for and granted qualified options and other consideration based upon shares of Company’s Common Stock on the same basis as are other executives of Company; provided, however, that Company shall seek to establish the terms of such bonus awards, qualified options or other consideration so as not to subject Executive to additional taxes under Section 409A. Company shall also provide Executive with the following additional benefits:
(i) Health Coverage. Executive shall continue to be eligible for Company's health and dental coverage, life insurance, flexible spending accounts, and other Company benefits. This plan is subject to IRS flexible spending account guidelines; therefore, currently, the unused funds will not roll over to the next calendar year.
(ii) 401(K). Executive shall be eligible to participate in Company's 401(K) plan and the Employee Stock Purchase Plan after meeting the eligibility requirements of each.
(iii) Vacation. Executive shall be eligible to take four (4) weeks of vacation as of January 12, 2015, and Executive shall accrue vacation at the rate of four (4) weeks per annum in accordance with Company's vacation plan; provided further, that Executive shall not accrue more than four (4) weeks of vacation.
4. Expense Reimbursement.
Company shall reimburse Executive, upon the submission of receipts or vouchers therefore, for all necessary expenses and disbursements reasonably incurred by him for the proper performance of his duties with the Company. Executive, as a condition to such reimbursement, shall submit reports of such expenses and disbursements to the Chief Financial Officer of Company (i) not later than one month from the date such expenses and disbursements are incurred and determinable and (ii) in a form and with such detail as will constitute a proper record of tax deductible expenses, (iii) together with proper vouchers and receipts therefore.
5. Termination of Employment.
(a) Upon Death. Executive's employment shall terminate upon his death.
(b) By Company. Company may terminate Executive's employment hereunder at any time with or without Cause.
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(c) By Executive. Executive may terminate his employment hereunder at any time for Good Reason or Disability.
(d) Notice of Termination, Payments. Any termination of Executive's employment hereunder (other than by death) shall be communicated by thirty (30) days' advance written Notice of Termination by the terminating party to the other party to this Agreement; provided that no Notice of Termination is required in advance if the Executive is terminated by Company for Cause.
6. Payments in the Event of Termination of Employment.
(a) Payments in the Event of Termination by Company for Cause or Death or Disability. If Executive's employment hereunder is terminated by Company for Cause, as a result of death or Disability, Company shall pay Executive (a) his accrued and unpaid Base Salary through the Date of Termination and (b) any vested or accrued and unpaid payments, rights or benefits Executive may be otherwise entitled to receive pursuant to the terms of any accrued but unused vacation or other employee benefit or compensation plan (but not any Annual Stock or Cash Incentive Program) maintained by Company at the time or times provided therein. In addition, in the event that Executive’s employment is terminated by death or Disability, all stock options provided as an Employment Incentive under Section 3(d) of this Agreement shall vest and all restrictions on restricted stock provided as an Employment Incentive under Section 3(d) of this Agreement shall immediately lapse.
(b) Payments in the Event of Termination by Company other than for Cause or by Executive for Good Reason. If Executive's employment hereunder is terminated by Company other than for Cause, or by Executive for Good Reason, and Executive experiences a Separation From Service:
(i) Company shall pay Executive (1) his accrued and unpaid Base Salary through the Date of Termination, (2) any accrued and unpaid bonus or additional compensation under any Annual Cash Incentive plan for any fiscal year ended before the Date of Termination, and (3) any vested or accrued and unpaid payments, rights or benefits Executive may be otherwise entitled to receive pursuant to the terms of any accrued but unused vacation or other employee benefit or compensation plan (but not any Annual Stock or Cash Incentive Program) maintained by Company at the time or times provided therein.
