Back to GetFilings.com
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended January 30, 1999
Commission File Number 000-19288
FRED'S, INC.
(Exact Name of Registrant as Specified in its Charter)
TENNESSEE 62-0634010
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
4300 New Getwell Road
MEMPHIS, TENNESSEE 38118
(Address of Principal Executive Offices)
Registrant's telephone number, including area code (901) 365-8880
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Title of Each Class
Class A Common Stock, no par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
As of April 28, 1999, there were 11,958,703 shares outstanding of the
Registrant's Class A no par value voting common stock. Based on the last
reported sale price of $11.625 per share on the NASDAQ Stock Market on April 28,
1999, the aggregate market value of the Registrant's Common Stock held
by those persons deemed by the Registrant to be non-affiliates was $139,019,922.
As of April 28, 1999, there were no shares outstanding of the Registrant's
Class B no par value non-voting common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Shareholders for the year ended January
30, 1999 are incorporated by reference into Part II, Items 5, 6, 7 and 8, and
into Part IV, Item 14.
Portions of the Company's Proxy Statement are incorporated by reference
into Part III, Items 11, 12 and 13.
Portions of the Company's Registration Statement on Form S-1 (file no.
33-45637) are incorporated as exhibits into Part IV.
With the exception of those portions that are specifically incorporated
herein by reference, the aforesaid documents are not to be deemed filed as part
of this report.
Cautionary Statement Regarding Forward-looking Information
Statements, other than those based on historical facts, including the
discussion of management's expectations for Year 2000 compliance, which address
activities, events or developments that the Company expects or anticipates may
occur in the future are forward-looking statements which are based upon a number
of assumptions concerning future conditions that may ultimately prove to be
inaccurate. Actual events and results may materially differ from anticipated
results described in such statements. The Company's ability to achieve such
results is subject to certain risks and uncertainties, including, but not
limited to, economic and weather conditions which affect buying patterns of the
Company's customers, changes in consumer spending and the Company's ability to
anticipate buying patterns and implement appropriate inventory strategies,
continued availability of capital and financing, competitive factors and other
factors affecting business beyond the Company's control. Consequently, all of
the forward-looking statements are qualified by these cautionary statements and
there can be no assurance that the results or developments anticipated by the
Company will be realized or that they will have the expected effects on the
Company or its business or operations.
PART I
Item 1: Business
General
Fred's, Inc. ("Fred's" or the "Company"), founded in 1947, operates 283
discount general merchandise stores in ten states in the southeastern United
States. Fred's stores generally serve low, middle and fixed income families
located in small to medium sized towns (approximately 65% of Fred's stores are
in markets with populations of 15,000 or fewer people). One hundred and eighty
of the Company's stores have full service pharmacies. The Company also markets
goods and services to 29 franchised "Fred's" stores.
Fred's stores stock over 12,000 frequently purchased items which address
the everyday needs of its customers, including nationally recognized brand name
products, proprietary "Fred's" label products and lower priced off-brand
products. Fred's management believes its customers shop Fred's stores as a
result of the stores' convenient location and size, everyday low prices on key
products and regularly advertised departmental promotions and seasonal specials.
Fred's stores have average selling space of 13,925 square feet and had average
sales of $2,036,000 in fiscal 1998. No single store accounted for more than 1.0%
of sales during fiscal 1998.
Business Strategy
The Company's strategy is to meet the general merchandise and pharmacy
needs of the small to medium sized towns it serves by offering a wider variety
of quality merchandise and a more attractive price-to-value relationship than
either drug stores or smaller variety/dollar stores and a shopper-friendly
format which is more convenient than larger sized discount merchandise stores.
The major elements of this strategy include:
Wide variety of frequently purchased, basic merchandise - Fred's combines
everyday basic merchandise with certain specialty items to offer its
customers a wide selection of general merchandise. The selection of
merchandise is supplemented by seasonal specials, private label products,
the inclusion of pharmacies in 180 of its stores, and Lawn and Garden
centers in 122 of its stores.
Discount prices - The Company provides value and low prices to its
customers (i.e., a good "price-to-value relationship") through a
coordinated discount strategy and an Everyday Low Pricing program that
focuses on strong values day in and day out, while minimizing the Company's
reliance on promotional activities. As part of this strategy, Fred's
maintains low opening price points and competitive prices on key products
across all departments, and regularly offers seasonal specials and
departmental promotions supported by tabloid, television and radio
advertising.
Convenient shopper-friendly environment - Fred's stores are typically
located in convenient shopping and/or residential areas. Approximately 28%
of the Company's stores are freestanding as opposed to being located in
strip shopping center sites. Freestanding sites allow for easier access and
shorter distances to the store entrance, and will be the primary site
growth in the future. Fred's stores are of a manageable size and have an
understandable store layout, wide aisles and fast checkouts.
Expansion Strategy
The Company expects that expansion will occur primarily within its present
geographic area and will be focused in small to medium sized towns. The Company
may also enter larger metropolitan and urban markets where it already has a
market presence in the surrounding area.
Fred's added a net 22 stores in 1998, and anticipates opening up to a net
of twenty new stores in 1999. The Company's store prototype has from 14,000 to
17,000 square feet of space. Opening a new store currently costs between
$350,000 and $500,000 for inventory, furniture, fixtures, equipment and
leasehold improvements. The Company has 28 stand-alone Xpress locations which
sell pharmaceuticals and other health and beauty related items. These locations
range in size from 1,000 to 6,000 square feet, and enable the Company to enter a
new market with an initial investment of under $200,000. It is the Company's
intent to expand these locations into a full size Fred's location as market
conditions dictate. During 1998, the Company converted three Xpress locations to
full size Fred's locations and anticipates converting up to six more Xpress
locations during 1999.
A significant growth area for the Company has been its pharmacy business.
In 1998, the Company added a net 39 new pharmacies. During 1999, the Company
anticipates adding at least 20 additional pharmacies. Approximately 64% of
Fred's stores contain a pharmacy and sell prescription drugs. The Company's
primary mechanism for adding new pharmacies is through the acquisition of
prescription files from independent pharmacies. These acquisitions provide an
immediate sales benefit, and in many cases, the independent pharmacist will move
to Fred's, thereby providing continuity in the pharmacist-patient relationship.
The following tables set forth certain information with respect to stores
and pharmacies for each of the last five years:
1994 1995 1996 1997 1998
------ ------ ------ ------ -----
Stores open at beginning of period 170 184 206 213 261
Stores opened/acquired during period 20 36 13 49 29
Stores closed during period (6) (4) (6) (1) (7)
------- ------- ------- ------- -------
Stores open at end of period 184 206 213 261 283
========= ======== ========= ========= =========
Number of stores with Pharmacies at end
of period 83 92 101 141 180
========= ======== ========= ========= =========
Square feet of selling space at end of
period (in thousands) 2,625 2,797 2,828 3,362 3,680
========= ======== ========= ========= =========
Average square feet of selling space
per store 14,266 13,915 13,277 13,875 13,925
========= ======== ========= ========= =========
Franchise stores at end of period 35 34 32 31 29
========= ======== ========= ========= =========
Merchandising and Marketing
The business in which the Company is engaged is highly competitive. The
principal competitive factors include location of stores, price and quality of
merchandise, in-stock consistency, merchandise assortment and presentation, and
customer service. The Company competes for sales and store locations in varying
degrees with national, regional and local retailing establishments, including
department stores, discount stores, variety stores, dollar stores, discount
clothing stores, drug stores, grocery stores, outlet stores, warehouse stores
and other stores. Many of the largest retail merchandising companies in the
nation have stores in areas in which the Company operates.
Management believes that Fred's has a distinctive niche in that it offers a
wider variety of merchandise at a more attractive price-to-value relationship
than either a drug store or smaller variety/dollar store and is more
shopper-convenient than a larger discount store. The variety and depth of
merchandise offered at Fred's stores in high traffic departments, such as health
and beauty aids and paper and cleaning supplies, are comparable to those of
larger discount retailers. Management believes that its knowledge of regional
and local consumer preferences, developed in over fifty years of operation by
the Company and its predecessors, enables the Company to compete effectively in
its region.
Purchasing
The Company's primary non-prescription drug buying activities are directed
from the corporate office by two Senior Vice Presidents-Merchandising who are
supported by a staff of 19 buyers and assistants. The buyers and assistants are
participants in an incentive compensation program, which is based upon various
factors primarily relating to gross margin returns on inventory controlled by
each individual buyer. The Company believes that adequate alternative sources of
products are available for these categories of merchandise.
Substantially all of the Company's prescription drugs are purchased
individually by its pharmacies and shipped direct from Fred's primary
pharmaceutical wholesaler, McKesson Drug Company. This purchasing strategy
allows the Company to minimize its inventory investment and eliminate the
distribution center investment necessary to warehouse and handle these products.
During 1998, approximately 29% of the Company's total purchases were made from
this one vendor. Although there are alternative wholesalers that supply
pharmaceutical products, the Company operates under a purchase and supply
contract with McKesson as its primary wholesaler. Accordingly, the unplanned
loss of this particular supplier could have a short-term gross margin impact on
the Company's business until an alternative wholesaler arrangement could be
implemented.
Sales Mix
Sales of merchandise through stores which include company-owned and
franchised Fred's locations is the only significant industry segment of which
the Company is a part.
The Company's sales mix by major category during 1998 was as follows:
Pharmaceuticals............................................................26.7%
Household Goods............................................................23.0%
Apparel and Linens.........................................................13.6%
Health and Beauty Aids.....................................................13.0%
Food and Tobacco Products...................................................8.9%
Paper and Cleaning Supplies.................................................8.8%
Franchise Sales.............................................................6.0%
The sales mix varies from store to store depending upon local consumer
preferences and whether the stores include pharmacies and/or a full-line of
apparel. In 1998, the average customer transaction size was approximately
$13.45, and the number of customer transactions totaled approximately 42
million.
Products sold under the "Fred's" private label program, including household
cleaning supplies, health and beauty aids, disposable diapers, pet foods, paper
products and a variety of beverage and other products, constituted approximately
5% of total sales in 1998. Private label products afford the Company higher than
average gross margins while providing the customer with lower priced products
that are of a quality comparable to that of competing branded products. An
independent laboratory testing program is used for substantially all of the
Company's private label products.
As mentioned above, the Company sells merchandise to its 29 franchised
"Fred's" stores. These sales during the last three years totaled $35,766,000 in
1998, $37,700,000 in 1997 and $36,600,000 in 1996 representing 6.0%, 7.7% and
8.7% of total revenue, respectively. Franchise and other fees totaling
approximately $2 million have been earned by Fred's in each of these three years
(recorded as a reduction to the Company's operating expenses). The Company does
not intend on expanding its franchise network, and therefore, expects that this
category will continue to decrease as a percentage of the Company's total
revenues.
