TABLE OF CONTENTS
PART I
ITEM 1. - Business
ITEM 2. - Properties
ITEM 3. - Legal Proceedings
ITEM 4. - Submission of Matters to a Vote of Security Holders
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PART II
ITEM 5. - Market for the Registrant's Common Equity and Related
Stockholder Matters
ITEM 6. - Selected Financial Data
ITEM 7. - Management's Discussion and Analysis of Financial Condition and
Results of Operations
ITEM 7A. - Quantitative and Qualitative Disclosure about Market Risk
ITEM 8. - Financial Statements and Supplementary Data
ITEM 9. - Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
ITEM 9A. - Controls and Procedures
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PART III
ITEM 10. - Directors and Executive Officers of the Registrant
ITEM 11. - Executive Compensation
ITEM 12. - Security Ownership of Certain Beneficial Owners and Management
ITEM 13. - Certain Relationships and Related Transactions
ITEM 14. - Principal Accountant Fees and Services
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PART IV
ITEM 15.
SIGNATURES
EXHIBIT INDEX
EX-21 (Subsidiaries of the registrant)
EX-23 (Consents of experts and counsel)
EX-31 Certification of Chief Executive Officer and Chief Financial Officer)
EX-32 (Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350)
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 31, 2004
Commission File Number 001-14565
FRED'S, INC.
------------
(Exact Name of Registrant as Specified in its Charter)
TENNESSEE 62-0634010
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
4300 New Getwell Road
MEMPHIS, TENNESSEE 38118
(Address of Principal Executive Offices)
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].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2.
Yes [X] No [ ]
Aggregate market value of the voting stock held by non-affiliates of the
Registrant as of August 1, 2003, was approximately $1.176 billion based upon the
last reported sale price on such date by the NASDAQ Stock Market, Inc.
As of April 2, 2004, there were 39,129,117 shares outstanding of the
Registrant's Class A no par value voting common stock.
As of April 2, 2004, 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 Form 8-K dated May 14, 2002 are incorporated by reference
into Part II, Item 9.
Portions of the Company's Proxy Statement for the 2004 annual shareholders
meeting, to be filed within 120 days of the registrant's fiscal year end, are
incorporated by reference into Part III, Items 10, 11, 12, 13 and 14.
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
Other than statements based on historical facts, many of the matters
discussed in this Form 10-K relate to events which we expect or anticipate may
occur in the future. Such statements are defined as "forward-looking statements"
under the Private Securities Litigation Reform Act of 1995 (the "Reform Act"),
15 U.S.C.A. Sections 77z-2 and 78u-5 (Supp. 1996). The Reform Act created a safe
harbor to protect companies from securities law liability in connection with
forward-looking statements. Fred's Inc. ("Fred's" or the "Company") intends to
qualify both its written and oral forward-looking statements for protection
under the Reform Act and any other similar safe harbor provisions.
The words "believe", "anticipate", "project", "plan", "expect", "estimate",
"objective", "forecast", "goal", "intend", "will likely result", or "will
continue" and similar expressions generally identify forward-looking statements.
All forward-looking statements are inherently uncertain, and concern matters
that involve risks and other factors which may cause the actual performance of
the Company to differ materially from the performance expressed or implied by
these statements. Therefore, forward-looking statements should be evaluated in
the context of these uncertainties and risks, including but not limited to:
o Economic and weather conditions which affect buying patterns of our
customers and supply chain efficiency;
o Changes in consumer spending and our ability to anticipate buying patterns
and implement appropriate inventory strategies;
o Continued availability of capital and financing;
o Competitive factors;
o Changes in reimbursement practices for pharmaceuticals;
o Governmental regulation;
o Increases in fuel and utility rates;
o Other factors affecting business beyond our control.
Consequently, all forward-looking statements are qualified by this cautionary
statement. We undertake no obligation to update any forward-looking statement to
reflect events or circumstances arising after the date on which it was made.
PART I
------
Item 1: Business
General
Fred's, founded in 1947, operates 488 discount general merchandise stores
in fourteen states primarily in the southeastern United States. Fred's
stores generally serve low, middle and fixed income families located in
small- to medium- sized towns (approximately 65% of Fred's stores are in
markets with populations of 15,000 or fewer people). Two hundred and
forty-one of the Company's stores have full service pharmacies. The Company
also markets goods and services to 26 franchised "Fred's" stores.
Fred's stores stock over 12,000 frequently purchased items which
address the everyday needs of its customers, including nationally
recognized brand name products, proprietary "Fred's" label products and
lower priced off-brand products. Fred's management believes its customers
shop Fred's stores as a result of their convenient locations and sizes,
everyday low prices on key products and regularly advertised departmental
promotions and seasonal specials. Fred's stores have average selling space
of 15,112 square feet and had average sales of $3,008,430 in fiscal 2003.
No single store accounted for more than 1.0% of net sales during fiscal
2003.
Business Strategy
The Company's strategy is to meet the general merchandise and pharmacy
needs of the small- to medium- sized towns it serves by offering a wider
variety of quality merchandise and a more attractive price-to-value
relationship than either drug stores or smaller variety/dollar stores and a
shopper-friendly format which is more convenient than larger sized discount
merchandise stores. The major elements of this strategy include:
Wide variety of frequently purchased, basic merchandise -Fred's combines
everyday basic merchandise with certain specialty items to offer its
customers a wide selection of general merchandise. The selection of
merchandise is supplemented by seasonal specials, private label products,
and the inclusion of pharmacies in 241 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 daily, while minimizing the Company's reliance on
promotional activities. As part of this strategy, Fred's maintains low
opening price points and competitive prices on key products across all
departments, and regularly offers seasonal specials and departmental
promotions supported by direct mail, television, radio and newspaper
advertising.
Convenient shopper-friendly environment - Fred's stores are typically
located in convenient shopping and/or residential areas. Approximately 33%
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. Fred's stores are of a manageable
size and have an understandable store layout, wide aisles and fast
checkouts.
Expansion Strategy
The Company expects that expansion will occur primarily within its
present geographic area and will be focused in small-to medium- sized
towns. The Company may also enter larger metropolitan and urban markets
where it already has a market presence in the surrounding area.
Fred's opened 79 stores in 2003 and closed 5 stores,and anticipates a
net increase of 80 to 100 new stores in 2004. The Company's new store
prototype has 16,000 square feet of space. Opening a new store currently
costs between $350,000 and $475,000 for inventory, furniture, fixtures,
equipment and leasehold improvements. The Company has 20 stand-alone
"Xpress" locations which sell only pharmaceuticals and other health and
beauty related items. These locations range in size from 1,000 to 8,000
square feet, and enable the Company to enter a new market with an initial
investment of under $400,000. During 2003, the Company opened 4 Xpress
locations. During 2004, the Company anticipates opening 5 to 10 new Xpress
locations. It is the Company's intent to expand these locations into a full
size Fred's location as market conditions permit.
The Company believes that its pharmaceuticals business will continue
to be a significant growth area. In 2003, the Company added 27 new
pharmacies and closed 2 pharmacies. During 2004, the Company anticipates
adding at least 35 additional pharmacies. Approximately 52% of Fred's
stores contain a pharmacy and sell prescription drugs. The Company's
primary mechanism for obtaining customers for new pharmacies is through the
acquisition of prescription files from independent pharmacies. These
acquisitions provide an immediate sales benefit, and in many cases, the
independent pharmacist will move to Fred's, thereby providing continuity in
the pharmacist-patient relationship.
The following tables set forth certain information with respect to
stores and pharmacies for each of the last five years:
1999 2000 2001 2002 2003
- ----------------------------------------------------------------------------------------------------------------
Stores open at beginning of period 283 293 320 353 414
Stores opened/acquired during period 20 31 33 62 79
Stores closed during period (10) (4) (0) (1) (5)
------------------------------------------------------
Stores open at end of period 293 320 353 414 488
======================================================
Number of stores with Pharmacies at
End of period 182 198 202 216 241
======================================================
Square feet of selling space at end of
period (in thousands) 3,968 4,346 4,892 5,785 6,884
======================================================
Average square feet of selling space
per store 14,015 14,690 14,517 15,086 15,112
======================================================
Franchise stores at end of period 26 26 26 26 26
======================================================
Merchandising and Marketing
The business in which the Company is engaged is highly competitive.
The principal competitive factors include location of stores, price and
quality of merchandise, in-stock consistency, merchandise assortment and
presentation, and customer service. The Company competes for sales and
store locations in varying degrees with national, regional and local
retailing establishments, including department stores, discount stores,
variety stores, dollar stores, discount clothing stores, drug stores,
grocery stores, outlet stores, warehouse stores and other stores. Many of
the largest retail merchandising companies in the nation have stores in
areas in which the Company operates.
Management believes that Fred's has a distinctive niche in that it
offers a wider variety of merchandise at a more attractive price-to-value
relationship than either a drug store or smaller variety/dollar store and
is more shopper-convenient than a larger discount store. The variety and
depth of merchandise offered at Fred's stores in high traffic departments,
such as health and beauty aids and paper and cleaning supplies, are
comparable to those of larger discount retailers. Management believes that
its knowledge of regional and local consumer preferences, developed in over
fifty-five years of operation by the Company and its predecessors, enables
the Company to compete effectively in its region. Purchasing The Company's
primary buying activities (other than prescription drug buying) are
directed from the corporate office by the General Merchandise Manager
through 3 Vice Presidents-Merchandising who are supported by a staff of 20
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 purchases its merchandise from a wide variety
of suppliers. Approximately 11% of the Company's purchases in 2003 were
made from Procter and Gamble. Excluding the purchases made from our
pharmaceutical supplier, no other supplier accounted for more than 3% of
the Company's purchases in 2003. The Company believes that adequate
alternative sources of products are available for these categories of
merchandise.
During 2003, all of the Company's prescription drugs were purchased by
its pharmacies individually and shipped direct from the Company's primary
pharmaceutical wholesaler AmerisourceBergen Corporation ("Bergen"). Bergen
provides substantially all of the Company's prescription drugs. During
2003, approximately 34% of the Company's total purchases were made from
Bergen. Although there are alternative wholesalers that supply
pharmaceutical products, the Company operates under a purchase and supply
contract with one supplier as its primary wholesaler. Accordingly, the
unplanned loss of this particular supplier could have a short-term gross
margin impact on the Company's business until an alternative wholesaler
arrangement could be implemented.