(ii) In addition to the compensation and benefits described in Section 6(a)(i):
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In the event of Executive’s involuntary Separation From Service by Company action other than for Cause or Separation From Service by Executive for Good Reason beyond the first two years of the Initial Term, Company shall pay Executive, in substantially equal installments at Executive's regular pay intervals in effect prior to such Separation From Service, over a period of twelve (12) months beginning no later than the first regular Company payroll payment date (the "First Severance Payment Date") which occurs within thirty (30) days following the later of (x) Executive's Separation From Service and (y) the lapse of any right of Executive to revoke the general release he will have signed substantially (as determined by counsel to Company) in the form attached hereto as Attachment "B" (the "General Release", which General Release must be executed within twenty one (21) days following the Separation From Service for any such amount to be payable), an aggregate amount equal to the Executive's Annual Base Salary.
In the event of Executive’s involuntary Separation From Service by Company action other than for Cause or Separation From Service by Executive for Good Reason, during the first two years of the Initial Term, Company shall pay an aggregate amount equal to the Annual Base Salary multiplied by the number of years remaining on the Initial Term and shall be paid in substantially equal installments at Executive's regular pay intervals in effect prior to such Separation From Service, over the period of time remaining under the Initial Term. For example, should Executive be terminated other than for cause after 10 months of service, the amount owed would be 1 and 1/6 years times Executive’s Annual Base Salary and paid out over the next 16 months.
(iii) Until the earlier of the first anniversary of Executive's Separation From Service or the date Executive is employed by a new employer, the Executive, his dependents, beneficiaries and estate shall be entitled to all benefits under Company's group medical and dental insurance plans as if the Executive were still employed by Company hereunder during such period, with benefits or premium payments, as applicable, to be paid with the same frequency and at the same time as applies for active employees of the Company.
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(iv) On the date of Separation From Service, Executive's rights under any compensation or benefits programs shall become vested and any restrictions on stock options or contractual rights granted to Executive shall be removed.
(v) All stock options provided as an Employment Incentive under Section 3(d) of this Agreement shall vest and all restrictions on restricted stock held by Executive no matter when granted shall lapse.
(vi) Notwithstanding any other provision of this Agreement to the contrary, in the case of any compensation which is subject to Code Section 409A, if the Executive is a Specified Employee at the time of a Separation From Service and the payment or provision of such compensation is made as a result of the Separation From Service, then no portion of such benefits or other such compensation shall be made before the date that is six (6) months after the date of the Separation from Service or, if earlier, the date of death of the Specified Employee. Any compensation which would otherwise be paid within such six (6) month period after a Separation From Service shall be paid on the date which is six (6) months and one day after the Separation From Service, or the first business day thereafter. The provisions and application of this paragraph will be construed and applied in a manner consistent with Code Section 409A and Treasury Regulations of other guidance issued thereunder.
(c) Notwithstanding anything else to the contrary in this Agreement, Company's obligation regarding the payments, benefit continuation and acceleration provided for in this Section 6 is expressly conditioned upon the execution, delivery and non-revocation of the General Release.
(d) Payment in the Event of Termination Upon Change in Control of Company.
(i) If in the eighteen-month period following the Change in Control, Executive is terminated for any reason other than Cause, then upon any such Separation From Service Company shall be obligated to make the payments and provide the benefits to Executive as set forth in Section 6.
(ii) Nothing set forth in Section 6(d) is intended or shall be construed to limit Executive's right to terminate his employment for Good Reason during the aforementioned eighteen-month period or to limit Company's obligation to make the payments or provide the benefits set forth in Section 6 upon events described in Section 6.
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(iii) Executive shall not be required to mitigate the amount of any payment provided for in this Section 6 by seeking other employment or otherwise, and no such payment shall be offset or reduced as a result of Executive obtaining new employment.
(e) Executive’s Retirement
Executive shall be eligible to Retire no earlier than the end of the Initial Term by providing at least six (6) months’ notice to Company. In order to be eligible for Retirement, Executive must have remained in continuous service and is in good standing. In the event that Executive Retires:
(i) Company shall pay Executive (1) his accrued and unpaid Base Salary through the Date of Retirement, (2) any accrued and unpaid bonus or additional compensation under any Annual Cash Incentive plan for any calendar year ended on or before the Date of Retirement, and (3) any vested or accrued and unpaid payments, rights or benefits Executive may be otherwise entitled to receive pursuant to the terms of any accrued but unused vacation or other employee benefit or compensation plan maintained by Company at the time or times provided therein.