Highly Competitive Pricing Strategy
The implementation of an everyday low pricing strategy (EDLP) in December
1994 included price reductions for many key items, and has proven to be a
successful element of the Company's sales strategy. The Company continues to
implement additional price reductions on key items in appreciation of our
customers recognition of Fred's as a store that offers good values everyday.
Advertising and Promotions
Advertising and promotion costs represented 1.6% of net sales in 1998. The
Company uses direct mail, television, radio and newspaper advertising to promote
its merchandise, special promotional events and a discount retail image.
The Company's buyers have discretion to mark down slow moving items. The
Company runs regular clearances of seasonal merchandise and conducts sales and
promotions of particular items. The Company also encourages its store managers
to create in-store advertising displays and signage in order to increase
customer traffic and impulse purchases. The store managers, with corporate
approval, are permitted to tailor the price structure at their particular store
to meet competitive conditions within each store's marketing area.
Store and Pharmacy Operations
All Fred's stores and pharmacies are open six days a week (Monday through
Saturday), and many stores are open seven days a week. Store hours are generally
from 9:00 a.m. to 9:00 p.m.; however, certain stores are open only until 6:00
p.m. Each Fred's store is managed by a full-time store manager and those stores
with a pharmacy are also managed by a full-time pharmacist. The Company's
fifteen district managers supervise the management and operation of Fred's
stores and pharmacies.
Fred's operates 180 in-store pharmacies which offer brand name and generic
pharmaceuticals and are staffed by licensed pharmacists. The addition of
acquired pharmacies in the Company's stores has resulted in increased store
sales and sales per selling square foot. Management believes that in-store
pharmacies increase customer traffic and repeat visits and are an integral part
of the store's operation.
The Company has an incentive compensation plan for store managers,
pharmacists and district managers based on meeting or exceeding targeted profit
percentage contributions. Various factors included in determining profit
percentage contribution are gross profits and controllable expenses at the store
level. Management believes that this incentive compensation plan, together with
the Company's store management training program, are instrumental in maximizing
store performance.
Inventory Control and Distribution
Inventory Control
The Company's computerized central management information system (known as
"SWORD," which stands for Store Warehouse Order Replenishment and Distribution)
maintains a daily SKU level inventory and current and historical sales
information for each store and the distribution center. This system is supported
by in-store point-of-sale ("POS") cash registers which capture SKU and other
data at the time of sale for daily transmission to the Company's central data
processing center. Data received from the stores is used to automatically
replenish frequently purchased merchandise on a weekly basis and to assist the
Company's buyers in their decision making process.
Distribution
The Company has an 850,000 square foot centralized distribution center in
Memphis, Tennessee (see "Properties" below). During 1998, the Company completed
a $12 million project to modernize and automate its distribution center. This
project, including implementation of a new warehouse management computer system,
has increased the center's capacity sufficiently to accommodate the Company's
store expansion plans for the next several years. Approximately 67% of the
merchandise received by Fred's stores in 1998 was shipped through the
distribution center, with the remainder (primarily pharmaceuticals, certain
snack food items, greeting cards, beverages and tobacco products) being shipped
directly to the stores by suppliers. For distribution, the Company uses owned
and leased trailers and tractors, as well as common carriers.
Seasonality
The Company's business is seasonal to a certain extent. Generally, the
highest volume of sales and net income occurs in the fourth fiscal quarter and
the lowest volume occurs during the second fiscal quarter.
Employees
At January 30, 1999, the Company had approximately 6,830 full-time and
part-time employees, comprising 680 corporate and distribution center employees
and 6,150 store employees. The number of employees varies during the year,
reaching a peak during the Christmas selling season. The Company's labor force
is not subject to a collective bargaining agreement. Management believes it has
good relationships with its employees.
Item 2: Properties
As of January 30, 1999, the geographical distribution of the Company's 283
locations was as follows:
State Number of Stores
----- ----------------
Mississippi 85
Tennessee 61
Arkansas 50
Alabama 29
Louisiana 25
Georgia 23
Kentucky 3
North Carolina 3
Missouri 3
Florida 1
The Company owns the real estate and the buildings for 57 locations, and
owns the buildings at five locations which are subject to ground leases. The
Company leases the remaining 221 locations from third parties pursuant to leases
that provide for monthly rental payments primarily at fixed rates (although a
number of leases provide for additional rent based on sales). Store locations
range in size from 1,000 square feet to 27,000 square feet. Two hundred and four
of the locations are in strip centers or adjoined with a downtown shopping
district, with the remainder being free-standing.
It is anticipated that existing buildings and buildings to be developed by
others will be available for lease to satisfy the Company's expansion program in
the near term. It is management's intention to enter into leases of relatively
moderate length with renewal options, rather than entering into long-term
leases. The Company will thus have maximum relocation flexibility in the future,
since continued availability of existing buildings is anticipated in the
Company's market areas.
The Company owns its distribution center and corporate headquarters
situated on a 60 acre site in Memphis, Tennessee. The site contains the
distribution center with approximately 850,000 square feet of space, and 250,000
square feet of office and retail space. Presently, the Company utilizes 90,000
square feet of office space and 22,000 square feet of retail space at the site.
The retail space is operated as a Fred's store and is used to test new products,
merchandising ideas and technology.
Item 3: Legal Proceedings
The Company is party to several pending legal proceedings and claims.
Although the outcome of the proceedings and claims cannot be determined with
certainty, management of the Company is of the opinion that it is unlikely that
these proceedings and claims will have a material effect on the results of
operations or the financial condition of the Company.
Item 4: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended January 30, 1999.
PART II
Item 5: Market for the Registrant's Common Equity and Related
Stockholder Matters
The information required by this item is incorporated herein by reference
to Page 29 of the Annual Report to Shareholders for the year ended January 30,
1999 (the "Annual Report to Shareholders").
Item 6: Selected Financial Data
The selected financial data for the five years ended January 30, 1999,
which appears on page 8 of the Annual Report to Shareholders is incorporated
herein by reference.
Item 7: Management's Discussion and Analysis of Financial
Condition and Results of Operations
Management's Discussion and Analysis of financial condition and results of
operations appearing on pages 9 through 12 of the Annual Report to Shareholders
is incorporated herein by reference.
Item 7a: Quantitative and Qualitative Disclosure About Market Risk
Not Applicable.
Item 8: Financial Statements and Supplementary Data
The consolidated financial statements appearing on pages 13 through 26 of
the Annual Report to Shareholders are incorporated herein by reference.
Item 9: Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure
None.
PART III
Item 10: Directors and Executive Officers of the Registrant
The following information is furnished with respect to each of the
directors and executive officers of the Registrant:
Name Age Positions and Offices
Michael J. Hayes(1) 57 Director, Managing Director (2),
Chief Executive Officer and President
David A. Gardner(1) 51 Director and Managing Director (2)
John R. Eisenman(1) 57 Director
Roger T. Knox(1) 61 Director
Edwin C. Boothe 41 Executive Vice President and
Chief Operating Officer
John A. Casey 52 Executive Vice President -
Store/Pharmacy Operations
Richard B. Witaszak 38 Executive Vice President and
Chief Financial Officer
D. Keith Curtis 39 Senior Vice President - Merchandising
Brett W. Little 45 Senior Vice President - Merchandising
Charles S. Vail 56 Corporate Secretary, Vice President -
Legal Services and General Counsel
(1) Four directors, constituting the entire Board of Directors, are to be
elected at the Annual Meeting to serve one year or until their
successors are elected.
(2) According to the By-laws of the Company, the Managing Directors
(Messrs. Hayes and Gardner) are the chief executive officers of the
Company and have general supervisory responsibility for the business of
the Company.
Michael J. Hayes was elected a director of the Company in January 1987 and
has been a Managing Director of the Company since October 1989. Mr. Hayes has
been Chief Executive Officer since October 1989 and President since May 1991.
Additionally, Mr. Hayes is a Managing Director of Hayes Financial Corp. He was
previously employed by Oppenheimer & Company, Inc. in various capacities from
1976 to 1985, including Managing Director and Executive Vice President -
Corporate Finance and Financial Services.
David A. Gardner was elected a director of the Company in January 1987 and
has been a Managing Director of the Company since October 1989. Mr. Gardner has
been President of Gardner Capital Corporation, a real estate and venture capital
investment firm since April 1980. Additionally, Mr. Gardner is a director of
NumeriX, LLC and Joyce International, Inc.
John R. Eisenman is involved in real estate investment and development with
REMAX Island Realty, Inc., located in Hilton Head Island, South Carolina. Mr.
Eisenman has been engaged in commercial and industrial real estate brokerage and
development since 1983. Previously, he founded and served as President of
Sally's, a chain of fast food restaurants from 1976 to 1983, and prior thereto
held various management positions in manufacturing and in securities brokerage.
Roger T. Knox has served the Memphis Zoological Society as its President
and Chief Executive Officer since January 1989. Mr. Knox was the President and
Chief Operating Officer of Goldsmith's Department Stores, Inc. (a full-line
department store in Memphis and Jackson, Tennessee) from 1983 to 1989 and its
Chairman of the Board and Chief Executive Officer from 1987 to 1989. Prior
thereto, Mr. Knox was with Foley's Department Stores in Houston, Texas for 20
years.
Edwin C. Boothe is Executive Vice President and Chief Operating Officer.
Mr. Boothe joined the Company in 1975 and has served in various positions in
Store Operations and Loss Prevention, and was elected to Chief Operating Officer
in January 1998.
John A. Casey is Executive Vice President - Store/Pharmacy Operations. Mr.
Casey joined the Company in 1979 and has served in various positions in Pharmacy
Operations. Mr. Casey is a registered Pharmacist.
Richard B. Witaszak joined the Company in October 1996 as Executive Vice
President and Chief Financial Officer. Prior to joining the Company, Mr.
Witaszak was employed by AE Clevite, Inc., a distributor of engine parts as
Executive Vice President of Finance and Operations from 1989 to 1996, and in
various capacities with Coopers & Lybrand from 1985 to 1989.
D. Keith Curtis is Senior Vice President - Merchandising. Mr. Curtis joined
the Company in 1980 and has served in various positions in Merchandising and
Store Operations.