Sales Mix
Sales of merchandise through Company owned stores and to franchised
Fred's locations are the only significant industry segment of which the
Company is a part.
The Company's sales mix by major category for the preceding three
years was as follows:
2003 2002 2001
---- ---- ----
Pharmaceuticals........................ 32.4% 33.2% 34.4%
Household Goods........................ 23.6% 23.0% 22.4%
Apparel and Linens..................... 14.2% 13.6% 12.3%
Food and Tobacco Products.............. 10.2% 9.6% 9.5%
Health and Beauty Aids................. 8.8% 9.0% 9.4%
Paper and Cleaning Supplies............ 8.1% 8.4% 8.3%
Sales to Franchised Fred's Stores...... 2.7% 3.2% 3.7%
The sales mix varies from store to store depending upon local consumer
preferences and whether the stores include pharmacies and/or a full-line of
apparel. In 2003 the average customer transaction size was approximately
$17.78, and the number of customer transactions totaled approximately 73
million.
The private label program includes household cleaning supplies, health
and beauty aids, disposable diapers, pet foods, paper products and a
variety of beverage and other products. Private label products sold
constituted approximately 3% of total sales in 2003. Private label products
afford the Company higher than average gross margins while providing the
customer with lower priced products that are of a quality comparable to
that of competing branded products. An independent laboratory-testing
program is used for substantially all of the Company's private label
products.
The Company sells merchandise to its 26 franchised "Fred's" stores.
These sales during the last three years totaled $34,780,000 in 2003,
$35,261,000 in 2002, and $33,452,000 in 2001. Franchise and other fees
earned totaled $1,964,000 in 2003, $2,016,000 in 2002, and $1,764,000 in
2001. These fees represent a reimbursement for use of the Fred's name and
administrative costs incurred on behalf of the franchised stores. The
Company does not intend to expand its franchise network, and therefore,
expects that this category will continue to decrease as a percentage of the
Company's total revenues.
Advertising and Promotions
Advertising and promotion costs represented 1.3% of net sales in 2003.
The Company uses direct mail, television, radio and thirteen major
newspaper-advertising circulars 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. There is certain
flexibility by the store managers to tailor the price structure at their
particular store to meet competitive conditions within each store's
marketing area.
Store Operations
All Fred's stores are open six days a week (Monday through Saturday),
and most stores are open seven days a week (other than pharmacy). Store
hours are generally from 9:00 a.m. to 9:00 p.m.; however, certain stores
are open only until 6:00 p.m. Each Fred's store is managed by a full-time
store manager and those stores with a pharmacy employ a full-time
pharmacist. The Company's thirty-two district managers supervise the
management and operation of Fred's stores.
Fred's operates 241 in-store pharmacies, which offer brand name and
generic pharmaceuticals and are staffed by licensed pharmacists. The
addition of acquired pharmacies in the Company's stores has resulted in
increased store sales and sales per selling square foot. Management
believes that in-store pharmacies increase customer traffic and repeat
visits and are an integral part of the store's operation.
The Company has an incentive compensation plan for store managers,
pharmacists and district managers based on meeting or exceeding targeted
profit percentage contributions. Various factors included in determining
profit percentage contribution are gross profits and controllable expenses
at the store level. Management believes that this incentive compensation
plan, together with the Company's store management training program, are
instrumental in maximizing store performance.
Inventory Control and Distribution
Inventory Control
The Company's computerized central management information system
(known as "AURORA," which stands for Automation Utilizing Replenishment
Ordering and Receiving Accuracy) maintains a daily stock-keeping unit
("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 and a 600,000 square foot distribution center in
Dublin, Georgia (see "Properties" below). Approximately 58% of the
merchandise received by Fred's stores in 2003 was shipped through these
distribution centers, with the remainder (primarily pharmaceuticals,
certain Snack food items, greeting cards, beverages and tobacco products)
being shipped directly to the stores by suppliers. For distribution, the
Company uses owned and leased trailers and tractors, as well as common
carriers.
Seasonality
The Company's business is somewhat seasonal. Generally, the highest
volume of sales and net income occurs in the fourth fiscal quarter. In
2003, 2002 and 2001, the fourth quarter generated 29%, 30% and 30% of the
Company's total annual revenue and 37%, 39% and 42% of the Company's net
income, respectively.
Employees
At January 31, 2004, the Company had approximately 9,035 full-time and
part-time employees, comprised of 950 corporate and distribution center
employees and 8,085 store employees. The number of employees varies during
the year, reaching a peak during the Christmas selling season. In May of
2002, certain of our Memphis distribution center employees voted in an
election conducted by the National Labor Relations Board ("NLRB") to decide
whether or not they wished to be represented by the Union of Needletrades,
Industrial and Textile Employees (UNITE). We received notice that the NLRB
has reviewed the appeal and is certifying UNITE as the collective
bargaining representative of those Memphis distribution center employees.
The Company has informed the NLRB that it is taking a technical refusal to
bargain in order to appeal the matter to the Federal Appeals Court: and at
the same time, the Company is meeting with union representatives to see if
the issues can be resolved. The Company believes that it continues to have
good relations with these and all of its other employees. The Company does
not believe union representation in our Memphis distribution center will
have a material effect upon the Company's results of operations.
Available Information
Our website address is http://www.fredsinc.com. We make available
through this address, without charge, our annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to these reports as soon as reasonably practicable after these materials
are electronically filed or furnished to the SEC.
Item 2: Properties
As of January 31, 2004, the geographical distribution of the Company's
488 retail store locations in 14 states was as follows:
State Number of Stores
--------------------------------------------------
Mississippi 95
Tennessee 79
Georgia 70
Alabama 68
Arkansas 66
Louisiana 33
South Carolina 24
Kentucky 12
Missouri 11
Florida 9
North Carolina 9
Illinois 8
Indiana 2
Texas 2
The Company owns the real estate and the buildings for 60 locations,
and owns the buildings at 5 locations which are subject to ground leases.
The Company leases the remaining 423 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.
Three hundred and twenty-eight of the locations are in strip centers or
adjacent to a downtown-shopping district, with the remainder being
freestanding.
It is anticipated that existing buildings and buildings to be
developed by others will be available for lease to satisfy the Company's
expansion program in the near term. It is management's intention to enter
into leases of relatively moderate length with renewal options, rather than
entering into long-term leases. The Company will thus have maximum
relocation flexibility in the future, since continued availability of
existing buildings is anticipated in the Company's market areas.
The Company owns its distribution center and corporate headquarters
situated on approximately 60 acres 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. The
Company financed the construction of its 600,000 square foot distribution
center in Dublin, Georgia with taxable industrial development revenue bonds
issued by the City of Dublin and County of Laurens Development Authority.
Item 3: Legal Proceedings
The Company is party to several pending legal proceedings and claims
arising in the normal course of business. Although the outcome of the
proceedings and claims cannot be determined with certainty, management of
the Company is of the opinion that it is unlikely that these proceedings
and claims will have a material adverse effect on the financial statements
as a whole. However, litigation involves an element of uncertainty. There
can be no assurance that pending lawsuits will not consume the time and
energies of our management, or that future developments will not cause
these actions or claims, individually or in aggregate, to have a material
adverse effect on the financial statements as a whole. We intend to
vigorously defend or prosecute each pending lawsuit.
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 31, 2004.
PART II
Item 5: Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's common stock is traded on the Nasdaq Stock Market under
the symbol "FRED." The following table sets forth the high and low sales
prices, together with cash dividends paid per share of the Company's common
stock during each quarter in 2003 and 2002. All amounts have been adjusted
for a three-for-two stock split on July 1, 2003.
First Second Third Fourth
2003 Quarter Quarter Quarter Quarter
---- ------- ------- ------- -------
High $22.19 $30.16 $37.80 $37.99
Low $15.04 $20.60 $28.43 $27.49
Dividends $.02 $.02 $.02 $.02
First Second Third Fourth
2002 Quarter Quarter Quarter Quarter
---- ------- ------- ------- -------
High $26.73 $26.03 $23.33 $20.14
Low $18.25 $17.50 $17.40 $15.49
Dividends $.02 $.02 $.02 $.02
The Company's stock price at the close of the market on April 2, 2004, was
$24.90. There were approximately 16,600 shareholders of record of the
Company's common stock as of April 2, 2004. The Board of Directors
regularly reviews the Company's dividend plans to ensure that they are
consistent with the Company's earnings performance, financial condition,
need for capital and other relevant factors. The Company has paid cash
dividends on its common stock since 1993.
Item 6: Selected Financial Data
(dollars in thousands, except per share amounts)
2003 2002 2001 20001 1999
Statement of Income Data:
Net sales $1,302,650 $1,103,418 $910,831 $781,249 $665,777
Operating income 50,621 42,677 31,751 25,720 18,943
Income before income taxes 50,223 42,474 30,140 22,494 16,439
Provision for income taxes 16,502 14,258 10,511 7,645 5,737
Net income 33,721 28,216 19,629 14,849 10,702
Net income per share: 2
Basic .87 .74 .56 .44 .32
Diluted .85 .72 .54 .43 .31
Cash dividend paid per share 2 .08 .08 .08 .08 .08
Selected Operating Data:
Operating income as a percentage of sales 3.9% 3.9% 3.5% 3.3% 2.9%
Increase in comparable store sales 3 5.7% 11.2% 10.5% 9.2% 4 5.2%
Stores open at end of period 488 414 353 320 293
Balance Sheet Data (at period end):
Total assets $413,750 $345,848 $284,059 $254,795 $240,222
- -----------------------------
1 Results for 2000 include 53 weeks.
2 Adjusted for the 5-for-4 stock split effected on June 18, 2001, the 3-for-2
stock split effected on February 1, 2002 and the 3-for-2 stock split effected
on July 1, 2003.
3 A store is first included in the comparable store sales calculation after the
end of the twelfth month following the stores grand opening month.
4 The increase in comparable store sales for 2000 is computed ont he same
53-week period for 1999.