(ii) Company shall pay for eighteen (18) months all of Executive’s cost to continue his and his dependents group medical and dental insurance plans pursuant according to COBRA.
(iii) On the date of Retirement, Executive's rights under any compensation or benefits programs shall become vested and any restrictions on stock options or contractual rights granted to Executive shall be removed.
(iv) All stock options held by Executive no matter when granted shall vest and all restrictions on restricted stock held by Executive no matter when granted shall lapse.
(v) Executive shall have the right to exercise any vested stock options for a period of eighteen (18) months after a Separation of Service and shall not be required to exercise within any set amount of time from Retirement (i.e. within 30 days).
(vi) Notwithstanding any other provision of this Agreement to the contrary, in the case of any compensation which is subject to Code Section 409A, if the Executive is a Specified Employee at the time of a Separation From Service and the payment or provision of such compensation is made as a result of the Separation From Service, then no portion of such benefits or other such compensation shall be made before the date that is six (6) months after the date of the Separation from Service or, if earlier, the date of death of the Specified Employee. Any compensation which would otherwise be paid within such six (6) month period after a Separation From Service shall be paid on the date which is six (6) months and one day after the Separation From Service, or the first business day thereafter. The provisions and application of this paragraph will be construed and applied in a manner consistent with Code Section 409A and Treasury Regulations of other guidance issued thereunder.
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7. Board/Committee Resignation.
Executive's termination of employment or Separation From Service for any reason, shall constitute, as of the date of such termination and to the extent applicable, a resignation as an officer of Company and a resignation from the Board (and any committees thereof) and the Board of Directors (and any committees thereof) of any of Company's affiliates and from the board of directors or similar governing body of any corporation, limited liability company or other entity in which Company or any affiliate holds an equity interest and with respect to which board or similar governing body Executive serves as Company's or such affiliate's designee or other representative. Provided however, the Board of the Company, may elect in its sole discretion not to accept the resignation and continue to allow Executive to serve on the Board of Directors, or in another such office.
8. Confidentiality, Non-Competition, Non-Solicitation, Non-disparagement.
(a) Confidentiality. While employed by Company and thereafter, Executive shall not disclose any Confidential Information either directly or indirectly, to anyone (other than appropriate Company employees and advisors), or use such information for his own account, or for the account of any other person or entity, without the prior written consent of Company or except as required by law. This confidentiality covenant has no temporal or geographical restriction. For purposes of this Agreement, "Confidential Information" shall mean all non-public information respecting Company's business, including, but not limited to, its services, pricing, scheduling, products, research and development, processes, customer lists, marketing plans and strategies, and financing plans, but excluding information that is, or becomes, available to the public (unless such availability occurs through an unauthorized act on the part of Executive). Upon termination of this Agreement, Executive shall promptly supply to Company all property and any other tangible product or document that has been produced by, received by or otherwise submitted to Executive during or prior to his term of employment, and shall not retain any copies thereof.
(b) Non-Competition. Executive acknowledges that his services are of special, unique and extraordinary value to Company. Accordingly, the Executive shall not at any time prior to the end of the Initial Term or twelve months after the Date of Termination (whichever is later) become an employee, consultant, officer, partner or director or provide services in any fashion to any Competitor with Company (or any of its affiliates). If this Agreement is not renewed pursuant to Section 1, this Section shall not apply after expiration of the Agreement.
8 |
(c) Non-Solicitation. Executive shall not, at any time prior to the end of the Initial Term or at any time prior to twelve months after the Date of Termination (whichever is later), whether on Executive's own behalf or on behalf of or in conjunction with any person, company, business entity or other organization whatsoever, directly or indirectly, (x) solicit or encourage any employee of Company or its affiliates to leave the employment of Company or its affiliates or (y), without permission of Company, knowingly hire a former employee of Company or its affiliates.