Brett W. Little is Senior Vice President - Merchandising. Mr. Little joined
the Company in August of 1996 and was with Dollar General Stores from 1993 to
1996 as the General Merchandise Manager of their Softlines Division. Prior
thereto, Mr. Little was with Big Bear/Hart's stores in Columbus, Ohio for 18
years.
Charles S. Vail has served the Company as General Counsel since 1973, as
Corporate Secretary since 1975, and as Vice President - Legal since 1984. Mr.
Vail joined the Company in 1968.
Compliance with Section 16(a) of the Exchange Act
Based solely upon a review of reports of beneficial ownership of the
Company's Common Stock and written representations furnished to the Company by
its officers, directors and principal shareholders, the Company is not aware of
any such reporting person who or which failed to file with the Securities and
Exchange Commission on a timely basis any required reports of changes in
beneficial ownership.
Item 11: Executive Compensation
Information regarding executive compensation is incorporated herein by
reference from the information on pages 4 through 7 of the Company's Proxy
Statement, which will be filed within 120 days of the registrant's fiscal year
end.
Item 12: Security Ownership of Certain Beneficial Owners and
Management
Information regarding security ownership of certain beneficial owners and
management is incorporated herein by reference from pages 1 and 2 of the
Company's Proxy Statement, which will be filed within 120 days of the
Registrant's fiscal year end.
Item 13: Certain Relationships and Related Transactions
This information is incorporated herein by reference from the information
under the caption "Compensation Committee Interlocks and Insider Participation"
on page 8 of the Company's Proxy Statement, which will be filed within 120 days
of the Registrant's fiscal year end.
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on
Form 8-K
(a)(1) Consolidated Financial Statements
The following consolidated financial statements are
incorporated herein by reference from pages 13 through 26 of
the Annual Report to Shareholders for the year ended January
30, 1999.
Report of Independent Accountants.
Consolidated Statements of Income for the years ended
January 30, 1999, January 31, 1998 and February 1,
1997.
Consolidated Balance Sheets as of January 30, 1999
and January 31, 1998.
Consolidated Statements of Changes in
Shareholders' Equity for the years ended
January 30, 1999, January 31, 1998 and February 1,
1997.
Consolidated Statements of Cash Flows for the years
ended January 30, 1999, January 31, 1998 and February
1, 1997.
Notes to Consolidated Financial
Statements.
(a)(2) Financial Statement Schedules
Report of Independant Accountants on Financial Statement
Schedules for each of the three years in the period ended
January 30,1999
II Valuation and qualifying accounts
(a)(3) Those exhibits required to be filed as Exhibits to this Annual
Report on Form 10-K pursuant to Item 601 of Regulation S-K are
as follows:
2.1 Asset Purchase Agreement between CVS Revco D.S.,
Inc., Fred's Stores of Tennessee, Inc., CVS
Corporation and Fred's, Inc., dated as of October
10, 1997 [incorporated herein by reference to
Exhibit 2.1 to the Company's Current Report on Form
8-K dated December 1, 1997].
2.2 Letter Agreement between CVS Revco D.S., Inc.,
Fred's Stores of Tennessee, Inc., CVS Corporation
and Fred's, Inc. dated as of November 1, 1997
[incorporated herein by reference to Exhibit 2.2 to
the Company's Current Report on Form 8-K dated
December 1, 1997].
3.1 Certificate of Incorporation, as amended
[incorporated herein by reference to Exhibit 3.1 to
the Form S-1 as filed with the Securities and
Exchange Commission February 7, 1992 (SEC File No.
33-45637) (the "Form S-1")].
3.2 By-laws, as amended [incorporated herein by
reference to Exhibit 3.2 to the Form S-1].
4.1 Specimen Common Stock Certificate [incorporated
herein by reference to Exhibit 4.2 to PreEffective
Amendment No. 3 to the Form S-1]
9.1 Baddour, Inc. (Registrant changed its name to
"Fred's, Inc." in 1991) Shareholders Agreement
dated as of June 28, 1986 [incorporated herein by
reference to Exhibit C, pages C-1 through C-42 to
Baddour, Inc.'s Report on Form 8-K dated July 1,
1986]
10.1 Lease Agreement dated November 12, 1991 with the
U.S. Government [incorporated herein by reference
to Exhibit 10.6 to the Form S-1].
10.2 Form of Fred's, Inc. Franchise Agreement
[incorporated herein by reference to Exhibit 10.8
to the Form S-1].
10.3 401(k) Plan dated as of May 13, 1991 [incorporated
herein by reference to Exhibit 10.9 to the Form S-
1].
10.4 Employee Stock Ownership Plan (ESOP) dated as of
January 1, 1987 [incorporated herein by reference
to Exhibit 10.10 to the Form S-1].
*10.5 Incentive Stock Option Plan dated as of December
22, 1986 [incorporated herein by reference to
Exhibit 10.11 to the Form S-1].
10.6 Lease Agreement by and between Hogan Motor
Leasing, Inc. and Fred's, Inc. dated February 5,
1992 for the lease of truck tractors to Fred's,
Inc. and the servicing of those vehicles and other
equipment of Fred's, Inc. [incorporated herein by
reference to Exhibit 10.15 to Pre-Effective
Amendment No. 1 to the Form S-1].
* Management Compensatory Plan
10.7 Revolving Loan and Credit Agreement between Fred's,
Inc. and Union Planters National Bank dated as of
May 15, 1992 [incorporated herein by reference to
the Company's report on Form 10-Q for the quarter
ended May 2, 1992].
10.8 Note and Security Agreement between National Bank
of Commerce as Trustee for the ESOP of Fred's,
Inc., together with the Limited Guaranty of
Fred's, Inc. dated as of May 29, 1992
[incorporated herein by reference to the Company's
report on Form 10-Q for the quarter ended August
1, 1992].
*10.9 1993 Long Term Incentive Plan dated as of January
21, 1993 [incorporated herein by reference to the
Company's report on Form 10-Q for the quarter ended
July 31, 1993].
10.10 Negative Pledge and Loan Agreement between Fred's,
Inc. and National Bank of Commerce dated as of
February 17, 1994 [incorporated herein by reference
to the Company's report on Form 10-K for the year
ended January 29, 1994].
10.11 Modification Agreement between Fred's, Inc. and
Union Planters National Bank dated as of May 31,
1995 (modifies the Revolving Loan and Credit
Agreement included as Exhibit 10.7) [incorporated
herein by reference to the Company's report on Form
10-Q for the quarter ended July 29, 1995].
10.12 Second Modification Agreement between Fred's, Inc.
and Union Planters National Bank dated as of July
31, 1995 (modifies the Revolving Loan and Credit
Agreement included as Exhibit 10.7) [incorporated
herein by reference to the Company's report on Form
10-Q for the quarter ended July 29, 1995].
10.13 Seasonal Overline Revolving Credit Agreement
between Fred's, Inc. and Union Planters National
Bank dated as of July 23, 1996 [incorporated herein
by reference to the Company's report on Form 10-Q
for the quarter ended August 3, 1996].
10.14 Addendum to Leasing Agreement and form of schedules
2 through 6 of Schedule A by and between Hogan
Motor Leasing, Inc. and Fred's, Inc. dated December
19, 1996 (modifies the Lease Agreement included as
Exhibit 10.6) [incorporated herein by reference to
the Company's report on Form 10-K for the year
ended February 1, 1997].
10.15 Third Modification Agreement between Fred's, Inc.
and Union Planters National Bank dated as of
February 28, 1997 (modifies the Revolving Loan and
Credit Agreement included as Exhibit 10.7)
[incorporated herein by reference to the Company's
report on Form 10-K for the year ended February 1,
1997].
* Management Compensatory Plan
10.16 Term Loan Agreement between Fred's, Inc. and Union
Planters National Bank dated as of May 5, 1998
[incorporated herein by reference to the Company's
Report on Form 10-Q for the quarter ended May 2,
1998].
10.17 Fourth Modification Agreement between Fred's, Inc.
and Union Planters National Bank dated as of
September 1998. [Incorporated herein by reference
to the Company's Report on Form 10-Q for the
quarter ended August 1, 1998].
10.18 Preferred Share Purchase Plan [Incorporated herein
by reference to the Company's Report on Form 10-Q
for the quarter ended October 31, 1998].
**13.1 Annual report to shareholders for the year
ended January 30, 1999 (to the extent
incorporated herein by reference).
**18.1 Letter regarding change in accounting principle.
**21.1 Subsidiaries of Registrant
**23.1 Consent of PricewaterhouseCoopers LLP
**27. Financial Data Schedule
(b) Reports on Form 8-K
None
** Filed herewith
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on this 29th day of
April, 1999.
FRED'S, INC.
By:/s/ Michael J. Hayes
-------------------------------
Michael J. Hayes, Chief Executive
Officer and President
By: /s/ Richard B. Witaszak
-------------------------------
Richard B. Witaszak, Executive Vice
President and Chief Financial
Officer (Principal Accounting and
Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on this 29th day of April, 1999.
Signature Title Date
/s/ Michael J. Hayes
- -------------------- Director, Managing Director, --------
Michael J. Hayes Chief Executive Officer, and
President
/s/ David A. Gardner
- -------------------- Director and Managing Director --------
David A. Gardner
/s/ Roger T. Knox
- ----------------- Director --------
Roger T. Knox
/s/ John R. Eisenman
- -------------------- Director ---------
John R. Eisenman
Annual Report to Shareholders Exhibit 13.1
- -----------------------------
Stock Market Information
Selected Financial Data
Management's Discussion and Analysis of Financial Condition and Results
of Operations
Financial Statements and Supplementary Data
Stock Market Information
The Company's common stock trades on the Nasdaq Stock Market under the symbol
FRED (CUSIP No. 356108-10-0). At April 30, 1999, the Company had an estimated
5,000 shareholders, including beneficial owners holding shares in nominee or
"street" name.