Short-term debt (including capital leases) 743 905 1,240 2,678 30,736
Long-term debt (including capital leases) 7,289 2,510 1,320 31,705 11,761
Shareholders' equity 290,613 250,770 218,907 159,687 145,913
Item 7: Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
Accounting Periods
The following information contains references to years 2003, 2002, and
2001, which represent fiscal years ending or ended January 31, 2004,
February 1, 2003 and February 2, 2002, each of which will be or was a
52-week accounting period. This discussion and analysis should be read
with, and is qualified in its entirety by, the Consolidated Financial
Statements and the notes thereto.
Executive Overview
In 2003, the Company continued the strategic direction that it implemented
in 2001 to grow its store base by approximately 15% per year and achieve
same store sales growth producing strong earnings per share growth. Fred's
operates 488 discount general merchandise stores in fourteen states
primarily in the southeastern United States. We did not enter into any new
states in 2003. The majority of our new store openings were in Alabama,
Georgia, Florida, and South Carolina. Additionally, we opened 27 new
pharmacies during the year.
The Company opened its second distribution center in Dublin, Georgia in
April 2003. This 600,000 square foot center will service up to 350 stores
within a 250 to 300 mile radius. At the end of 2003, the Dublin
distribution center was providing service to approximately 200 stores.
We expect to continue the same growth strategy in 2004 with the addition of
approximately 80 to 100 new stores. The majority of the new stores opening
will be in the territory serviced by the Dublin distribution center. We
anticipate opening an additional 35 pharmacies in 2004.
During 2003, the Company increased its executive management by announcing
promotions of Executive Vice President & General Merchandise Manager, and
Executive Vice President of Stores Operations.
We continue to focus our merchandising and store direction on maintaining a
competitive differentiation within the $25 shopping trip. Our unique store
format and strategy combine the attractive element of a discount dollar
store, drug store and mass merchant. Our average customer transaction was
approximately $17.78. In comparison, the discount dollar stores average $8
- $9 and chain drugs and mass merchants average in the range of $40 - $80
per transaction. Our stores operate equally well in rural and urban
markets. Our everyday low pricing strategy is supplemented by 14
promotional circulars per year. Our product selection is enhanced by a
private label program and opportunistic buys.
In 2004, we expect to continue this strategy with an additional
emphasis on space and inventory productivity. The Company has implemented
improvements in employee training, store POS systems upgrades, allocation
system upgrades, and SKU level inventory management. In 2004, we anticipate
sales in the range of $1.495 billion to $1.520 billion, up 15% to 17% over
fiscal 2003. Comparable store sales increases are expected to be in the
range of 4% to 7%.
Subsequent to our announcement of unaudited results for the year ended
January 31, 2004, the Company determined that certain adjustments were
needed in order to properly present the financial statements as a whole.
These adjustments reflect the effect of a minor difference in methodology
in determining inventory valuation under the "RIM" inventory method,
reimbursement of cost incurred from a vendor in accordance with "EITF
02-16", fiscal versus calendar year timing differences regarding vacation
expense accrual, and a cost accrual timing error. The Company does not
consider any one of these items alone to be material, but we believe that
the adjustments are necessary in aggregate for a proper presentation of our
financial statements. The effect of these adjustments was a decrease in
diluted earnings per share from $.87 to $.85 for the year ended January 31,
2004.
Critical Accounting Policies
The preparation of Fred's financial statements requires management to make
estimates and judgments in the reporting of assets, liabilities, revenues,
expenses and related disclosures of contingent assets and liabilities. Our
estimates are based on historical experience and on other assumptions that
we believe are applicable under the circumstances, the results of which
form the basis for making judgments about the values of assets and
liabilities that are not readily apparent from other sources. While we
believe that the historical experience and other factors considered provide
a meaningful basis for the accounting policies applied in the consolidated
financial statements, the Company cannot guarantee that the estimates and
assumptions will be accurate under different conditions and/or assumptions.
A summary of our critical accounting policies and related estimates and
judgments, can be found in Note 1 and the most critical accounting policies
are as follows:
Inventories
Warehouse inventories are stated at the lower of cost or market using the
FIFO (first-in, first-out) method. Retail inventories are stated at the
lower of cost or market as determined by the retail inventory method. Under
the retail inventory method ("RIM"), the valuation of inventories at cost
and the resulting gross margin are calculated by applying a calculated
cost-to-retail ratio to the retail value of inventories. RIM is an
averaging method that has been widely used in the retail industry due to
its practicality. Also, it is recognized that the use of the RIM will
result in valuing inventories at lower of cost or market if markdowns are
currently taken as a reduction of the retail value of inventories. Inherent
in the RIM calculation are certain significant management judgments and
estimates including, among others, initial markups, markdowns, and
shrinkage, which significantly impact the ending inventory valuation at
cost as well as resulting gross margin. These significant estimates,
coupled with the fact that the RIM is an averaging process, can, under
certain circumstances, produce distorted or inaccurate cost figures.
Management believes that the Company's RIM provides an inventory valuation
which reasonably approximates cost and results in carrying inventory at the
lower of cost or market. For pharmacy inventories, which are $33,129 and
$27,819 at January 31, 2004 and February 1, 2003, respectively, cost was
determined using the LIFO (last-in, first-out) method. The current cost of
inventories exceeded the LIFO cost by approximately $7,778 at January 31,
2004 and $6,138 at February 1, 2003. The LIFO reserve increased by $1,640,
$1,535, and $642, at January 31, 2004, February 1, 2003, and February 2,
2002, respectively.
Property and equipment
Property and equipment are stated at cost, and depreciation is computed
using the straight-line method over their estimated useful lives. Leasehold
costs and improvements which are included in buildings 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,fixtures,and equipment - 3 to 10
years. Amortization on equipment under capital leases is computed on a
straight-line basis over the terms of the leases. Gains or losses on the
sale of assets are recorded at disposal.
Vendor rebates and allowances.
The Company receives vendor rebates for achieving certain purchase or sales
volume and receives vendor allowances to fund certain expenses. The
Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting by a
Customer (including a Reseller) for Certain Consideration Received from a
Vendor" ("EITF 02-16") is effective for arrangements with vendors initiated
on or after January 1, 2003. EITF 02-16 addresses the accounting and income
statement classification for consideration given by a vendor to a retailer
in connection with the sale of the vendor's products or for the promotion
of sales of the vendor's products. The EITF concluded that such
consideration received from vendors should be reflected as a decrease in
prices paid for inventory and recognized in cost of sales as the related
inventory is sold, unless specific criteria are met qualifying the
consideration for treatment as reimbursement of specific, identifiable
incremental costs. The provisions of this consensus have been applied
prospectively. The adoption of EITF 02-16 did not have a material impact on
the Company's financial statements as a whole.
For vendor funding arrangements that were entered into prior to December
31, 2002 and have not been modified subsequently, the Company recognizes a
reduction to selling, general and administrative expenses or cost of goods
sold when earned. If these arrangements are modified in the future, the
provisions of EITF 02-16 will apply and the effect may be material to the
financial statements as a whole.
Insurance reserves
The Company is largely self-insured for workers compensation, general
liability and medical insurance. The Company's liability for self-insurance
is determined based on known claims and estimates for incurred but not
reported claims. If future claim trends deviate from recent historical
patterns, the Company may be required to record additional expense or
expense reductions which could be material to the Company's financial
statements as a whole.
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 sales.
2003 2002 2001
-----------------------------------------------------------------------------------------------------
Net sales 100.0% 100.0% 100.0%
Cost of goods sold 71.7 72.4 72.6
------------------------------------
Gross profit 28.3 27.6 27.4
Selling, general and administrative expenses 24.4 23.7 23.9
------------------------------------
Operating income 3.9 3.9 3.5
Interest expense, net 0.0 0.0 0.2
------------------------------------
Income before taxes 3.9 3.9 3.3
Income taxes 1.3 1.3 1.1
------------------------------------
Net income 2.6% 2.6% 2.2%
------------------------------------
Fiscal 2003 Compared to Fiscal 2002
Sales
Net sales increased 18.1% ($199.2 million) in 2003. Approximately $138.6
million of the increase was attributable to a net addition of 74 new
stores, upgraded stores, and a net addition of 25 pharmacies during 2003,
together with the sales of 62 store locations and 14 pharmacies that were
opened or upgraded during 2002 and contributed a full year of sales in
2003. During 2003, the Company closed two pharmacy locations. Comparable
store sales, consisting of sales from stores that have been open for more
than one year, increased 5.7% in 2003.
The Company's front store (non-pharmacy) sales increased approximately
20.5% over 2002 front store sales. Front store sales growth benefited from
the above mentioned store additions and improvements, and solid sales
increases in categories such as ladies, ladies accessories, missy,
footwear, home furnishings, small appliances, photo supplies, prepaid
products, stationery, electronics, and tobacco.
Fred's pharmacy sales were 32.4% of total sales in 2003 from 33.2% of total
sales in 2002 and continues to rank as the largest sales category within
the Company. The total sales in this department, including the Company's
mail order operation, increased 15.0% over 2002, with third party
prescription sales representing approximately 85% of total pharmacy sales,
the same percentage as the prior year. The Company's pharmacy sales growth
continued to benefit from an ongoing program of purchasing prescription
files from independent pharmacies and the addition of pharmacy departments
in existing store locations.
Sales to Fred's 26 franchised locations decreased approximately $.5 million
in 2003 and represented 2.7% of the Company's total sales, as compared to
3.2% in 2002. 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 increased to 28.3% in 2003 compared
to 27.6% in 2002. The increase in gross margin is a result of higher
initial markup, vendor slotting allowances, and other vendor allowances.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were 24.4% of net sales in
2003 compared with 23.7% of net sales in 2002. The increase for the year
was attributed to costs associated with the Company's expansion of store
and distribution facilities.
Operating Income
Operating income increased approximately $7.9 million or 18.6% to $50.6
million in 2003 from $42.7 million in 2002. Operating income as a
percentage of sales was 3.9% in 2003 the same as in 2002.
Interest Expense, Net
Interest expense for 2003 totaled $.4 million (less than .1% of sales)
compared to net interest expense of $.2 million (less than .1% of sales) in
2002. The increase in interest expense were attributed to the Company's
expansion program.