(d) Non-Disparagement. While employed by Company and at any time after the Date of Termination, Executive agrees not to make any untruthful or disparaging statements, written or oral, about Company, its affiliates, their predecessors or successors or any of their past and present officers, directors, stockholders, partners, members, agents and employees or Company's business practices, operations or personnel policies and practices to any of Company's customers, clients, competitors, suppliers, investors, directors, consultants, employees, former employees, or the press or other media in any country.
(e) Condition and Remedies. Notwithstanding the foregoing, if Executive is entitled to any payments under Sections 6(b) hereof, then Executive's obligations pursuant to this Section 8 are specifically conditioned on Company paying (whether in installments or as a lump sum, as required herein) any amounts to which Executive may be entitled thereunder in the manner required. Executive agrees that any breach of the terms of this Section 8 would result in irreparable injury and damage for which there would be no adequate remedy at law, and that, in the event of said breach or any threat of breach, Company shall be entitled to (i) an immediate injunction and restraining order to prevent such breach or threatened breach, without having to prove damages and (ii) any other remedies to which Company may be entitled at law or in equity. Executive further agrees that the provisions of the covenant not to compete are reasonable. Should a court determine, however, that any provision of the covenant not to compete is unreasonable, either in period of time, geographical area, or otherwise, the parties hereto agree that the covenant should be interpreted and enforced to the maximum extent which such court deems reasonable. The provisions of this Section 8 shall survive any termination of this Agreement and Executive's term of employment. The existence of any claim or cause of action or otherwise, shall not constitute a defense to the enforcement of the covenants and agreements of this Section 8.
9 |
8. Successors and Assigns.
(a) This Agreement shall bind any successor to Company, whether by purchase, merger, consolidation or otherwise, in the same manner and to the same extent that Company would be obligated under this Agreement if no such succession had taken place.
(b) This Agreement shall not be assignable by Executive. This Agreement and all rights of Executive hereunder shall inure to the benefit of and be enforceable by, Executive's personal or legal representatives, executors, administrators, successors, heirs, distributes, devises and legatees.
9. Term.
The term of this Agreement shall commence on the Effective Date and end upon Executive's termination of employment. The rights and obligations of Company and Executive shall survive the termination of this Agreement to the fullest extent necessary to give effect to the terms hereof.
10. Notices.
Notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered by hand or e-mail, the day after delivery to Federal Express for overnight delivery, two days after delivery to the United States Postal Service for mailing, addressed:
(a) if to Executive, to the address set forth on the signature page hereto, and
(b) if to Company, Fred’s Inc., 4300 New Getwell Road, Memphis TN 38118 Attention: Chairman of the Board of Directors, or, in each case, to such other address as may have been furnished in writing.
11. Withholding.
All payments required to be made by Company hereunder shall be subject to the withholding and/or deduction of such amounts as are required to be withheld or deducted pursuant to any applicable law or regulation. Company shall have the right and is hereby authorized to withhold or deduct from any compensation or other amount owing to Executive, applicable withholding taxes and deductions and to take such action as may be necessary in the opinion of Company to satisfy all obligations for the payment of such taxes or deductions.
12. Certain Defined Terms.
As used herein, the following terms have the following meanings:
10 |
"Agreement" shall mean this Management Compensation Agreement, as the same may be amended, supplemented or otherwise modified from time to time in accordance herewith.
"Affiliate" shall mean any corporation, trust, partnership, limited liability company or other organization which controls, is controlled by, or is under common control with Company.
"Base Salary" shall mean the salary of Executive in effect from time to time under Section 3.
"Board" shall mean the Board of Directors of Company.
"Cause" shall mean with respect to termination by Company of Executive's employment hereunder (i) an act or acts of dishonesty by Executive resulting in, or intended to result in, directly or indirectly, any personal enrichment of Executive, (ii) an act or acts of dishonesty by Executive intended to cause substantial injury to Company, (iii) material breach (other than as a result of a Disability) by Executive of Executive's obligations under this Agreement which action was (a) undertaken without a reasonable belief that the action was in the best interests of Company and (b) not remedied within a reasonable period of time after receipt of written notice from Company specifying the alleged breach, (iv) Executive's conviction of, or plea of nolo contendere to, (a) a crime constituting a felony under the laws of any country, the United States or any state thereof or (b) a misdemeanor involving moral turpitude, (v) a material breach of (a) Company's policies and procedures in effect from time to time or (b) the provisions of this Agreement; provided, however, that such breach shall constitute "Cause" only if Company gives Executive notice pursuant to Section 9 hereof, which shall include a detailed and specific description of the alleged material breach or breaches.