The table below sets forth the high and low stock prices, together with cash
dividends paid per share, for each fiscal quarter in the past two fiscal years
(all information reflects the effect of a five-for-four stock split distributed
in December 1997):
Dividends
High Low Per Share
----- ---- ---------
1997
First $8 1/8 $7 $.04
Second $14 $7 2/3 $.04
Third $19 1/3 $13 2/3 $.04
Fourth $23 1/2 $16 $.05
1998
First $26 7/8 $19 $.05
Second $26 1/2 20 3/4 $.05
Third $22 3/8 10 1/2 $.05
Fourth $18 $12 9/16 $.05
Selected Financial Data
(dollars in thousands, except per share amounts)
1998(1) 1997 1996 1995(2) 1994
Statement of Income Data:
Net sales $600,902 $492,236 $418,297 $410,086 $380,702
Operating income 14,711 15,511 6,779(3) 4,771 13,563
Income before income taxes 13,605 15,660 6,508 4,337 13,103
Provision for income taxes 4,775 5,873 702 1,604 4,730
Net income 8,830 9,787 5,806 2,733 8,373
Net income per share:
Basic .75 .84 .50 .23 .72
Diluted .73 .83 .50 .23 .72
Selected Operating Data:
Operating income as a percentage of sales 2.4% 3.2% 1.6%(3) 1.2% 3.6%
Increase in comparable store sales (4) 5.6% 8.3% 2.2% 1.3% 3.6%
Stores open at end of period 283 261 213 206 184
Balance Sheet Data (at period end):
Total assets $220,757 $195,407 $161,148 $158,023 $151,585
Short-term debt (including capital leases) 11,914 214 1,641 1,961 2,037
Long-term debt (including capital leases) 11,821 1,368 138 1,779 3,740
Shareholders' equity 136,983 129,359 119,579 115,570 114,457
(1) Results for 1998 include the effect of the 1998 adoption of
LIFO for pharmacy inventories.
(2) Results of 1995 include 53 weeks.
(3) After $3,289 of restructuring and other charges.
(4) A store is first included in the comparable store sales calculation after
the end of the twelfth month following the store's grand opening month.
Management's Discussion and Analysis
Results of Operations
The following table provides a comparison of Fred's financial results for the
past three years. In this table, categories of income and expense are expressed
as a percentage of net sales.
1998 1997 1996
------ ------ -----
Net Sales 100.0% 100.0% 100.0%
Cost of goods sold 72.6 72.5 73.2
----- ----- -----
Gross profit 27.4 27.5 26.8
Selling, general and
administrative expenses 24.9 24.3 24.4
Restructuring and other charges - - .8
----- ----- -----
Operating income 2.5 3.2 1.6
Interest expense, net .2 - -
----- ----- ----
Income before taxes 2.3 3.2 1.6
Income taxes .8 1.2 .2
----- ----- -----
Net income 1.5% 2.0% 1.4%
===== ===== =====
Results for 1998 include the effect of the 1998 adoption of LIFO for Pharmacy
inventories.
Fiscal 1998 Compared to Fiscal 1997
Sales
Net sales increased 22.1% ($109 million) in 1998. Approximately $84 million of
the increase was attributable to the addition of 29 store locations and 39
pharmacies during 1998, together with the net sales of 48 stores and 34
pharmacies that were opened during 1997 and not considered in the comparable
store sales computation until sometime during 1998. During 1998, the Company
also closed 7 store locations. Comparable store sales, consisting of sales from
stores that have been open for more than one year, increased 5.6% in 1998.
The Company's front store (non-pharmacy) sales increased approximately 15% over
1997 front store sales. Front store sales growth benefitted from the additional
stores, coupled with solid performances in categories such as home furnishings,
domestics, ladies accessories, missy and girls apparel, housewares, hardware and
photofinishing.
Fred's pharmacy sales grew from 23% of total sales in 1997 to 27% of total sales
in 1998, and now ranks as the largest sales category within the Company. The
total sales in this department, including the Company's mail order operation,
increased 54% over 1997, with third-party payor prescription sales representing
approximately 71% of total pharmacy sales, compared with 66% of total pharmacy
sales in 1997. The Company's pharmacy sales growth continued to benefit from an
ongoing program of purchasing prescription files from independent pharmacies,
the addition of pharmacy departments in existing store locations, significant
inflation caused by drug manufacturer increases, the introduction of more
expensive drugs and favorable industry trends.
Sales to Fred's 29 franchised locations decreased approximately $2 million in
1998 and represented 6% of the Company's total sales compared with approximately
8% of 1997 total sales. It is anticipated that this category of business will
continue to decline as a percentage of total Company sales since the Company has
not added and does not intend to add any additional franchisees.
Gross Margin
Gross margin as a percentage of sales was 27.4% in 1998 compared to 27.5% in
1997. During 1998, the Company adopted the LIFO (last in, first out) method of
accounting for its pharmacy inventories. This change was made to address the
significant inflation incurred in pharmacy costs during 1998 and to provide a
better matching of current costs with current revenues. Excluding the LIFO
change, gross margin as a percentage of sales increased to 27.9% in 1998
compared with 27.5% in 1997. In general, the Company has experienced deflation
in its non-pharmacy inventory costs in recent periods.
Gross margin benefitted from reduced levels of markdowns as a percentage of
sales, higher initial purchase margins resulting from greater volumes of import
and opportunistic purchases and a lesser percentage of franchise sales, which
carry substantially lower margins than retail sales. This benefit was partially
offset by pharmacy sales growing at a faster pace than front store sales, since,
on average, the gross margin on pharmacy sales is lower than gross margins on
front store sales. Pharmacy gross margins were also negatively impacted by the
continuing shift in pharmacy sales to customers covered by third party insurance
programs, which generally carry lower margins than pharmacy cash sales due to
the efforts of managed care organizations and other pharmacy benefit managers to
reduce prescription drug costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were 24.9% of net sales in 1998
compared with 24.3% of net sales in 1997. Higher labor costs and additional
rental costs associated with the process of modernizing and automating the
Company's distribution center, higher payroll costs associated with a
significant increase in average pharmacy labor rates, and a decrease in the
percentage of franchise sales, which carry a lower expense percentage than
retail sales, contributed to the higher expense ratio in 1998.
Operating Income
Operating income decreased approximately $.8 million to $14.7 million in 1998
from $15.5 million in 1997. Excluding the effect of the Company's adoption of
LIFO in 1998, operating income increased by approximately $2.3 millon or 15% in
1998. Operating income as a percentage of sales, excluding the effect of LIFO in
1998, decreased from 3.2% in 1997 to 3.0% in 1998, due to the above mentioned
reasons.
Interest Expense, Net
Interest expense for 1998 totaled $1.2 million while interest income totaled $.1
million, for a net 1998 interest expense of $1.1 million compared to net
interest income of $.1 million in 1997 (interest income of $.4 million less
interest expense of $.3 million).
The interest expense for 1998 reflects higher average revolver borrowing levels
to finance inventories and other working capital requirements. Interest expense
also includes the partial year impact of a $12 million seven-year term loan the
Company obtained to finance the modernization and automation of its distribution
center.
Income Taxes
The effective income tax rate decreased to 35.1% in 1998 from 37.5% in 1997. The
Company completed a realignment of its corporate organizational structure during
the fourth quarter of 1998, which resulted in a reduction in the Company's
liability for taxes.
At January 30, 1999, the Company had certain net operating loss carryforwards
which were acquired in reorganizations and certain purchase transactions and are
available to reduce income taxes, subject to usage limitations. These
carryforwards total approximately $26.3 million for state income tax purposes,
which expire during the period 2000 through 2020. If certain substantial changes
in the Company's ownership should occur, there would be an annual limitation on
the amount of carryforwards which can be utilized.
Net Income
Net income for 1998 was $8.8 million (or $.73 per diluted share) versus $9.8
million (or $.83 per diluted share) in 1997. Excluding the $2.0 million (or $.17
per diluted share) impact of the Company's adoption of LIFO in 1998, net income
increased to $10.8 million (or $.90 per diluted share) and 10.2% over 1997
levels.
Fiscal 1997 Compared to Fiscal 1996
Sales
Net sales increased 17.7% ($74 million) in 1997. Approximately $42 million of
the increase was attributable to the net addition of 48 store locations and 40
pharmacies during 1997, together with the net sales of 13 stores and 9
pharmacies that were opened during 1996. Additionally, wholesale and franchise
sales were up $1 million in 1997, while comparable store sales increased 8.3%
($31 million), with strong performances in the pharmacy, stationery, pets,
giftware, home furnishings and domestics departments.
Gross Margin
Gross margin as a percentage of sales was 27.5% in 1997 versus 26.8% in 1996.
The increase in percentage was due to higher initial purchase margins resulting
from improved sourcing and higher volumes of import and opportunistic purchases,
coupled with a higher ratio of softline and pharmacy sales, which generally
yield slightly higher margins than hardline sales. Wholesale sales, which carry
lower gross margins than retail sales, also decreased as a percentage of total
sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of sales improved
to 24.3% in 1997 compared to 24.4% in 1996. The improvement in comparable store
sales for 1997 contributed to higher leveraging of expenses, and therefore, an
improved expense ratio. This leveraging more than offset the adverse impact of
October 1996 and September 1997 minimum wage increases, higher incentive
compensation accruals and the costs of an additional advertising circular
distributed during 1997.
Operating Income
Operating income increased to $15.5 million in 1997 from $6.8 million in 1996.
This increase was a direct result of the 17.7% increase in sales experienced
during 1997, and the higher gross margin as a percentage of sales discussed
above. Operating income for 1996 also included $3.3 million of restructuring and
other charges as discussed in Note 13 of the Notes to Consolidated Financial
Statements.
Net Interest Income
Net interest income of $.1 million (interest income of $.4 million less interest
expense of $.3 million) was generated in 1997 due to lower average revolver
borrowings and the pay-down of the remaining balance of a 1994 term loan.
Income Taxes
The effective income tax rate increased to 37.5% in 1997 from 10.8% in 1996. The
1996 rate included a benefit resulting from the Company's ability to assure
utilization of certain net operating loss carryforwards and tax credits that
were originally anticipated to expire unused. See Note 6 of the Notes to
Consolidated Financial Statements.
Liquidity and Capital Resources
Fred's primary sources of working capital are cash flow from operations and
borrowings under its current facility. The company had working capital of $72.8
million, $70.7 million and $66.5 million at year end 1998, 1997 and 1996,
respectively. Working capital fluctuates in relation to profitability, seasonal
inventory levels, net of trade accounts payable, and the level of store openings
and closings.
The Company has a five-year $15 million unsecured revolving credit commitment
with a bank that has generally been used to build inventory levels during
seasonal periods. The credit commitment expires in June 2003 and bears interest
at the lesser of 1.5% below prime rate or a LIBOR-based rate (weighted average
interest rate of 6.5% on 1998 outstanding borrowings).
Delays in the processing of merchandise receipts caused by implementation of the
Company's new distribution center automation and computer system in January 1999
resulted in a reduction of days payable (i.e. the number of days between the
Company's receipt of goods and payments to vendors therefor) at year end 1998.
Accordingly, approximately $10.2 million of inventories were financed with
outstanding borrowings under the Company's revolver at year end. It is
anticipated that these borrowings will be reduced as the Company rebuilds its
days payable position during 1999. No borrowings were outstanding on the
revolver as of year end 1997 and 1996.