Income Taxes
The effective income tax rate decreased to 32.9% in 2003 from 33.6% in
2002, primarily due to realization of income tax credits in the amount of
$.8 million related to empowerment zone and renewal communities, vesting of
restricted stock previously granted to employees and state income tax
planning that allowed utilization of $7.2 million of state operating losses
that were previously reserved.
State net operating loss carry-forwards are available to reduce state
income taxes in future years. These carry-forwards total approximately
$57.5 million for state income tax purposes and expire at various times
during the period 2004 through 2023. If certain substantial changes in the
Company's ownership should occur, there would be an annual limitation on
the amount of carry-forwards that can be utilized.
Net Income
Net income for 2003 was $33.7 million (or $.85 per diluted share) or
approximately 19.5% higher than the $28.2 million (or $.72 per diluted
share) reported in 2002.
Fiscal 2002 Compared to Fiscal 2001
Sales
Net sales increased 21.1% ($192.6 million) in 2002. Approximately $95.0
million of the increase was attributable to a net addition of 61 new
stores, upgraded stores, and a net addition of 14 pharmacies during 2002,
together with the sales of 33 store locations and 7 pharmacies that were
opened or upgraded during 2001 and contributed a full year of sales in
2002. During 2002, the Company closed one pharmacy location. Comparable
store sales, consisting of sales from stores that have been open for more
than one year, increased 11.2% in 2002.
The Company's front store (non-pharmacy) sales during 2002 increased
approximately 24.2% over 2001 front store sales. Front store sales growth
benefited from the above mentioned store additions and improvements, and
solid sales increases in categories such as ladies and plus size apparel,
ladies accessories, footwear, bedding and windows, home furnishings, floor
coverings, giftware, small appliances, photo supplies, electronics, tobacco
and auto.
Fred's pharmacy sales were 33.2% of total sales in 2002 from 34.4% of total
sales in 2001 and continues to rank as the largest sales category within
the Company. The total sales in this department, including the Company's
mail order operation, increased 17.1% over 2001, with third party
prescription sales representing approximately 85% of total pharmacy sales,
the same percentage as the prior year. The Company's pharmacy sales growth
continued to benefit from an ongoing program of purchasing prescription
files from independent pharmacies and the addition of pharmacy departments
in existing store locations.
Sales to Fred's 26 franchised locations increased approximately $1.8
million in 2002 and represented 3.2% of the Company's total sales, as
compared to 3.7% in 2001. 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 increased to 27.6% in 2002 compared
to 27.4% in 2001. The increase in gross margin is a result of product mix
in the general merchandise categories and increased margins in the pharmacy
department due in part to the shift to more generic medications.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were 23.7% of net sales in
2002 compared with 23.9% of net sales in 2001. Labor expenses as a percent
of sales improved in the stores and pharmacies as a result of strong sales
coupled with store productivity initiatives. Expenses in the stores and
pharmacies improved by .4% as a percent of net sales. Increases offsetting
these improvements were in insurance, distribution and transportation
expenses. Insurance expense rose in 2002 due to premium increases for
insurance coverage, as well as increasing reserves associated with business
growth. Distribution and transportation expenses increased as a percent of
sales due to the distances required to service newer stores, which opened
in the area of the new distribution center in Dublin, Georgia, which opened
in 2003.
Operating Income
Operating income increased approximately $10.9 million or 34.4% to $42.7
million in 2002 from $31.8 million in 2001. Operating income as a
percentage of sales increased to 3.9% in 2002 from 3.5% in 2001, due to the
above-mentioned improvements in gross margins and selling, general and
administrative expense control.
Interest Expense, Net
Interest expense for 2002 totaled $.2 million (less than .1% of sales)
compared to net interest expense of $1.6 million (.2% of sales) in 2001.
The significant reduction results from the funds raised from our public
offering in September 2001 and March 2002 coupled with cash flows from
operations, effective working capital management throughout the year and
controlling capital expenditures.
Income Taxes
The effective income tax rate decreased to 33.6% in 2002 from 34.9% in
2001, primarily due to state income tax planning that allowed utilization
of $.8 million of state operating losses that were previously reserved.
As a result of certain changes in methods of accounting for income tax
purposes, net operating loss carry forwards increased in certain states
during 2002. These state net operating loss carry forwards are available to
reduce state income taxes in future years. These carry forwards total
approximately $63.7 million for state income tax purposes and expire at
various times during the period 2003 through 2022. If certain substantial
changes in the Company's ownership should occur, there would be an annual
limitation on the amount of carry forwards that can be utilized.
Net Income
Net income for 2002 was $28.2 million (or $.72 per diluted share) or
approximately 43.8% higher than the $19.6 million (or $.54 per diluted
share) reported in 2001.
Liquidity and Capital Resources
Fred's primary sources of working capital have traditionally been cash flow
from operations and borrowings under its credit facility. In June 2003 the
Company raised proceeds of $5.5 million from the offering of 225,000
Company shares. In March 2002 the Company raised proceeds of $3.5 million
from the offering of 148,134 Company shares. The Company had working
capital of $165.4 million, $138.5 million, and $138.4 million at year-end
2003, 2002 and 2001, respectively. Working capital fluctuates in relation
to profitability, seasonal inventory levels, net of trade accounts payable,
and the level of store openings and closings. Working capital at year-end
2003 increased by approximately $27.0 million from 2002. The increase was
primarily attributed to inventory purchased for new store openings
scheduled for the first quarter of 2004. The Company plans to open 22 new
stores during the first quarter of 2004.
Net cash flow provided by operating activities totaled $36.2 million in
2003, $43.7 million in 2002, and $26.4 million in 2001.
In fiscal 2003, cash was primarily used to increase inventories by
approximately $47.9 million during the fiscal year. This increase is
primarily attributable to our adding a net of 74 new stores, upgrading 26
stores and adding a net of 25 new pharmacies, as well as supporting the
improved comparable store sales. Accounts payable and accrued liabilities
increased by $15.9 million due primarily to higher inventory purchases.
Income taxes payable increased by approximately $.9 million and the net
deferred income tax liability increased by approximately $6.6 million
primarily as a result of first-year depreciation allowance for income tax
purposes.
In fiscal 2002, cash was primarily used to increase inventories by
approximately $31.4 million during the fiscal year. This increase is
primarily attributable to our adding a net of 61 new stores, upgrading 30
stores and adding a net of 14 new pharmacies, as well as supporting the
improved comparable store sales. Accounts payable and accrued liabilities
increased by $20.0 million due primarily to higher inventory purchases.
Income taxes payable decreased by approximately $6.8 million and the net
deferred income tax liability increased by approximately $12.3 million
primarily as a result of certain changes in method of accounting for income
tax purposes. The majority of the adjustment from the accounting method
changes is due to a change in method of accounting for inventory in retail
stores from the retail inventory method to the cost method.
Capital expenditures in 2003 totaled $48.0 million compared with $50.8
million in 2002 and $17.4 million in 2001. The 2003 capital expenditures
included approximately $23.2 million for new stores and pharmacies, $3.4
million for existing stores, $9.0 million related to the completion of the
new Georgia distribution center that was completed in April 2003, $2.2
million for the Memphis distribution center and 10.2 million for
technology, corporate and other capital expenditures. The 2002 capital
expenditures included approximately $23.9 million for the new distribution
center constructed in Dublin, Georgia. Expenditures totaling approximately
$24.2 million were associated with upgraded, remodeled, or new stores and
pharmacies. Approximately $2.7 million in expenditures related to
technology upgrades, distribution center equipment, freight equipment, and
capital maintenance. The 2001 capital expenditures included approximately
$13.5 million of expenditures associated with upgraded, remodeled, or new
stores and pharmacies and approximately $3.9 million in expenditures
related to technology upgrades, distribution center equipment, freight
equipment, and capital maintenance. Cash used for investing activities also
includes $.9 million in 2003, $1.8 million in 2002, and $1.0 million in
2001 for the acquisition of customer lists and other pharmacy related
items.
In 2004, the Company is planning capital expenditures totaling
approximately $41.6 million. Expenditures are planned totaling $31.1
million for the upgrades, remodels, or new stores and pharmacies. Planned
expenditures of $6.9 million relate to technology upgrades, distribution
center equipment and capital maintenance. The Company also plans
expenditures of $3.6 million in 2004 for the acquisition of customer lists
and other pharmacy related items.
Cash and cash equivalents were $4.7 million at the end of 2003 compared to
$8.2 million at year-end 2002. Short-term investment objectives are to
maximize yields while minimizing company risk and maintaining liquidity.
Accordingly, limitations are placed on amounts and types of investments.
On July 31, 2003, the Company and a bank entered into the third loan
modification agreement (the "Agreement") to modify the April 3, 2000
Revolving Loan and Credit Agreement, as amended. The Agreement provides the
Company with an unsecured revolving line of credit commitment of up to $40
million and bears interest at 1.5% below the prime rate or a LIBOR-based
rate. Under the most restrictive covenants of the Agreement, the Company is
required to maintain specified shareholders' equity (which was $247,677 at
January 31, 2004) and net income levels. The Company is required to pay a
commitment fee to the bank at a rate per annum equal to 0.15% on the
unutilized portion of the revolving line commitment over the term of the
Agreement. The term of the Agreement extends to July 31, 2006. There were
$5.5 million of borrowings outstanding under the Agreement at January 31,
2004.
On April 23, 1999, the Company and a bank entered into a Loan Agreement
(the "Loan Agreement"). The Loan Agreement provided the Company with a
four-year unsecured term loan of $2.3 million to finance the replacement of
the Company's mainframe computer system. The interest rate for the Loan
Agreement was 6.15% per annum and matured on April 15, 2003. There were
$141 borrowings outstanding under the Loan Agreement at February 1, 2003.
On March 6, 2002, the Company filed a Registration Statement on Form S-3
registering 750,000 shares of Class A common stock. The common stock may be
used from time to time as consideration in the acquisition of assets,
goods, or services for use or sale in the conduct of our business. On March
22, 2002, the Company raised proceeds of $3.5 million from the offering of
148,134 shares. On June 6, 2003, the Company raised proceeds of $5.5
million from the offering of 225,000 shares. On September 3, 2003, the
Company sold 75,000 shares in common stock for $2.6 million with the
intention of purchasing an airplane. Later, the Company decided not to
purchase the airplane, whereupon the Company purchased and retired $2.6
million of common stock of the CEO. A Limited Liability Company (LLC) of
which the CEO is the sole member purchased the airplane for $4.7 million.