"Change in Control" shall have the meaning given such term in the Company’s Long-Term Incentive Plan in effect on the effective date of this Agreement.
“Competitor” shall include, without limitation, the following businesses: Wal-Mart, K-Mart/Sears, Family Dollar, Dollar General, Big Lots, Variety Wholesalers, Retail Ventures, Inc. (including, without limitation, its subsidiaries Value City Department Stores, DSW, and Filene’s Basement) and Dollar Tree (and/or any other trade name or similar business used by any of the foregoing businesses, their parents, affiliates, subsidiaries, successors or assigns), and Walgreen’s, CVS, and Rite Aid (and/or any other trade name or similar business used by any of the foregoing businesses, their parents, affiliates, subsidiaries, successors or assigns). The parties expressly recognize that the term “Competitor” shall not be limited by this Agreement and that such term may expand to include other businesses, industries and/or markets in which Company may engage from time to time.
11 |
"Date of Termination" shall mean, with respect to Executive, the date of termination of Executive's employment hereunder after the notice period provided by Section 5(d).
"Disability" shall mean Executive's physical or mental condition which prevents continued performance of his duties hereunder, if Executive establishes by medical evidence that such condition will be permanent and continuous during the remainder of Executive's life or is likely to be of at least three (3) years duration.
"Effective Date" shall mean January 12, 2015.
"Good Reason" shall mean with respect to an Executive, any one or more of the following:
(a) a material reduction in Executive's Base Salary or level of target bonus under the bonus plan or any successor bonus plan without Executive's consent;
(b) any substantial and sustained diminution in Executive's position, authority, or responsibilities hereunder (unless due to Executive's disability); or
(c) a failure by Company to comply with any provision of this Agreement; provided, however, that the foregoing events shall constitute Good Reason only if Company fails to cure such event within thirty (30) days after receipt from Executive of written notice of the event which constitutes Good Reason; provided, further, that "Good Reason" shall cease to exist for an event on the 90th day following the later of its occurrence or Executive's knowledge thereof, unless Executive has given Company written notice thereof prior to such date.
In order for Executive's termination of his employment to be considered for Good Reason, such termination must occur within six (6) months after the event giving rise to such Good Reason. Executive's continued employment shall not constitute consent to, or a waiver of rights with respect to, any circumstance constituting Good Reason hereunder.
"Notice of Termination” shall mean a notice specifying the Date of Termination.
12 |
“Separation From Service” means the time at which the parties reasonably anticipate that no further services will be performed by Executive after a certain date, or that the level of bona fide services Executive would perform after such date (whether as an employee or as an independent contractor) would permanently decrease to no more than 20 percent of the average level of bona fide services performed (whether as an employee or an independent contractor) by the individual over the immediately preceding 36-month period. If Executive provides services both as an employee and as an independent contractor, Executive must separate from service both as an employee and as an independent contractor to be treated as having a Separated From Service. If Executive ceases providing services an employee and begins providing services as an independent contractor, Executive will not be considered to have a Separation From Service until Executive has ceased providing services in both capacities. The provisions and application of this paragraph will be construed and applied in a manner consistent with Code Section 409A and Treasury Regulations of other guidance issued thereunder.
“Specified Employee” means a service provider who, as of the date of the service provider’s Separation from Service, is a key employee of a service recipient any stock of which is publicly traded on an established securities market or otherwise. A key employee is any individual who is described in Code Section 416(i)(1)(A)(i), (ii), or (iii) (applied in accordance with the Regulations thereunder and disregarding section 416(i)(5)) at any time during the 12-month period ending on a Specified Employee identification date. The provisions and application of this paragraph will be construed and applied in a manner consistent with Code Section 409A and Treasury Regulations of other guidance issued thereunder.