In May 1998, the Company entered into a seven-year unsecured term loan of $12
million to finance the modernization and automation of the Company's
distribution center and corporate facilities. The Loan Agreement bears interest
of 6.82% per annum and matures on November 1, 2005. At year end 1998, the
outstanding principal balance on the term loan was $11,670,000.
Cash provided by operations was $.6 million in 1998 compared to $21.0 million in
1997 and $10.0 million in 1996. As mentioned above, accounts payable was
adversely impacted during 1998 as a result of merchandise processing delays, and
was supplemented with short-term borrowings at year end. The 1997 year-end
accounts payable balance also included some vendor dating support associated
with the Company's November 1997 acquisition of a 17-store chain.
Capital expenditures in 1998 totaled $23.3 million compared with $9.7 million in
1997 and $3.1 million in 1996. The 1998 capital expenditures included $12.0
million of expenditures associated with the Company's modernization and
automation of its distribution center, and $11.3 million of expenditures
associated with new stores and pharmacies, store and pharmacy upgrades and
annual capital maintenance. This compares with 1997 capital expenditures of $9.7
million for new stores and pharmacies, store and pharmacy upgrades and annual
capital maintenance. Cash used for investing activities in 1997 also included
$12.9 million for the acquisition of inventory, fixed assets and pharmacy
customer lists of a 17-store chain.
The Company believes that sufficient capital resources are available in both the
short-term and long-term through currently available cash, cash generated from
future operations and, if necessary, the ability to obtain additional financing.
Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use," effective for fiscal years beginning
after December 15, 1998. This statement defines which costs incurred to develop
or purchase internal-use software should be capitalized and which costs should
be expensed. The Company is in the process of determining what impact, if any,
this pronouncement will have on its consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This statement requires companies to record derivative
instruments on their balance sheet at fair value and establishes new accounting
practices for hedge instruments. This statement is effective for years beginning
after June 15, 1999, and is not expected to have any impact on the Company's
consolidated financial statements.
Year 2000
The "Year 2000 Issue" relates to the inability of certain computer hardware and
software to properly recognize and process datesensitive information for the
Year 2000 and beyond. Without corrective measures, the Company's computer
applications could fail and/or produce erroneous results. To address this
concern, the Company has a Year 2000 compliance project in place to identify the
potential issues that could affect its business. The following discussion is an
update on where the Company stands on this important matter.
The Year 2000 Compliance Project is monitored by a Year 2000 oversight
committee, consisting of senior level management, that meets and reviews
progress towards the Company's targeted completion dates on a bi-weekly basis.
The Year 2000 compliance project at Fred's includes:
Upgrading store point of sale and pharmacy hardware and software systems to
be Year 2000 compliant. The Company has evaluated and determined its
hardware and software needs and is in the process of procuring the
necessary products to become Year 2000 compliant. All necessary equipment
will be upgraded, tested and implemented in the stores by a targeted
completion date of October 1999.
Verifying Year 2000 compliance of computer hardware and software providers
and obtaining Year 2000 product warranties as necessary. Targeted
completion date for verification certificates is June 1999.
Having key suppliers and service providers demonstrate or certify their
Year 2000 compliance, ensuring their ability to continue to supply and
provide service to the Company up to and beyond January 1, 2000. The
Company is also evaluating, correcting and testing electronic data
interchange systems between Fred's, and its key suppliers. The targeted
completion date for these process is August 1999. Although there can be no
assurance that the Company we will not be adversely affected by the Year
2000 issues of its key suppliers and service providers, Management believes
that ongoing communications will continue to minimize its risk.
Evaluate, test and correct the Company's personal computer hardware and
software, voice and data communication systems, and other date sensitive
operating devices, to ensure Year 2000 compliance exists by a targeted
completion date of August 1999.
The Company's distribution center hardware and software were replaced
during 1997 and 1998, and are completely Year 2000 compatible. The Company
operates its merchandising and inventory replenishment/distribution systems
with software that is being modified for Year 2000 compatibility. All
mission critical systems have been rewritten and implemented, and the
remaining non-critical systems will be rewritten and corrected by a
targeted completion date of September 1999.
The Company's financial information systems are heavily dependent on date
fields and are in the process of being rewritten. All mission critical
systems are expected to be corrected and implemented by May 1999, and the
remaining noncritical systems will be rewritten and corrected by a targeted
completion date of September 1999.
The Company's payroll and human resource systems are moderately dependent
on date fields. The Company currently anticipates replacing these systems
with newly acquired software during the third quarter of 1999. Should the
Company decide not to replace these systems, the rewrite and correction
process can also be accomplished during the third quarter of 1999.
The potential risks associated with failing to remediate our Year 2000 issues
include: temporary disruptions in store operations; temporary disruptions in the
ordering, receiving and shipping of merchandise and in the ordering and
receiving of other goods and services; temporary disruptions in the billing and
collecting of accounts receivable; temporary disruptions in services provided by
banks and other financial institutions; temporary disruptions in communication
services; and temporary disruptions in utility services.
The Company currently estimates that the incremental cost associated with
completing its Year 2000 compliance project will be approximately $.5 million,
about half of which had been incurred through January 30, 1999. This estimate
could change as additional information becomes available. The cost to resolve
the Year 2000 issues are being funded through operating cash flows. These costs
are in addition to the costs incurred to replace the Company's distribution
center hardware and software, since these systems were to be replaced
irrespective of Year 2000 issues.
Contingency Plan - The Company is currently in the process of completing a
contingency plan for each area in the organization that could be affected by the
Year 2000 issue, in the event that any of the above remediation activities prove
unsuccessful. Although the Company currently anticipates minimal business
disruption, the failure of either the Company or one or more of its major
business partners to remediate critical Year 2000 issues could have a materially
adverse impact on the Company's business, operations and financial condition.
Please read the "Cautionary Statement Regarding Forward Looking Statements"
section below.
Cautionary Statement Regarding Forward-looking Information
Statements, other than those based on historical facts, including the discussion
of management's expectations for Year 2000 compliance, which address activities,
events, or developments that the Company expects or anticipates may occur in the
future are forward-looking statements which are based upon a number of
assumptions concerning future conditions that may ultimately prove to be
inaccurate. Actual events and results may materially differ from anticipated
results described in such statements. The Company's ability to achieve such
results is subject to certain risks and uncertainties, including, but not
limited to, economic and weather conditions which affect buying patterns of the
Company's customers, changes in consumer spending and the Company's ability to
anticipate buying patterns and implement appropriate inventory strategies,
continued availability of capital and financing, competitive factors, and other
factors affecting business beyond the Company's control. Consequently, all of
the forward-looking statements are qualified by these cautionary
statements and there can be no assurance that the results or developments
anticipated by the Company will be realized or that they will have the expected
effects on the Company or its business or operations.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Fred's, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Fred's, Inc. and its subsidiaries at January 30, 1999 and January 31, 1998, and
the results of their operations and their cash flows for each of the three years
in the period ended January 30, 1999, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for pharmacy inventories during the year ended
January 30, 1999.
/s/PricewaterhouseCoopers LLP
Memphis, Tennessee
March 9, 1999
Fred's, Inc.
Consolidated Balance Sheets
(in thousands, except for number of shares)
January 30, January 31,
1999 1998
---------------- ----------------
ASSETS
Current assets:
Cash and cash equivalents $ 2,406 $ 5,303
Receivables, less allowance for doubtful accounts of $644
($766 at January 31, 1998) 8,931 7,086
Inventories 126,577 115,021
Deferred income taxes 3,783 5,441
Other current assets 1,367 1,005
---------------- ----------------
Total current assets 143,064 133,856
Property and equipment, at depreciated cost 68,923 53,099
Equipment under capital leases, less accumulated amortization of
$501 ($218 at January 31, 1998) 1,578 1,352
Deferred income taxes 2,598 3,284
Other noncurrent assets 4,594 3,816
---------------- ----------------
Total assets $ 220,757 $ 195,407
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 46,767 $ 49,438
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Balance Sheets
(in thousands, except for number of shares)
Current portion of indebtedness 11,606 -
Current portion of capital lease obligations 308 214
Accrued liabilities 10,776 11,817
Income taxes payable 826 1,716
---------------- ----------------
Total current liabilities 70,283 63,185
Long-term portion of indebtedness 10,264 -
Capital lease obligations 1,557 1,368
Other noncurrent liabilities 1,670 1,495
---------------- ----------------
Total liabilities $ 83,774 $ 66,048
---------------- ----------------
Commitments and contingencies (Notes 7 and 12)
Shareholders' equity:
Common stock, Class A voting, no par value, 11,946,772 shares
issued and outstanding (11,866,789 shares at January 31, 1998) 66,951 65,700
Retained earnings 70,596 64,147
Deferred compensation on restricted stock incentive plan (564) (488)
---------------- ----------------
Total shareholders' equity 136,983 129,359
---------------- ----------------
$ 220,757 $ 195,407
================ ================
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statements of Income
(in thousands, except share and per share amounts)
For the Years Ended
----------------------------------------------------
January 30, January 31, February 1,
1999 1998 1997
---------------- ---------------- ---------------
Net sales $ 600,902 $ 492,236 $ 418,297
Cost of goods sold 436,523 357,135 306,054
---------------- ---------------- ---------------
Gross profit 164,379 135,101 112,243
Selling, general and administrative expenses 149,668 119,590 102,175
Restructuring and other charges - - 3,289
---------------- ---------------- ---------------
Operating income 14,711 15,511 6,779
Interest expense (income), net 1,106 (149) 271
---------------- ---------------- ---------------
Income before taxes 13,605 15,660 6,508
Income taxes 4,775 5,873 702
---------------- ---------------- ---------------
Net income $ 8,830 $ 9,787 $ 5,806
================ ================ ===============
Net income per share
Basic $ .75 $ .84 $ .50
================ ================ ===============
Diluted $ .73 $ .83 $ .50
================ ================ ===============
Weighted average shares outstanding
Basic 11,798 11,670 11,634