The Company entered into a dry lease agreement with the LLC for its usage
at the annualized rate of 2.5%. On December 30, 2003, the Company purchased
the LLC for $4.7 million. As of January 31, 2004, the Company has 301,866
shares of Class A common stock available to be issued from the March 6,
2002 Registration Statement.
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.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet financing arrangements.
Effects of Inflation and Changing Prices. The Company believes that
inflation and/or deflation had a minimal impact on its overall operations
during fiscal years 2003, 2002 and 2001.
Contractual Obligations and Commercial Commitments
As discussed in Note 6 of the consolidated financial statements, 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.
The following table summarizes the Company's significant contractual
obligations as of January 31, 2004, which excludes the effect of imputed
interest:
(Dollars in thousands) Payments due by period
---------------------------------------------------------------------------------------------------------
Contractual Obligations Total < 1 yr 1-3 yrs 3-5 yrs >5 yrs
---------------------------------------------------------------------------------------------------------
Capital Lease obligations $2,884 $927 $1,442 $515 $0
----------------------------------------------------------------------------------------------------------
Revolving loan 5,500 - 5,500 - -
----------------------------------------------------------------------------------------------------------
Operating leases 128,619 29,353 48,941 29,007 21,318
----------------------------------------------------------------------------------------------------------
Inventory purchase obligations 8,261 6,033 2,228
----------------------------------------------------------------------------------------------------------
Industrial revenue bonds 33,234 - - - 33,234
----------------------------------------------------------------------------------------------------------
Miscellaneous financing 121 18 37 42 24
----------------------------------------------------------------------------------------------------------
Total Contractual Obligations $178,619 $36,331 $58,148 $29,564 $54,576
----------------------------------------------------------------------------------------------------------
As discussed in Note 10 of the consolidated financial statements, the
Company had commitments approximating $11.1 million at January 31, 2004 on
issued letters of credit, which support purchase orders for merchandise.
Additionally, the Company had outstanding letters of credit aggregating
$8.5 million at January 31, 2004 utilized as collateral for their risk
management programs.
The Company financed the construction of its Dublin, Georgia distribution
center with taxable industrial development revenue bonds issued by the City
of Dublin and County of Laurens development authority. The Company
purchased 100% of the bonds and intends to hold them to maturity,
effectively financing the construction with internal cash flow. Because a
legal right of offset exists, the Company has offset the investment in the
bonds ($33,234) against the related liability and neither is reflected in
the consolidated balance sheet.
Recent Accounting Pronouncements
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145 rescinds both SFAS No. 4, "Reporting Gains and
Losses from Extinguishment of Debt," and the amendment to SFAS No. 4, SFAS
No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." Generally, under SFAS No. 145, gains and losses from debt
extinguishments will no longer be classified as extraordinary items. The
Company adopted the provisions of SFAS No. 145 on February 2, 2003 and the
adoption of SFAS No. 145 did not have a material effect on the Company's
financial statements as a whole.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 nullifies EITF
Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)" ("EITF 94-3"). SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be
recognized when the liability is incurred, whereas EITF 94-3 had recognized
the liability at the commitment date to an exit plan. The Company was
required to adopt the provisions of SFAS No. 146 effective for exit or
disposal activities initiated after December 31, 2002. The adoption of SFAS
No. 146 did not have a material impact on the Company's financial
statements as a whole.
FASB Interpretation No. 46, "Accounting for Variable Interest Entities"
("FIN 46"), expands upon current guidance relating to when a company should
include in its financial statements the assets, liabilities and activities
of a variable interest entity. The consolidation requirements of FIN 46
apply immediately to variable interest entities ("VIE") created after
January 31, 2003. In October 2003, the FASB deferred the effective date of
Fin 46, and the consolidation requirements for "older" VIEs to the first
fiscal year or interim period after March 15, 2004. Additional
modifications to FIN 46 may be proposed by the FASB, and the Company will
continue to monitor future developments related to this interpretation. The
Company does not believe that the adoption of FIN 46 in 2004 will have a
material effect on the Company's financial statements as a whole.
Item 7a: Quantitative and Qualitative Disclosure about Market Risk
The Company has no holdings of derivative financial or commodity
instruments as of January 31, 2004. The Company is exposed to financial
market risks, including changes in interest rates. All borrowings under the
Company's Revolving Credit Agreement bear interest at 1.5% below prime rate
or a LIBOR-based rate. An increase in interest rates of 100 basis points
would not significantly affect the Company's income. All of the Company's
business is transacted in U.S. dollars and, accordingly, foreign exchange
rate fluctuations have never had a significant impact on the Company, and
they are not expected to in the foreseeable future.
Item 8: Financial Statements and Supplementary Data Report of Independent
Auditors
To the Board of Directors and Shareholders
of Fred's, Inc., Memphis, Tennessee
We have audited the accompanying consolidated balance sheets of Fred's,
Inc. and subsidiaries as of January 31, 2004 and February 1, 2003, and the
related consolidated statements of income, shareholders' equity, and cash
flows for the years then ended. 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. The
consolidated financial statements of Fred's, Inc. and subsidiaries for the
year ended February 2, 2002, were audited by other auditors whose report
dated March 15, 2002, expressed an unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards 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. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Fred's,
Inc. and subsidiaries at January 31, 2004 and February 1, 2003, and the
consolidated results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in
the United States.
/s/ Ernst & Young LLP
Memphis, Tennessee
April 5, 2004
Fred's, Inc.
Consolidated Balance Sheets
---------------------------
(in thousands, except for number of shares)
- --------------------------------------------------------------------------------
January 31, February 1,
2004 2003
--------------------- ---------------------
ASSETS
Current assets:
Cash and cash equivalents $ 4,741 $ 8,209
Receivables, less allowance for doubtful accounts of $1,437
($975 at February 1, 2003) 23,931 18,400
Inventories 239,748 193,506
Other current assets 4,094 7,775
--------------------- ---------------------
Total current assets 272,514 227,890
Property and equipment, at depreciated cost 135,433 110,794
Equipment under capital leases, less accumulated amortization of
$3,169 ($2,542 at February 1, 2003) 1,798 2,425
Other noncurrent assets, net 4,005 4,739
--------------------- ---------------------
Total assets $ 413,750 $ 345,848
===================== =====================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 74,799 $ 58,489
Current portion of indebtedness 18 177
Current portion of capital lease obligations 725 728
Accrued liabilities 19,113 19,484
Deferred tax liability 11,487 10,559
Income taxes payable 930 -
--------------------- ---------------------
Total current liabilities 107,072 89,437
Long-term portion of indebtedness 5,603 121
Deferred tax liability 6,335 676
Capital lease obligations 1,686 2,389
Other noncurrent liabilities 2,441 2,455
--------------------- ---------------------
Total liabilities 123,137 95,078
--------------------- ---------------------
Commitments and contingencies (Notes 6 and 10)
Shareholders' equity:
Preferred stock, nonvoting, no par value, 10,000,000 shares
authorized, none outstanding - -
Preferred stock, Series A junior participating nonvoting,
no par value, 224,594 shares authorized, none outstanding - -
Common stock, Class A voting, no par value, 60,000,000 shares
authorized, 39,105,639 shares issued and outstanding
(38,509,888 shares issued and outstanding at February 1, 2003) 126,430 117,209
Common stock, Class B nonvoting, no par value, 11,500,000
shares authorized, none outstanding - -
Retained earnings 164,183 133,589
Deferred compensation on restricted stock incentive plan - (28)
--------------------- ---------------------
Total shareholders' equity 290,613 250,770
--------------------- ---------------------
Total liabilities and shareholders' equity $ 413,750 $ 345,848
===================== =====================
Fred's, Inc.
Consolidated Statements of Income
(in thousands, except per share amounts)
- --------------------------------------------------------------------------------
For the Years Ended
--------------------------------------------------------------------
January 31, February 1, February 2,
2004 2003 2002
--------------------- ------------------ -----------------------
Net sales $ 1,302,650 $ 1,103,418 $ 910,831
Cost of goods sold 934,665 798,441 661,110
--------------------- ------------------ -----------------------
Gross profit 367,985 304,977 249,721
Selling, general and administrative expenses 317,364 262,300 217,970
--------------------- ------------------ -----------------------
Operating income 50,621 42,677 31,751
Interest expense, net 398 203 1,611
--------------------- ------------------ -----------------------
Income before taxes 50,223 42,474 30,140
Income taxes 16,502 14,258 10,511
--------------------- ------------------ -----------------------
Net income $ 33,721 $ 28,216 $ 19,629
===================== ================== =======================
Net income per share
Basic $ .87 $ .74 $ .56
===================== ================== =======================
Diluted $ .85 $ .72 $ .54
===================== ================== =======================
Weighted average shares outstanding
Basic 38,754 38,255 35,330
===================== ================== =======================
Diluted 39,652 39,251 36,296
===================== ================== =======================
Fred's, Inc.
Consolidated Statements of Changes in Shareholders' Equity
(in thousands, except share data)
- --------------------------------------------------------------------------------
Common Stock Retained Deferred
-------------------------------
Shares Amount Earnings Compensation Total
--------------- ------------- ------------ -------------- ----------
Balance, February 3, 2001 33,942,706 $ 68,557 $ 91,342 $ (212) $159,687
Proceeds from public offering 3,566,250 38,156 38,156
Cash dividends paid ($.08 per share) (2,509) (2,509)
Cancellation of restricted stock (22,778) (63) 12 (51)
Other issuances 83,970 937 937
Exercises of stock options 471,520 2,165 2,165
Amortization of deferred compensation
on restricted stock incentive plan 137 137
Tax benefit on exercise of stock
options 756 756
Net income 19,629 19,629
--------------- ------------- ------------ -------------- ----------
Balance, February 2, 2002 38,041,668 $110,508 $108,462 $ (63) $218,907
Cash dividends paid ($.08 per share) (3,089) (3,089)
Issuance of restricted stock 1,125 19 (19) -
Other issuances 151,083 3,592 3,592
Exercises of stock options 316,012 1,684 1,684
Amortization of deferred compensation
on restricted stock incentive plan 54 54
Tax benefit on exercise of stock
options 1,406 1,406
Net income 28,216 28,216
--------------- ------------- ------------ -------------- ----------
Balance, February 1, 2003 38,509,888 $117,209 $133,589 $ (28) $250,770
Cash dividends paid ($.08 per share) (3,127) (3,127)
Issuance of restricted stock 1,406 7 7
Other issuances 304,167 8,110 8,110
Other cancellation (75,000) (2,646) (2,646)
Exercises of stock options 365,178 2,276 2,276
Amortization of deferred compensation
on restricted stock incentive plan 28 28
Tax benefit on exercise of stock
options 1,474 1,474
Net income 33,721 33,721
--------------- ------------- ------------ -------------- ----------
Balance, January 31, 2004 39,105,639 $126,430 $164,183 $ - $290,613
=============== ============= ============ ============== ==========
Fred's, Inc.