“Retire(s) or Retirement” means Executive terminating his employment with Company and no longer working full-time for another company.
13. Executive Representation.
Executive hereby represents to Company that the execution and delivery of this Agreement by Executive and Company and the performance by Executive of Executive's duties hereunder shall not constitute a breach of, or otherwise contravene, the terms of any employment agreement or other agreement or policy to which Executive is a party or otherwise bound.
15 Amendment.
No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing signed by Executive and an officer of Company authorized by the Board to do so. No waiver of any provision of this Agreement shall be deemed a continuing waiver or a waiver of any other provision, whether or not similar.
16. Governing Law.
The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Tennessee, without regard to principles of conflicts of laws. The provisions of this Agreement are intended to be construed and applied in a manner consistent with compliance with Code Section 409A, where applicable. Accordingly, the provisions hereof shall be construed and applied consistent with such intent, to the extent applicable.
13 |
17. Validity.
The invalidity or unenforceability of any provision or provisions of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement which shall remain in full force and effect.
18. Specific Performance.
Notwithstanding Section 16 of this Agreement, if Executive breaches or threatens to commit a breach of Section 8 of this Agreement, Company shall have the right to specific performance (i.e., the right and remedy to have the terms and conditions of Section 8 specifically enforced by a court of competent jurisdiction), it being agreed that any breach or threatened breach of Section 8 would cause irreparable injury and that money damages may not provide an adequate remedy. If Company exercises its right to seek specific performance in a court of competent jurisdiction, Executive may assert any claims he may have against Company or its affiliates in such action, and nothing set forth in Paragraph 18 of this Agreement is intended or shall be construed to limit Executive's right to assert such claims.
19. Cooperation.
Executive shall provide his reasonable cooperation in connection with any investigation, action or proceeding (or any appeal from any action or proceeding) which relates to events occurring during Executive's employment hereunder. This provision shall survive any termination of this Agreement.
20. Compensation Limitation
Notwithstanding the foregoing, Executive and Company agree that (i) to the extent permitted by any Federal statute (the "Act") that limits compensation of Executive hereunder, any payments or benefits payable to Executive under this Agreement (including, without limitation, payments under Sections 2 and 4 hereof) or pursuant to any other compensation or benefit plan of Company or other arrangement between Company and Executive that do not comply with the Act shall be deferred until such payments or benefits may be paid under the Act, and (ii) to the extent the Act does not permit the deferral of any such payments or benefits, the maximum compensation and/or severance Executive may receive from Company under this Agreement or any other compensation or benefit plan of Company or other arrangement between Company and Executive will not exceed the amount allowed under the Act.
14 |
21. Entire Agreement.
This Agreement, any award agreement between Company and Executive entered into pursuant to Company's Long-Term Incentive Compensation Programs, and Company's employee benefit plans in which Executive will continue to participate as provided in this Agreement, contain the entire understanding between Company and Executive with respect to Executive's employment with Company and supersede in all respects any prior or other agreement or understanding between Company or any affiliate of Company and Executive with respect to Executive's employment.
IN WITNESS WHEREOF, Company and Executive have executed this Agreement as of the day and year first above written.
Fred’s, Inc. | ||
By: | /s/ Michael Hayes | |
Michael Hayes | ||
Chairman | ||
EXECUTIVE: | ||
/s/ Jerry A. Shore | ||
Jerry A. Shore | ||
Chief Executive Officer |
15 |
General Release
This Release is made and entered into by Jerry A. Shore (the "Executive") and Fred’s, Inc. (the "Company").
In consideration of the payments, benefit continuation and acceleration provided for in Section 6(b)(ii)-(vi) of this Management Compensation Agreement, Executive, on behalf of himself and for any person or entity who may claim by or through him, irrevocably and unconditionally releases, waives, and forever discharges Company, its past, present, and future subsidiaries, divisions, affiliates, successors, and their respective officers, directors, attorneys, agents, and present and past employees from any and all claims or causes of action that Executive had, has, or may have relating to Executive's employment with Company and/or termination therefrom up to and including the date of this Agreement, including but not limited to any claims under Title VII of the Civil Rights Act of 1964, as amended, the Tennessee Human Rights Act, the Age Discrimination in Employment Act ("ADEA"), and claims under any other federal, state, or local statute, regulation, or ordinance, including wrongful or retaliatory discharge.