================ ================ ===============
Diluted 12,078 11,863 11,657
================ ================ ===============
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statements of Changes in Shareholders' Equity
(in thousands, except share amounts)
Common Stock Retained Deferred Loan to
--------------------------
Shares Amount Earnings Compensation ESOP Total
-------------- ---------- ---------- --------------- ----------- -----------
Balance, February 3, 1996 9,335,239 $ 63,458 $ 52,424 $ (169) (143) $115,570
Cash dividends paid ($.16 per share) (1,866) (1,866)
Repurchase of shares (17)
Cancellation of restricted shares,
net of issuances (6,500) (90) (90)
Exercises of stock options 100 1 1
Contribution to ESOP
to reduce loan balance 143 143
Amortization of deferred compensation
on restricted stock incentive plan 15 15
Net income 5,806 5,806
-------------- ---------- ---------- --------------- ----------- -----------
Balance, February 1, 1997 9,328,822 63,369 56,364 (154) - 119,579
Cash dividends paid ($.17 per share) (1,999) (1,999)
Repurchase of shares (80)
Issuance of restricted stock 56,491 507 (507)
Exercises of stock options 97,557 1,211 1,211
Other issuances 18,046 300 300
Amortization of deferred compensation
on restricted stock incentive plan 173 173
Tax benefit on exercise of stock
options 313 313
Five-for-four stock split 2,365,953 (5) (5)
Net income 9,787 9,787
-------------- ---------- ---------- --------------- ----------- -----------
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statements of Changes in Shareholders' Equity
(in thousands, except share amounts)
Balance, January 31, 1998 11,866,789 65,700 64,147 (488) - 129,359
Cash dividends paid ($.20 per share) (2,381) (2,381)
Repurchase of shares (30) -
Issuance of restricted stock 46,182 752 (362) 390
Cancellation of restricted stock (5,500) (38) 38 -
Exercises of stock options 39,331 329 329
Amortization of deferred compensation
on restricted stock incentive plan 248 248
Tax benefit on exercise of stock
options 208 208
Net income 8,830 8,830
-------------- ---------- ---------- --------------- ----------- -----------
Balance, January 30, 1999 11,946,772 $ 66,951 $ 70,596 $ (564) $ - $ 136,983
============== ========== ========== =============== =========== ===========
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statements of Cash Flows
(in thousands)
For the Years Ended
January 30, January 31, February
1,
1999 1998 1997
--------------- -------------- -------------
Cash flows from operating activities:
Net income $ 8,830 $ 9,787 $ 5,806
Adjustments to reconcile net income to net cash flows
from operating activities:
Depreciation and amortization 8,939 7,112 6,149
Provision for uncollectible receivables 124 589 261
Contribution to ESOP to reduce ESOP loan balance - - 143
Deferred income taxes 2,344 (652) (962)
Amortization of deferred compensation on restricted
stock incentive plan 248 173 15
Issuance (cancellation) of restricted stock 390 - (90)
Write-down of fixed assets - - 1,044
Gain on sale of fixed assets - (114) -
(Increase) decrease in assets:
Receivables (1,969) (3,182) 361
Inventories (11,556) (16,852) (3,294)
Other assets (2,354) (1,099) (488)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities (3,712) 25,137 17
Income taxes payable (890) 68 834
Other noncurrent liabilities 175 1 225
--------------- -------------- -------------
Net cash provided by operating activities 569 20,968 10,021
--------------- -------------- -------------
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Cash flows from investing activities:
Capital expenditures (23,266) (9,696) (3,122)
Proceeds from dispositions of property and equipment - 279 -
Acquisition, net of cash acquired - (12,850) -
---------------- ---------------- ------------
Net cash used in investing activities (23,266) (22,267) (3,122)
--------------- -------------- ------------
Cash flows from financing activities:
Reduction of indebtedness and capital lease obligations (556) (1,487) (1,961)
Proceeds from revolving line of credit, net of payments 10,200 - -
Proceeds from term loan 12,000 - -
Proceeds from exercise of options 329 1,211 1
Tax benefit upon exercise of stock options 208 313 -
Payment of cash for dividends (2,381) (2,004) (1,866)
--------------- -------------- -------------
Net cash provided by (used in) financing activities 19,800 (1,967) (3,826)
--------------- -------------- -------------
Increase (decrease) in cash and cash equivalents (2,897) (3,266) 3,073
Cash and cash equivalents:
Beginning of year 5,303 8,569 5,496
--------------- -------------- -------------
End of year $ 2,406 $ 5,303 $ 8,569
=============== ============== =============
Supplemental disclosures of cash flow information:
Interest paid $ 1,239 $ 346 $ 276
Income taxes paid $ 2,828 $ 6,154 $ 773
Non cash investing and financing activities:
Assets acquired through capital lease obligations $ 509 $ 1,290 $ -
Common stock issued for acquisition $ - $ 300 $ -
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Notes to Consolidated Financial Statements
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Description of business. The primary business of Fred's, Inc. (the "Company") is
the sale of general merchandise through its 283 retail discount stores located
in the southeastern United States. In addition, the Company sells general
merchandise to its 29 franchisees.
Consolidated financial statements. The consolidated financial statements include
the accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions are eliminated.
Fiscal year. The Company utilizes a 52 - 53 week accounting period which ends on
the Saturday closest to January 31. Fiscal years 1998, 1997 and 1996, as used
herein, refer to the years ended January 30, 1999, January 31, 1998 and February
1, 1997, respectively.
Use of estimates. The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Actual results could differ from those estimates.
Inventories. Wholesale inventories are stated at the lower of cost or market
using the FIFO (first-in, first-out) method. Retail inventories are stated at
the lower of cost or market as determined by the retail inventory method. For
pharmacy inventories, which comprise approximately 16% of the retail inventories
at January 30, 1999, cost was determined using the LIFO (last-in, first-out)
method. For the remainder of the retail inventories, the FIFO method was
applied. The current cost of inventories exceeded the LIFO cost by approximately
$3,108,000 at January 30, 1999.
During the fourth quarter of fiscal 1998, the Company adopted the LIFO method of
accounting for its pharmacy inventories. The change was made to address the
significant inflation experienced in pharmacy inventory costs during 1998 and
provide for a better matching of costs and revenues. Net income for the year
ended January 30, 1999 was reduced by $2,017,000 as a result of this adoption.
Fred's, Inc.
Notes to Consolidated Financial Statements
Depreciation and amortization. Depreciation is computed using the straight-line
method over the estimated useful lives of buildings, furniture, fixtures and
equipment. Leasehold costs and improvements are amortized over the lesser of
their estimated useful lives or the remaining lease terms. Average useful lives
are as follows: buildings and improvements - 8 to 30 years; furniture and
fixtures - 5 to 10 years; and equipment - 3 to 10 years. Amortization on
equipment under capital leases is computed on a straight-line basis over the
terms of the leases.
Selling, general and administrative expenses. The Company includes buying,
warehousing, transportation and occupancy costs in selling, general and
administrative expenses.
Advertising. The Company charges advertising, including production costs, to
expense on the first day of the advertising period. Advertising expense for
1998, 1997 and 1996 was $9,621,000, $7,383,000 and $6,400,000, respectively.
Preopening costs. The Company charges to expense the preopening costs of new
stores as incurred. These costs are primarily labor to stock the store,
preopening advertising, store supplies and other expendable items.
Franchise fees. The Company markets goods and services to 29 franchised stores.
Franchise revenues are recognized upon sale of merchandise to those stores based
on a percentage of their purchases from the Company's warehouse. Total franchise
income for 1998, 1997 and 1996 was $1,957,000, $1,967,000 and $1,931,000,
respectively.
Other intangibles. Other intangibles primarily represent amounts associated with
acquired pharmacies and are being amortized over five years. These intangibles,
net of accumulated amortization, totaled $4,521,000 at January 30, 1999,
$3,742,000 at January 31, 1998 and $1,828,000 at February 1, 1997. Amortization
expense for 1998, 1997 and 1996 was $1,214,000, $739,000 and $528,000,
respectively.
Cash and cash equivalents. Cash on hand and in banks, together with other highly
liquid investments having original maturities of three months or less, are
classified as cash equivalents.
Financial instruments. At January 30, 1999, the Company did not have any
outstanding derivative instruments. The recorded value of the Company's
financial instruments, which include cash and cash equivalents, receivables,
accounts payable and indebtedness, approximates fair value. The following
methods and assumptions were used to estimate fair value of each class of
financial instrument: (1) the carrying amounts of current assets and liabilities
approximate fair value because of the short maturity of those instruments and
(2) the fair value of the Company's indebtedness is
Fred's, Inc.
Notes to Consolidated Financial Statements
estimated based on the current borrowing rates available to the Company for bank
loans with similar terms and average maturities.
Business segments. The Company has one reportable operating segment, its retail
stores, which are organized around the products sold and markets served.
Comprehensive income. The Company discloses all comprehensive income items in
accordance with Statement of Financial Accounting Standards No. 130, Reporting
Comprehensive Income. Comprehensive income does not differ from the consolidated
net income presented in the consolidated statements of income.
Reclassifications. Certain prior year amounts have been reclassified to conform
to the 1998 presentation.
NOTE 2 - ACQUISITION
Effective October 10, 1997, the Company executed an Asset Purchase Agreement for
the purchase of inventory and other selected assets of CVS Revco D.S., Inc. for
$12.85 million in cash. Tangible assets acquired consisted of inventory of $9.7
million and fixed assets of $2.0 million. The remaining purchase price was
allocated to identifiable intangible assets acquired.
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment, at cost, consists of the following (in thousands):
1998 1997
--------------- --------------
Buildings and improvements $ 63,975 $ 55,553
Furniture, fixtures and equipment 71,612 56,794
--------------- --------------
135,587 112,347
Less accumulated depreciation and amortization (70,966) (63,550)
--------------- --------------
64,621 48,797
Land 4,302 4,302
--------------- --------------
$ 68,923 $ 53,099
=============== ==============
Depreciation expense totaled $7,442,000, $6,115,000 and $5,381,000 for 1998,
1997 and 1996, respectively.
Fred's, Inc.
Notes to Consolidated Financial Statements
NOTE 4 - ACCRUED LIABILITIES
The components of accrued liabilities are as follows (in thousands):
1998 1997
--------------- --------------
Payroll and benefits $ 2,761 $ 3,414
Sales and use taxes 1,909 1,727
Insurance 3,328 3,746
Other 2,778 2,930
--------------- --------------
$ 10,776 $ 11,817
=============== ==============
NOTE 5 - INDEBTEDNESS
On May 15, 1992, the Company and a bank entered into a Revolving Loan and Credit
Agreement (the "Agreement"). The Agreement, as amended, provides the Company
with an unsecured revolving line of credit commitment of up to $15 million and
bears interest at the lesser of 1.5% below prime rate or a LIBOR-based rate. The
term of the Agreement extends to June 2003, and under the most restrictive
covenants of the Agreement, the Company is required to maintain specified
shareholders' equity and net income levels. There were $10,200,000 of borrowings
outstanding under the Agreement at January 30, 1999. No borrowings were
outstanding under the Agreement at January 31, 1998. The Company is required to
pay a commitment fee to the bank at a rate per annum equal to .18% on the
unutilized portion of the revolving line commitment over the term of the
Agreement.