Consolidated Statements of Cash Flows
(in thousands, except share data)
- --------------------------------------------------------------------------------
For the Years Ended
January 31, February 1, February 2,
2004 2003 2002
---------------- ---------------- ------------------
Cash flows from operating activities:
Net income $ 33,721 $ 28,216 $ 19,629
Adjustments to reconcile net income to net cash flows
from operating activities:
Depreciation and amortization 25,671 21,032 17,846
Provision for uncollectible receivables 462 318 142
LIFO reserve 1,640 1,535 642
Deferred income taxes 6,587 12,329 1,026
Amortization of deferred compensation on restricted
stock incentive plan 28 54 137
Issuance (net of cancellation) of restricted stock 7 - (51)
Tax benefit upon exercise of stock options 1,474 1,406 756
(Increase) decrease in assets:
Receivables (5,992) (3,014) (416)
Inventories (47,882) (31,424) (14,291)
Other assets 3,668 (365) (195)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities 15,938 19,998 3,532
Income taxes payable 930 (6,778) (2,411)
Other noncurrent liabilities (14) 400 52
---------------- ---------------- ------------------
Net cash provided by operating activities 36,238 43,707 26,398
================ ================ ==================
Cash flows from investing activities:
Capital expenditures (48,020) (50,835) (17,372)
Asset acquisition(primarily intangibles),net of cash acquired (916) (1,844) (986)
---------------- ---------------- ------------------
Net cash used in investing activities (48,936) (52,679) (18,358)
=============== ================ ==================
Cash flows from financing activities:
Reduction of indebtedness and capital lease obligations (883) (855) (9,892)
Proceeds from revolving line of credit, net of payments 5,500 - (22,623)
Proceeds from public offering, net of expenses 8,110 3,535 38,156
Repurchase of shares (2,646) - -
Proceeds from exercise of options 2,276 1,684 2,165
Dividends and payment for fractional shares (3,127) (3,089) (2,509)
--------------- ---------------- ------------------
Net cash provided by financing activities 9,230 1,275 5,297
=============== ================ ==================
Increase (decrease) in cash and cash equivalents (3,468) (7,697) 13,337
Cash and cash equivalents:
Beginning of year 8,209 15,906 2,569
--------------- ---------------- ------------------
End of year $ 4,741 $ 8,209 $ 15,906
=============== ================ ==================
Supplemental disclosures of cash flow information:
Interest paid $ 417 $ 180 $ 1,775
Income taxes paid $ 7,600 $ 7,300 $ 11,000
Non-cash investing and financing activities:
Assets acquired through capital lease obligations $ - $ 1,585 $ 691
Common stock issued for acquisition $ - $ 57 $ 937
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business. The primary business of Fred's, Inc. and subsidiaries
(the "Company") is the sale of general merchandise through its 488 retail
discount stores located in fourteen states mainly in the Southeastern United
States. Two hundred and forty-one of the Company's stores have full service
pharmacies. In addition, the Company sells general merchandise to its 26
franchisees.
Consolidated financial statements. The consolidated financial statements include
the accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions are eliminated.
Fiscal year. The Company utilizes a 52 - 53 week accounting period which ends on
the Saturday closest to January 31. Fiscal years 2003, 2002, and 2001, as used
herein, refer to the years ended January 31, 2004, February 1, 2003, and
February 2, 2002, respectively.
Use of estimates. The preparation of financial statements in accordance with
accounting principles generally accepted in the United States 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 and such differences could be material to the financial statements.
Cash and cash equivalents. Cash on hand and in banks, together with other highly
liquid investments which are subject to market fluctuations and having original
maturities of three months or less, are classified as cash equivalents.
Allowance for doubtful accounts. The Company is reimbursed for drugs sold by its
pharmacies by many different payors including insurance companies, Medicare and
various state Medicaid programs. The Company estimates the allowance on a
payor-specific basis, given its interpretation of the contract terms or
applicable regulations. However, the reimbursement rates are often subject to
interpretations that could result in payments that differ from the Company's
estimates. Additionally, updated regulations and contract negotiations occur
frequently, necessitating the Company's continual review and assessment of the
estimation process.
Inventories. Warehouse inventories are stated at the lower of cost or market
using the FIFO (first-in, first-out) method. Retail inventories are stated at
the lower of cost or market as determined by the retail inventory method
("RIM"). Under RIM, the valuation of inventories at cost and the resulting gross
margin are calculated by applying a calculated cost-to-retail ratio to the
retail value of inventories. RIM is an averaging method that has been widely
used in the retail industry due to its practicality. Also, it is recognized that
the use of the RIM will result in valuing inventories at lower of cost or market
if markdowns are currently taken as a reduction of the retail value of
inventories. Inherent in the RIM calculation are certain significant management
judgments and estimates including, among others, initial markups, markdowns, and
shrinkage, which significantly impact the ending inventory valuation at cost as
well as resulting gross margin. These significant estimates, coupled with the
fact that the RIM is an averaging process, can, under certain circumstances,
produce distorted or inaccurate cost figures. Management believes that the
Company's RIM provides an inventory valuation which reasonably approximates cost
and results in carrying inventory at the lower of cost or market. For pharmacy
inventories, which are $33,129 and $27,819 at January 31, 2004 and February 1,
2003, respectively, cost was determined using the LIFO (last-in, first-out)
method. The current cost of inventories exceeded the LIFO cost by $7,778 at
January 31, 2004 and $6,138 at February 1, 2003. The LIFO reserve increased by
$1,640, $1,535, and $642, during 2003, 2002, and 2001, respectively.
Property and equipment. Property and equipment are stated at cost, and
depreciation is computed using the straight-line method over their estimated
useful lives. Leasehold costs and improvements which are included in buildings
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, fixtures and equipment - 3 to 10 years.
Amortization on equipment under capital leases is computed on a straight-line
basis over the terms of the leases. Gains or losses on the sale of assets are
recorded at disposal.
Impairment of Long-lived assets. The Company's policy is to review the carrying
value of all long-lived assets annually and whenever events or changes indicate
that the carrying amount of an asset may not be recoverable. The Company adjusts
the net book value of the underlying assets if the sum of expected future cash
flows is less than the book value. Assets to be disposed of are adjusted to the
fair value less the cost to sell if less than the book value. Based upon the
Company's review as of January 31, 2004 and February 1, 2003, no material
adjustments to the carrying value of such assets were necessary.
Vendor rebates and allowances. The Company receives vendor rebates for achieving
certain purchase or sales volume and receives vendor allowances to fund certain
expenses. The Emerging Issues Task Force ("EITF") Issue No. 02-16, "Accounting
by a Customer (including a Reseller) for Certain Consideration Received from a
Vendor" ("EITF 02-16") is effective for arrangements with vendors initiated on
or after January 1, 2003. EITF 02-16 addresses the accounting and income
statement classification for consideration given by a vendor to a retailer in
connection with the sale of the vendor's products or for the promotion of sales
of the vendor's products. The EITF concluded that such consideration received
from vendors should be reflected as a decrease in prices paid for inventory and
recognized in cost of sales as the related inventory is sold, unless specific
criteria are met qualifying the consideration for treatment as reimbursement of
specific, identifiable incremental costs. The provisions of this consensus have
been applied prospectively. The adoption of EITF 02-16 did not have a material
impact on the Company's financial statements as a whole.
For vendor funding arrangements that were entered into prior to December 31,
2002 and have not been modified subsequently, the Company recognizes a reduction
to selling, general and administrative expenses or cost of goods sold when
earned. If these arrangements are modified in the future, the provisions of EITF
02-16 will apply and the effect may be material to the financial statements as a
whole.
Selling, general and administrative expenses. The Company includes buying,
warehousing, distribution, depreciation and occupancy costs in selling, general
and administrative expenses.
Advertising. The Company charges advertising, including production costs, to
expense on the first day of the advertising period. Advertising expense for
2003, 2002, and 2001 was $16,956, $14,124, and $12,079, respectively.
Preopening costs. The Company charges to expense the preopening costs of new
stores as incurred. These costs are primarily labor to stock the store,
preopening advertising, store supplies and other expendable items.
Revenue Recognition. The Company markets goods and services through Company
owned stores and 26 franchised stores. Net sales includes sales of merchandise
from Company owned stores, net of returns and exclusive of sales taxes. Sales to
franchised stores are recorded when the merchandise is shipped from the
Company's warehouse. Revenues resulting from layaway sales are recorded upon
delivery of the merchandise to the customer. In addition, the Company charges
the franchised stores a fee based on a percentage of their purchases from the
Company. These fees represent a reimbursement for use of the Fred's name and
other administrative costs incurred on behalf of the franchised stores and are
therefore netted against selling, general and administrative expenses. Total
franchise income for 2003, 2002, and 2001 was $1,964, $2,016, and $1,764,
respectively.
Other intangible assets. Other identifiable intangible assets, which are
included in other noncurrent assets, primarily represent amounts associated with
acquired pharmacies and are being amortized on a straight-line basis over five
years. During 2002 and 2001 the Company issued 2,949 and 83,970 shares for
pharmacy acquisitions, respectively. Intangibles, net of accumulated
amortization, totaled $3,913 at January 31, 2004 and $4,661 at February 1, 2003.