This Release shall not be construed as an admission by Company of any liability, wrongdoing, or violation of any law, statute, regulation, agreement or policy, and Company denies any such liability or wrongdoing.
Executive acknowledges and agrees that this Release includes a release and waiver as to claims under the ADEA. Executive acknowledges and confirms that he understands and agrees to the terms and conditions of this Release; that these terms are written in layperson terms, and that he has been fully advised of his rights to seek the advice and assistance of consultants, including an attorney, to review this Release. Executive further acknowledges that he does not waive any rights or claims under the ADEA that arise after the date this Release is signed by him, and specifically, Executive understands that he is receiving money and benefits beyond anything of value to which he is already entitled from Company. Executive acknowledges that he has had up to 21 days to consider whether to accept and sign this Release, and has had adequate time and opportunity to review the Release and consult with any legal counsel or other advisors of his choosing. Executive understands that if he signs this Release before the expiration of the 21-day period, his signature will evidence his voluntary election to forego waiting the full 21 days to sign this Release. If Executive chooses not to accept, or the 21-day period expires without his acceptance, then the offer in this Release is null and void. Executive further acknowledges that in compliance with the Older Workers' Benefit Protection Act of 1990, he has been fully advised by Company of his right to revoke and nullify this Release, and that this revocation must be exercised, if at all, within seven days of the date he signs this Release. Executive may revoke his acceptance at any time within the seven days following his signing of this Release by notifying Company of his decision to revoke the acceptance by writing directed and delivered to Fred’s Inc., 4300 New Getwell Road, Memphis, TN 38118, Attention Secretary.
Acceptance of this offer is strictly voluntary. This Release shall become effective and enforceable only after the seven-day revocation period has expired. Should Executive decline to accept the benefits of this Release, or if is revoked by him, Executive will not receive the proposed additional compensation and benefits.
16 |
By his signature below, Executive accepts the terms of this Release.
FRED’S, INC. | EXECUTIVE | |||
By: | ||||
Name: | Name: | |||
Title: | Address: | |||
Date: | Date: |
17 |
Exhibit 31.1
Certification of Chief Executive Officer
I, Jerry A. Shore, certify that:
1. | I have reviewed this quarterly report on Form 10-Q of Fred's, Inc.; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) | Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. | The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: |
a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. |
Date: December 11, 2014 | /s/ Jerry A. Shore |
Jerry A. Shore | |
Chief Executive Officer |
Exhibit 31.2
Certification of Chief Accounting Officer
I, Sherri L. Tagg, certify that:
1. | I have reviewed this quarterly report on Form 10-Q of Fred's, Inc.; |
2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
3. | Based on my knowledge, the financial statements, and other financial information included in report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
4. | The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
c) | Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
d) | Disclosed in this report any changes in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
5. | The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors: |
a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and |
b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. |
Date: December 11, 2014 | /s/ Sherri L. Tagg |
Sherri L. Tagg | |
Executive Vice President and | |
Chief Accounting Officer |
Exhibit 32
Certification
of Chief Executive Officer AND CHIEF Accounting OFFICER
Pursuant to Rule 13(a) or 15(d) under the securities
exchange act Of 1934 and 18 U.S.C. Section 1350
Each of the undersigned hereby certifies that the Quarterly Report on Form 10-Q for the fiscal quarter ended November 1, 2014 of Fred’s, Inc. (the “Company”) filed with the Securities and Exchange Commission on the date hereof fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that the information contained in such report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Date: December 11, 2014 | /s/ Jerry A. Shore |
Jerry A. Shore | |
Chief Executive Officer | |
/s/ Sherri L. Tagg | |
Sherri L. Tagg | |
Executive Vice President and | |
Chief Accounting Officer |
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