In December 1993, the Company entered into a line of credit agreement with a
bank for the purpose of financing the purchase of new point-of-sale equipment
and a new mainframe computer. This line of credit was repaid in full during
fiscal 1997. During the period for which debt was outstanding in 1997, the
weighted average interest rate was 7.5%.
On May 5, 1998, the Company and a bank entered into a Loan Agreement (the "Loan
Agreement"). The Loan Agreement provides the Company with an unsecured term loan
of $12 million to finance the modernization and automation of the Company's
distribution center and corporate facilities. The Loan Agreement bears interest
of 6.82% per annum and matures on November 1, 2005. Under the most restrictive
covenants of the Loan Agreement, the Company is required to maintain specified
shareholders' equity and net income levels. Borrowings outstanding under this
Loan Agreement
Fred's, Inc.
Notes to Consolidated Financial Statements
totaled $11,670,000 at January 30, 1999. The principal maturities for the amount
outstanding at January 30, 1999 are as follows: $1,406,000 in fiscal 1999;
$1,495,000 in fiscal 2000; $1,603,000 in fiscal 2001; $1,718,000 in fiscal 2002;
$1,840,000 in fiscal 2003; and $3,608,000 thereafter.
Interest expense for 1998, 1997 and 1996 totaled $1,206,000, $343,000 and
$345,000, respectively.
NOTE 6 - INCOME TAXES
Deferred income taxes are provided for the tax effects of temporary differences
between the financial reporting basis and income tax basis of the Company's
assets and liabilities. The provision for income taxes consists of the following
(in thousands):
1998 1997 1996
------------- ------------- -------------
Current
Federal $ 2,639 $ 6,225 $ 894
State (208) 300 770
------------- ------------- -------------
2,431 6,525 1,664
------------- ------------- -------------
Deferred
Federal 1,974 (840) (431)
State 370 188 (531)
------------- ------------- -------------
2,344 (652) (962)
------------- ------------- -------------
$ 4,775 $ 5,873 $ 702
============= ============= =============
Deferred tax assets (liabilities) comprise the following (in thousands):
1998 1997
-------------- --------------
Current deferred tax assets:
Inventory valuation methods $ 861 $ 1,825
Accrual for inventory shrinkage 1,028 1,481
Allowance for doubtful accounts 358 431
Insurance accruals 1,160 1,262
Fred's, Inc.
Notes to Consolidated Financial Statements
Other 1,084 1,181
--------------- --------------
Gross current deferred tax assets 4,491 6,180
Deferred tax asset valuation allowance (328) (385)
--------------- --------------
4,163 5,795
Current deferred tax liabilities (380) (354)
-------------- ---------------
Net current deferred tax asset
$ 3,783 $ 5,441
============== ===============
1998 1997
-------------- ---------------
Noncurrent deferred tax assets:
Net operating loss carryforwards $ 1,028 $ 930
Depreciation - 873
Postretirement benefits other than pensions 634 567
Restructuring costs 229 391
Other 1,759 1,099
-------------- ---------------
Gross noncurrent deferred tax assets 3,650 3,860
Deferred tax asset valuation allowance (700) (546)
--------------- --------------
2,950 3,314
Noncurrent deferred tax liabilities:
Depreciation (319) -
Other (33) (30)
--------------- --------------
Gross noncurrent deferred tax liabilities (352) (30)
--------------- --------------
Net noncurrent deferred tax asset $ 2,598 $ 3,284
=============== ==============
The ultimate realization of these assets is dependent upon the generation of
future taxable income sufficient to offset the related deductions and loss
carryforwards within the applicable carryforward periods as described below. The
valuation allowance is based upon management's conclusion that
Fred's, Inc.
Notes to Consolidated Financial Statements
certain tax carryforward items will expire unused. During 1998, the valuation
allowance increased $98,000 as the result of the Company generating additional
net operating loss carryforwards in certain states. The release of valuation
allowance of $206,000 and $1,624,000 for the years ended January 31, 1998, and
February 1, 1997, respectively, resulted from the Company's ability to assure
utilization of certain state net operating loss carryforwards and tax credits
that were originally anticipated to expire unused.
At January 30, 1999, the Company has certain net operating loss carryforwards
which were acquired in reorganizations and purchase transactions which are
available to reduce income taxes, subject to usage limitations. These
carryforwards total approximately $26,300,000 for state income tax purposes, and
expire at various times during the period 2000 through 2020. If certain
substantial changes in the Company's ownership should occur, there would be an
annual limitation on the amount of carryforwards which can be utilized.
A reconciliation of the statutory Federal income tax rate to the effective tax
rate is as follows:
1998 1997 1996
--------------- ---------------- ---------------
Income tax provision at statutory rate 35.0% 35.0% 35.0%
State income taxes, net of federal benefit 0.8 3.4 2.4
Change in valuation allowance 0.7 (1.3) (25.0)
Other (1.4) 0.4 (1.6)
--------------- ---------------- ---------------
35.1% 37.5% 10.8%
=============== ================ ===============
NOTE 7 - LONG-TERM LEASES
The Company leases certain of its store locations under noncancelable operating
leases expiring at various dates through 2029. Many of these leases contain
renewal options and require the Company to pay taxes, maintenance, insurance and
certain other operating expenses applicable to the leased properties. In
addition, the Company leases various equipment under noncancelable operating
leases and certain transportation equipment under capital leases. Total rent
expense under operating leases was $13,618,000, $10,239,000 and $8,559,000, for
1998, 1997 and 1996, respectively. Amortization expense on assets under capital
leases for 1998, 1997 and 1996 was $283,000, $258,000 and $240,000,
respectively.
Fred's, Inc.
Notes to Consolidated Financial Statements
Future minimum rental payments under all operating and capital leases as of
January 30, 1999 are as follows (in thousands):
Operating Capital
Leases Leases
---------------- ----------------
1999 $ 12,350 $ 586
2000 10,485 586
2001 9,056 586
2002 7,647 586
2003 5,402 246
Thereafter 12,229 100
---------------- ----------------
Total minimum lease payments
$ 57,169 2,690
================
Imputed interest
(825)
----------------
Present value of net minimum lease payments, including
$308 classified as current portion of capital lease obligations
$ 1,865
================
NOTE 8 - SHAREHOLDERS' INTEREST
The Company has 30 million shares of Class A voting common stock authorized. The
Company's authorized capital also consists of 11.5 million shares of Class B
nonvoting common stock, of which no shares have been issued. In addition, the
Company has authorized 10 million shares of preferred stock, of which no shares
have been issued.
Effective October 12, 1998, the Company adopted a Shareholders' Rights Plan
which granted a dividend of one preferred share purchase right ("the Right") for
each common share outstanding at that date. Each Right represents the right to
purchase one-hundredth of a preferred share of stock at a preset price to be
exercised when any one individual, firm, corporation or other entity acquires
15%
Fred's, Inc.
Notes to Consolidated Financial Statements
or more of the Company's common stock. The Rights will become dilutive at the
time of exercise and will expire, if unexercised, on October 12, 2008.
NOTE 9 - STOCK SPLIT
On November 20, 1997, the board of directors approved a five-for-four stock
split to be effective on December 19, 1997 for shareholders of record on
December 5, 1997. The split resulted in the issuance of 2,365,953 shares of
common stock. All per share data included herein have been restated to reflect
the stock split.
Fred's, Inc.
Notes to Consolidated Financial Statements
NOTE 10 - EMPLOYEE BENEFIT PLANS
Incentive stock option plan. The Company has a long-term incentive plan under
which an aggregate of 1,168,750 shares may be granted. These options generally
expire five years from the date of grant. Options outstanding at January 30,
1999 expire in 1999 through 2003.
A summary of activity in the plan follows:
1998 1997 1996
-------------------------- ------------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------------ ------------ ------------ ----------- ------------ ---------
Outstanding at beginning
of year 411,298 $ 8.55 297,113 $ 10.60 362,562 $ 10.86
Granted 150,695 25.61 364,355 8.61 50,262 6.04
Canceled (32,523) 12.46 (16,353) 9.81 (115,588) 9.44
Expired - - (120,778) 14.45 - -
Exercised (39,331) 8.42 (113,039) 10.65 (123) 5.90
------------ ------------ ------------
Outstanding at end of year 490,139 13.40 411,298 8.55 297,113 10.60
============ ============ ============
Exercisable at end of year 152,483 9.85 90,115 10.70 246,712 11.23
============ ============ ============
The weighted average remaining contractual life of all outstanding options was
3.3 years at January 30, 1999.
Fred's, Inc.
Notes to Consolidated Financial Statements
The following table summarizes information about stock options outstanding at
January 30, 1999:
Options Outstanding Options Exercisable
------------------------------------- ----------------------------------
Weighted
Average
Remaining Weighted Weighted
Number Contractual Average Number Average
Range of Outstanding at Life Exercise Exercisable at Exercise
Exercise Prices January 30, 1999 (in Years) Price January 30, 1999 Price
- -------------------------- ------------------ ---------------- ---------------- ------------------ -------------
$5.90 to $8.00 281,985 3.0 7.13 96,980 $ 7.11
$11.00 to $17.90 71,779 2.8 14.38 52,903 $ 14.09
$22.75 to $25.88 136,375 4.2 25.84 2,600 $ 25.88
------------------ -----------------
490,139 152,483
================== =================
The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees and related interpretations in accounting for its
plans. Accordingly, no compensation expense has been recognized for its
stock-based compensation. Had compensation cost for the Company's stock option
plan been determined based on the fair value at the grant date for awards in
1998, 1997 and 1996 consistent with the method prescribed by SFAS No. 123,
Accounting for Stock Based Compensation, the Company's operating results for
1998, 1997 and 1996 would have been reduced to the pro forma amounts indicated
below (in thousands, except per share data):
1998 1997 1996
--------------- -------------- --------------
Net income
As reported $ 8,830 $ 9,787 $ 5,806
Pro forma 8,322 9,492 5,747
Basic earnings per share
As reported 0.75 0.84 0.50
Pro forma 0.71 0.81 0.49
Diluted earnings per share
As reported 0.73 0.83 0.50
Pro forma 0.69 0.80 0.49
Fred's, Inc.