Accumulated amortization for 2003 and 2002 totaled $8,882 and $7,218,
respectively. Amortization expense for 2003, 2002, and 2001, was $1,664, $1,945,
and $1,795, respectively. Estimated amortization expense for each of the next 5
years is as follows: 2004 - $1,547, 2005 - $1,192, 2006 - $702, 2007- $381 and
2008 - $91.
Financial instruments. At January 31, 2004, the Company did not have any
outstanding derivative instruments. The recorded value of the Company's
financial instruments, which include cash and cash equivalents, receivables,
accounts payable and indebtedness, approximates fair value. The following
methods and assumptions were used to estimate fair value of each class of
financial instrument: (1) the carrying amounts of current assets and liabilities
approximate fair value because of the short maturity of those instruments and
(2) the fair value of the Company's indebtedness is estimated based on the
current borrowing rates available to the Company for bank loans with similar
terms and average maturities.
Insurance reserves. The Company is largely self-insured for workers
compensation, general liability and medical insurance. The Company's liability
for self-insurance is determined based on known claims and estimates for future
claims cost and incurred but not reported claims. If future claim trends deviate
from recent historical patterns, the Company may be required to record
additional expense or expense reductions which could be material to the
Company's results of operations.
Deferred rent. The Company records rental expense on a straight-line basis over
the base, non-cancelable lease term. Any differences between the calculated
expense and the amounts actually paid are reflected as a liability in accrued
liabilities in the accompanying consolidated balance sheet and totaled
approximately $886 and $714 at January 31, 2004 and February 1, 2003,
respectively.
Stock-based compensation. The Company grants stock options having a fixed number
of shares and an exercise price equal to the fair value of the stock on the date
of grant to certain executive officers, directors and key employees. The Company
accounts for stock option grants in accordance with Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"), and
related interpretations because the Company believes the alternative fair value
accounting provided for under SFAS No. 123, "Accounting for Stock-Based
Compensation," as amended by SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," requires the use of option valuation
models that were not developed for use in valuing employee stock options. Under
APB No. 25, compensation expense is generally not recognized for plans in which
the exercise price of the stock options equals the market price of the
underlying stock on the date of grant and the number of shares subject to
exercise is fixed. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant date for
awards under these plans consistent with the methodology prescribed under SFAS
No. 123, net income and earnings per share would have been reduced to the pro
forma amounts indicated in the following table.
2003 2002 2001
------------- --------------- --------------
Net income
As reported $33,721 $28,216 $19,629
Less pro forma effect of stock option grants 900 330 384
Pro forma 32,821 27,886 19,245
Basic earnings per share
As reported 0.87 0.74 0.56
Pro forma 0.85 0.73 0.55
Diluted earnings per share
As reported 0.85 0.72 0.54
Pro forma 0.83 0.71 0.53
The Company also periodically awards restricted stock having a fixed number of
shares at a purchase price that is set by the Compensation Committee of the
Company's Board of Directors, which purchase price may be set at zero, to
certain executive officers, directors and key employees. The Company also
accounts for restricted stock grants in accordance with APB No. 25 and related
interpretations. Under APB No. 25, the Company calculates compensation expense
as the difference between the market price of the underlying stock on the date
of grant and the purchase price, if any, and recognizes such amount on a
straight-line basis over the period in which the restricted stock award is
earned by the recipient. The Company recognized compensation expense relating to
its restricted stock awards of approximately $28, $54, and $137 in 2003, 2002,
and 2001, respectively. (See Note 8 for further disclosure relating to stock
incentive plans).
Income taxes. The Company reports income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes." Under SFAS No. 109, the asset and liability
method is used for computing future income tax consequences of events, which
have been recognized in the Company's consolidated financial statements or
income tax returns. Deferred income tax expense or benefit is the net change
during the year in the Company's deferred income tax assets and liabilities.
Business segments. The Company's only reportable operating segment is its sale
of merchandise through its Company owned stores and to franchised Fred's
locations.
Comprehensive income. Comprehensive income does not differ from the consolidated
net income presented in the consolidated statements of income.
Reclassifications. Certain prior year amounts have been reclassified to conform
to the 2003 presentation.
Recent Accounting Pronouncements. In April 2002, the FASB issued SFAS No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections." SFAS No. 145 rescinds both SFAS No. 4,
"Reporting Gains and Losses from Extinguishment of Debt," and the amendment to
SFAS No. 4, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements." Generally, under SFAS No. 145, gains and losses from debt
extinguishments will no longer be classified as extraordinary items. The Company
adopted the provisions of SFAS No. 145 on February 2, 2003 and the adoption of
SFAS No. 145 did not have a material effect on the Company's financial
statements as a whole.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 nullifies EITF Issue No. 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring)"
("EITF 94-3"). SFAS No. 146 requires that a liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred,
whereas EITF 94-3 had recognized the liability at the commitment date to an exit
plan. The Company was required to adopt the provisions of SFAS No. 146 effective
for exit or disposal activities initiated after December 31, 2002. The adoption
of SFAS No. 146 did not have a material impact on the Company's financial
statements as a whole.
FASB Interpretation No. 46, "Accounting for Variable Interest Entities" ("FIN
46"), expands upon current guidance relating to when a company should include in
its financial statements the assets, liabilities and activities of a variable
interest entity. The consolidation requirements of FIN 46 apply immediately to
variable interest entities ("VIE") created after January 31, 2003. In October
2003, the FASB deferred the effective date of Fin 46, and the consolidation
requirements for "older" VIEs to the first fiscal year or interim period ending
after March 15, 2004. Additional modifications to FIN 46 may be proposed by the
FASB, and the Company will continue to monitor future developments related to
this interpretation. The Company does not believe that the adoption of FIN 46 in
2004 will have a material effect on the Company's financial statements as a
whole.
NOTE 2 - PROPERTY AND EQUIPMENT
Property and equipment, at cost, consist of the following:
2003 2002
------------------- --------------------
Buildings and improvements $ 93,572 $ 75,779
Furniture, fixtures and equipment 171,523 125,723
------------------- --------------------
265,095 201,502
Less accumulated depreciation and amortization (138,685) (117,312)
------------------- --------------------
126,410 84,190
Construction in progress 4,781 22,308
Land 4,242 4,296
------------------- --------------------
Total property and equipment, at depreciated cost $ 135,433 $ 110,794
=================== ====================
Depreciation expense totaled $23,380, $18,394, and $15,507, for 2003, 2002, and
2001, respectively.
NOTE 3 - ACCRUED LIABILITIES
The components of accrued liabilities are as follows:
2003 2002
------------------- --------------------
Payroll and benefits $ 5,729 $ 6,900
Sales and use taxes 3,439 3,320
Insurance 5,145 5,036
Other 4,800 4,228
------------------- --------------------
Total accrued liabilities $ 19,113 $ 19,484
=================== ====================
NOTE 4 - INDEBTEDNESS
On July 31, 2003, the Company and a bank entered into a new Revolving Loan and
Credit Agreement (the "Agreement") to replace the April 3, 2000 Revolving Loan
and Credit Agreement, as amended. The Agreement provides the Company with an
unsecured revolving line of credit commitment of up to $40 million and bears
interest at 1.5% below the prime rate or a LIBOR-based rate. Under the most
restrictive covenants of the Agreement, the Company is required to maintain
specified shareholders' equity (which was $247,677 at January 31, 2004) and net
income levels. The Company is required to pay a commitment fee to the bank at a
rate per annum equal to 0.15% on the unutilized portion of the revolving line
commitment over the term of the Agreement. The term of the Agreement extends to
July 31, 2006. There were $5.5 million of borrowings outstanding under the
Agreement at January 31, 2004.
On April 23, 1999, the Company and a bank entered into a Loan Agreement (the
"Loan Agreement"). The Loan Agreement provided the Company with a four-year
unsecured term loan of $2.3 million to finance the replacement of the Company's
mainframe computer system. The interest rate for the Loan Agreement was 6.15%
per annum and matured on April 15, 2003. There were $141 borrowings outstanding
under the loan Agreement at February 1, 2003.
The Company has other miscellaneous financing obligations totaling $121, which
relate primarily to business acquisitions. The Company's indebtedness under
miscellaneous financing matures as follows: 2004 - $18; 2005 - $18; 2006 - $19;
2007 - $21; 2008 - $21 and $24 thereafter.
The Company financed the construction of its Dublin, Georgia distribution center
with taxable industrial development revenue bonds issued by the City of Dublin
and County of Laurens Development Authority. The Company purchased 100% of the
issued bonds and intends to hold them to maturity, effectively financing the
construction with internal cash flow. Because a legal right of offset exists,
the Company has offset the investment in the bonds ($33,234) against the related
liability and neither is reflected on the consolidated balance sheet.
NOTE 5 - INCOME TAXES
The provision for income taxes consists of the following:
2003 2002 2001
---------------- ---------------- ----------------
Current
Federal $ 9,960 $ 1,929 $ 9,485
State (45) - -
---------------- ---------------- ----------------
9,915 1,929 9,485
---------------- ---------------- ----------------
Deferred
Federal 6,721 12,824 907
State (134) (495) 119
---------------- ---------------- ----------------
6,587 12,329 1,026
---------------- ---------------- ----------------
$ 16,502 $ 14,258 $ 10,511
================ ================ ================
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities are presented below:
2003 2002
---------------- ----------------
Deferred tax assets:
Accrual for incentive compensation $ 187 $ -
Allowance for doubtful accounts 659 333
Insurance accruals 1,829 1,467
Net operating loss carryforwards 2,406 2,474
Postretirement benefits other than pensions 999 960
Restructuring costs 45 59
Amortization of intangibles 2,365 2,209
---------------- ----------------
Total deferred tax assets 8,490 7,502
Less: valuation allowance (580) (700)
---------------- ----------------
Deferred tax assets, net of valuation allowance 7,910 6,802
---------------- ----------------
Deferred tax liabilities:
Property, plant, and equipment (14,162) (5,939)
Inventory valuation (11,570) (12,070)
Other - (28)
---------------- ----------------
Total deferred tax liability (25,732) (18,037)
---------------- ----------------
Net deferred tax liability $ (17,822) $ (11,235)
================ ================
The net operating loss carryforwards are available to reduce state income taxes
in future years. These carryforwards total approximately $57.5 million for state
income tax purposes and expire at various times during the period 2004 through
2023.