Notes to Consolidated Financial Statements
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions using grants in 1998, 1997 and 1996, respectively:
1998 1997 1996
--------------- ------------- ------------
Average expected life (years) 3.0 3.0 3.0
Average expected volatility 41.5% 37.6% 35.6%
Risk-free interest rates 5.5% 6.0% 5.0%
Dividend yield 1.3% 2.4% 2.7%
The weighted average grant-date fair value of options granted during 1998, 1997
and 1996 was $7.85, $2.40 and $1.90 respectively.
Restricted stock. During 1998, 1997 and 1996, the Company issued 46,182, 56,491
and 21,500 restricted shares, respectively. Compensation expense related to the
shares issued is recognized over the period for which restrictions apply.
Employee stock ownership plan. The Company has a non-contributory employee stock
ownership plan for the benefit of qualifying employees who have completed one
year of service and attained the age of 18. Benefits are fully vested upon
completion of seven years of service. The Company did not make any contributions
to the plan in 1998 or 1997. During 1996, the Company made a contribution in the
amount of $148,000, which represents the amount required to enable the plan to
make payments on its outstanding indebtedness.
Salary reduction profit sharing plan. The Company has a defined contribution
profit sharing plan for the benefit of qualifying employees who have completed
one year of service and attained the age of 21. Participants may elect to make
contributions to the plan up to a maximum of 15% of their compensation. Company
contributions are made at the discretion of the Company's Board of Directors.
Participants are 100% vested in their contributions and earnings thereon.
Contributions by the Company and earnings thereon are fully vested upon
completion of seven years of service. The Company's contributions for the years
ended January 30, 1999, January 31, 1998 and February 1, 1997 were $83,000,
$65,000 and $60,000, respectively.
Fred's, Inc.
Notes to Consolidated Financial Statements
Postretirement benefits. The Company provides certain health care benefits to
its full-time employees that retire between the ages of 58 and 65 with certain
specified levels of credited service. Health care coverage options for retirees
under the plan are the same as those available to active employees. The
Company's change in benefit obligation based upon an actuarial valuation is as
follows (in thousands):
For the Year Ended
-------------------------------------------
January 30, January 31,
1999 1998
------------------- --------------------
Benefit obligation at beginning of year $1,132 $1,235
Service cost 103 97
Interest cost 85 83
Participant contributions 4 2
Amendments - (7)
Actuarial (gain) loss (67) (258)
Benefits paid (5) (20)
------------------- --------------------
Benefit obligation at end of year $1,252 $1,132
=================== ====================
A reconciliation of the plan's funded status to accrued benefit cost follows:
January 30, January 31,
1999 1998
---------------- -------------------
Funded status $ (1,252) $ (1,132)
Unrecognized net actuarial loss (gain) (405) (356)
Unrecognized prior service cost (6) (7)
---------------- -------------------
Accrued benefit costs $ (1,663) $ (1,495)
================ ===================
The medical care cost trend used in determining this obligation is 10.0%
effective February 1, 1997, decreasing annually before leveling at 6.5% in 2003.
This trend rate has a significant effect on the amounts reported. To illustrate,
increasing the health care cost trend by 1% would increase the accumulated
postretirement benefit obligation by $202,000. The discount rate used in
calculating the obligation was 6.75% in 1998, 7.5% in 1997 and 8.0% in 1996.
Fred's, Inc.
Notes to Consolidated Financial Statements
The annual net postretirement cost is as follows (in thousands):
For the Year Ended
----------------------------------------------------
January 30, January 31, February 1,
1999 1998 1997
----------------- ---------------- ----------------
Service cost $ 103 $ 97 $ 124
Interest cost 85 83 92
Amortization of net loss (gain) from prior periods (21) (19) -
Amortization of unrecognized prior service cost 1 - -
----------------- ---------------- ----------------
Net periodic postretirement benefit cost $ 168 $ 161 $ 216
================= ================ ================
The Company's policy is to fund claims as incurred.
NOTE 11 - NET INCOME PER SHARE
Net income per share is calculated in accordance with Statement of Financial
Accounting Standards No. 128, Earnings Per Share, which requires the
presentation of basic and diluted earnings per share. Basic earnings per share
excludes dilution and is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity. Restricted stock is considered
contingently issuable and is excluded from the computation of basic earnings per
share.
Fred's, Inc.
Notes to Consolidated Financial Statements
A reconciliation of basic earnings per share to diluted earnings per share
follows (in thousands, except per share amounts):
Year Ended
------------------- ----------- --------------------- ----------- -------------------- ----------
January 30, 1999 January 31, 1998 February 1, 1997
------------------------------- ------------------------------- -------------------------------
Per-Share Per-Share Per-Share
Income Shares Amount Income Shares Amount Income Shares Amount
Basic EPS
Basic EPS $ 8,830 11,798 $ .75 $ 9,787 11,670 $ .84 5,806 11,634 $ .50
Effect of Dilutive
Securities
Restricted stock 79 42 23
Stock options 201 151
------- ------ ----- ------ ------- ------ ------ ------ ------
Diluted EPS $ 8,830 12,078 $ .73 $ 9,787 11,863 $ .83 5,806 11,657 .50
======= ====== ====== ====== ======= ====== ====== ====== ======
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Commitments. At January 30, 1999, the Company had commitments approximating
$6,413,000 on issued letters of credit which support purchase orders for
merchandise. Additionally, the Company had outstanding letters of credit
aggregating $2,064,000 utilized as collateral for their risk management
programs.
Litigation. The Company is a party to several pending legal proceedings and
claims in the normal course of business. Although the outcome of the proceedings
and claims cannot be determined with certainty, management of the Company is of
the opinion that it is unlikely that these proceedings and claims will have a
material adverse effect on the results of operations or the financial condition
of the Company.
NOTE 13 -
OTHER EXPENSES
During the year ended February 1, 1997, the Company recorded certain
non-recurring expenses of $3,289,000. These expenses consist of potential
merger-related costs and restructuring charges as discussed below.
During the third quarter of 1996, the Company terminated discussions relative to
a pending merger transaction with another company. Nonrecurring legal, travel
and other expenses resulting from this transaction totaled $429,000 and were
Fred's, Inc.
Notes to Consolidated Financial Statements
expensed upon termination of the potential merger. During the fourth quarter of
1996, the Company recorded a $2,860,000 accrual for the closure of certain
underperforming stores and the repositioning of certain merchandise categories.
This charge relates to an accrual for closed facility lease obligations
($1,156,000) and the write-off of fixed assets and other store closing costs
($1,044,000). In addition, $660,000 of costs to eliminate certain product lines
were incurred. These product lines were eliminated in 1997 and the reserves were
fully utilized upon such disposition. Fixed asset write-offs were taken against
assets being disposed. The remaining lease obligation reserves at January 30,
1999 represent future base payments required for two locations that have been
closed.
The 1998 activity in this reserve is as follows:
February 1, January 31, January 30,
1997 1998 Charges 1999
----------- ----------- ---------- ----------
Lease obligations $ 1,156 $ 666 $ (266) $ 400
=========== =========== =========== ===========
NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------------- ------------- ------------- -------------
(in thousands, except per share amounts)
Year Ended January 30, 1999(1)
- ---------------------------
Net sales $ 144,156 $ 141,635 $ 142,339 $ 172,772
Gross profit 37,869 38,614 41,449 46,447
Net income 2,286 1,430 2,568 2,546
Net income per share
Basic 0.19 0.12 0.22 0.22
Diluted 0.19 0.12 0.21 0.21
Cash dividends paid per share 0.05 0.05 0.05 0.05
Year Ended January 31, 1998
- ---------------------------
Net sales $ 112,668 $ 110,196 $ 114,021 $ 155,351
Gross profit 31,074 30,179 33,362 40,486
Net income 2,680 1,251 2,368 3,488
Net income per share
Basic 0.23 0.11 0.20 0.30
Diluted 0.23 0.11 0.20 0.29
Cash dividends paid per share 0.04 0.04 0.04 0.05
(1) The quarterly data for the year ended January 30, 1999 includes the impact
of the accounting change described in Note 1.
Report of Independent Accountants
on Financial Statement Schedules
To the Board of Directors
of Fred's, Inc.
Our audits of the consolidated financial statements referred to in our report
dated March 9, 1999 appearing in the 1998 Annual Report to Shareholders of
Fred's, Inc. (which report and consolidated financial statements are
incorporated by reference in this Annual Report on Form 10-K) also included an
audit of the financial statement schedules listed in Item 14(a)(2) of this Form
10-K. In our opinion, these financial statement schedules present fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
/s/ PricewaterhouseCoopers LLP
Memphis, Tennessee
March 9, 1999
Schedule II - Valuation and Qualifying Accounts
Balance at Charged to Balance at
Beginning Costs and Deductions End
of Period Expenses Write-Offs of Period
Allowance for doubtful accounts:
Year ended February 1, 1997 757 261 (72) 946
Year ended January 31, 1998 946 589 (769) 766
Year ended January 30, 1999 766 124 (246) 644
Exhibit 18.1
To the Board of Directors
of Fred's, Inc.
Dear Directors:
We have audited the consolidated financial statements included in Fred's Annual
Report on Form 10-K for the year ended January 30, 1999 and issued our report
thereon dated March 9, 1999. Note 1 to the consolidated financial statements
describes a change in Fred's method of determining the cost of pharmacy
inventories from the first-in, first-out to the last-in, first-out method. It
should be understood that the preferability of one acceptable method of
inventory accounting over another has not been addressed in any authoritative
accounting literature and in arriving at our opinion expressed below, we have
relied on management's business planning and judgment. Based on our discussions
with management and the stated reasons for the change, we believe that such a
change represents, in your circumstances, the adoption of a preferable
alternative accounting principle for inventories in conformity with Accounting
Principles Board Opinion No. 20.
Yours very truly,
/s/PricewaterhouseCoopers LLP
Memphis, Tennessee
March 9, 1999
EXHIBIT 21.1
FRED'S, INC.
SUBSIDIARIES OF REGISTRANT
Fred's, Inc. has the following subsidiaries, all of which are 100%
owned:
Fred's Stores of Tennessee, Inc.
Fred's Capital Management Company
Fred's Real Estate and Equipment Management Corporation
Fred's Capital Finance, Inc.
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements on Form S-8 (nos. 33-48380 and 33-67606) of Fred's, Inc. of our
report dated March 9, 1999 relating to the financial statements, which appears
in the Annual Report to Shareholders, which is incorporated in the Annual Report
on Form 10-K. We also consent to the incorporation by reference of our report
dated March 9, 1999 relating to the financial statement schedules, which appears
in the Form 10-K.
/s/PricewaterhouseCoopers LLP
Memphis, Tennessee
April 29, 1999