During 2003, the valuation allowance decreased $120, and during 2002, the
valuation allowance decreased $832. Based upon expected future income,
management believes that it is more likely than not that the results of
operations will generate sufficient taxable income to realize the deferred tax
asset after giving consideration to the valuation allowance.
A reconciliation of the statutory federal income tax rate to the effective tax
rate is as follows:
2003 2002 2001
------------------ ------------------ --------------
Income tax provision at statutory rate 35.0% 35.0% 35.0%
Tax credits (1.9) - -
State income taxes, net of federal benefit 0.1 1.4 0.1
Permanent differences (0.1) (1.0) -
Change in valuation allowance (0.2) (2.0) (0.1)
Other - 0.2 (0.1)
------------------ ------------------ --------------
32.9% 33.6% 34.9%
------------------ ------------------ --------------
NOTE 6 - LONG-TERM LEASES
The Company leases certain of its store locations under noncancelable operating
leases that require monthly rental payments primarily at fixed rates (although a
number of the leases provide for additional rent based upon sales) expiring at
various dates through 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 $34,287, $26,844, and $22,207, for 2003, 2002, and 2001,
respectively. Total contingent rentals included in operating leases above was
$1,135, $786, and $409, for 2003, 2002, and 2001, respectively. Amortization
expense on assets under capital lease for 2003, 2002, and 2001 was $627, $693,
and $544, respectively.
Future minimum rental payments under all operating and capital leases as of
January 31, 2004 are as follows:
Operating Capital
Leases Leases
- --------------------------------------------------------------------------------------------------------------
2004 $ 29,353 $ 927
2005 26,382 814
2006 22,559 628
2007 18,094 386
2008 10,913 129
Thereafter 21,318 -
------------- ------------------
Total minimum lease payments $ 128,619 2,884
=============
Imputed interest (473)
------------------
Present value of net minimum lease payments, including
$725 classified as current portion of capital lease obligations $ 2,411
------------------
The gross amount of property and equipment under capital leases at January 31,
2004 and February 1, 2003, was $38,201 and $23,452, respectively. Accumulated
depreciation on property and equipment under capital leases at January 31, 2004
and February 1, 2003, was $4,428 and $2,551, respectively.
NOTE 7 - SHAREHOLDERS' EQUITY
In 1998, the Company adopted a Shareholders Rights Plan which granted a dividend
of one preferred share purchase right (a "Right") for each common share
outstanding at that date. Each Right represents the right to purchase
one-hundredth of a preferred share of stock at a preset price to be exercised
when any one individual, firm, corporation or other entity acquires 15% or more
of the Company's common stock. The Rights will become dilutive at the time of
exercise and will expire, if unexercised, in October 2008.
On May 24, 2001, the Company announced a five-for-four stock split of its common
stock, Class A voting, no par value. The new shares, one additional share for
each four shares held by stockholders, were distributed on June 18, 2001 to
stockholders of record on June 4, 2001. All share and per share amounts included
in the accompanying financial statements have been adjusted to reflect this
stock split.
In October 2001, the Company completed a secondary stock offering of 3,566,250
company shares raising net proceeds to the Company of $38.2 million dollars.
On January 15, 2002, the Company announced a three-for-two stock split of its
common stock, Class A voting, no par value. The new shares, one additional share
for each two shares held by stockholders, were distributed on February 1, 2002
to stockholders of record on January 25, 2002. All share and per share amounts
included in the accompanying financial statements have been adjusted to reflect
this stock split.
On March 6, 2002, the Company filed a Registration Statement on Form S-3
registering 750,000 shares of Class A common stock. The common stock may be used
from time to time as consideration in the acquisition of assets, goods, or
services for use or sale in the conduct of our business. On March 22, 2002, the
Company raised proceeds of $3.5 million from the offering of 148,134 shares. On
June 6, 2003, the Company raised proceeds of $5.5 million from the offering of
225,000 shares. On September 3, 2003, the Company sold 75,000 shares in common
stock for $2.6 million with the intention of purchasing an airplane. Later, the
Company decided not to purchase the airplane, whereupon the Company purchased
and retired $2.6 million of common stock of the CEO. A Limited Liability Company
(LLC) of which the CEO is the sole member purchased the airplane for $4.7
million. The Company entered into a dry lease agreement with the LLC for its
usage at the annualized rate of 2.5%. On December 30, 2003, the Company
purchased the LLC for $4.7 million. As of January 31, 2004, the Company has
301,866 shares of Class A common stock available to be issued from the March 6,
2002 Registration Statement.
On June 5, 2003, the Company announced a three-for-two stock split of its common
stock, Class A voting, no par value. The new shares, one additional share for
each two shares held by stockholders, were distributed on July 1, 2003 to
stockholders of record on June 26, 2003. All share and per share amounts
included in the accompanying financial statements have been adjusted to reflect
this stock split.
NOTE 8 - EMPLOYEE BENEFIT PLANS
Incentive stock option plan. The Company has a long-term incentive plan under
which an aggregate of 3,013,652 shares are available to be granted as of January
31, 2004. These options expire five years to seven and one-half years from the
date of grant. Options outstanding at January 31, 2004 expire in 2004 through
2010.
Under the plan, stock option grants are made to key employees including
executive officers, as well as other employees, as prescribed by the
Compensation Committee (the "Committee") of the Board of Directors. The number
of options granted is directly linked to the employee's job classification.
Options, which include non-qualified stock options and incentive stock options,
are rights to purchase a specified number of shares of Fred's Common Stock at a
price fixed by the Committee. The exercise price for stock options issued under
the plan that qualify as incentive stock options within the meaning of Section
422(b) of the Code shall not be less than 100% of the fair value as of the date
of grant. The option exercise price may be satisfied in cash or by exchanging
shares of Fred's Common Stock owned by the optionee, or a combination of cash
and shares. Options have a maximum term of ten years from the date of grant.
Options granted under the plan generally become exercisable ten percent during
each of the first four years on the anniversary and sixty percent on the fifth
anniversary. The plan also contains a provision that if the Company meets or
exceeds a specified operating income margin during the most recently completed
fiscal year that the annual vesting percentage will accelerate from ten to
twenty percent during that vesting period. The plan also provides for annual
stock grants at the fair value of the stock on the grant date to non-employee
directors according to a non-discretionary formula. The number of shares granted
is dependent upon current director compensation levels.
A summary of activity in the plan follows:
2003 2002 2001
-------------------------------- --------------------------------- ---------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
-------------- ---------------- --------------- ---------------- -------------- -----------------
Outstanding at beginning
of year 1,207,799 $ 7.71 1,386,053 $ 5.77 1,863,623 $ 5.44
Granted 669,401 17.69 262,473 13.96 432,329 6.26
Forfeited/ canceled (40,753) 7.81 (124,715) 5.29 (438,380) 6.15
Exercised (365,178) 6.27 (316,012) 5.33 (471,519) 4.55
-------------- --------------- --------------
Outstanding at end of year 1,471,269 12.61 1,207,799 7.71 1,386,053 5.77
============== =============== ==============
Exercisable at end of year 740,568 7.65 658,589 6.83 534,102 5.55
============== =============== ==============
The weighted average remaining contractual life of all outstanding options
was 3.6 years at January 31, 2004.
The following table summarizes information about stock options outstanding at
January 31, 2004:
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 31, 2004 (in Years) Price January 31, 2004 Price
- ----------------------------- ----------------------- --------------- -------------- ----------------------- -------------
$4.09 to $7.95 538,286 0.9 $ 5.05 538,004 $ 5.05
$8.00 to $17.67 687,089 5.1 $ 15.60 150,956 $ 12.13
$18.27 to $30.16 245,894 5.4 $ 20.79 51,608 $ 21.71
----------------------- ----------------------
1,471,269 740,568
======================= ======================
Pro forma information regarding net income and earnings per share, as disclosed
in Note 1, has been determined as if the Company had accounted for its employee
stock-based compensation plans under the fair value method of SFAS No. 123. The
fair value of options granted during 2003, 2002, and 2001 was $6.68, $6.69 and
$4.60, respectively. The fair value of each stock option grant was estimated on
the date of grant using the Black-Scholes option pricing model with the
following assumptions:
2003 2002 2001
--------------- --------------- -------------
Average expected life (years) 5.0 3.0 3.0
Average expected volatility 35.7% 46.1% 41.9%
Risk-free interest rates 1.1% 2.1% 2.6%
Dividend yield 0.3% 0.5% 1.6%
The Black-Scholes option model was developed for use in estimating the fair
value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock volatility. Because the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
Restricted Stock. During 2003, 2002, and 2001, the Company issued (forfeited/
cancelled) a net of 1,406, 1,125, and (22,778) restricted shares, respectively.
Compensation expense related to the shares issued is recognized over the period
for which restrictions apply.
Employee stock ownership plan. The Company has a non-contributory employee stock
ownership plan for the benefit of qualifying employees who have completed one
year of service and attained the age of 18. Benefits are fully vested upon
completion of seven years of service. The Company has not made any contributions
to the plan since 1996 and the plan owns 376,812 shares of Company stock. All
shares are included in shares outstanding for computation of net income per
share.
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 six years of service. The Company's contributions for 2003, 2002,
and 2001 were $207, $176, and $117, respectively.
Postretirement benefits. The Company provides certain health care benefits to
its full-time employees that retire between the ages of 58 (effective January 1,
2004 this was changed to 62) 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:
----------------------------------------
January 31, February 1,
2004 2003
----------------- --------------------
Benefit obligation at beginning of year $ 2,501 $ 1,786
Service cost 36 213
Interest cost 45 152
Actuarial (gain) loss (1,782) 378
Benefits paid (41) (28)
----------------- --------------------
Benefit obligation at end of year $ 759 $ 2,501
================= ====================
A reconciliation of the Plan's funded status to accrued benefit cost follows:
January 31, February 1,
2004 2003
------------------ ------------------
Funded status $ (759) $ (2,501)
Unrecognized net actuarial gain (1,678) (2)
Unrecognized prior service cost (4) (4)
Other - 52
------------------ ------------------
Accrued benefit costs $ (2,441) $ (2,455)
------------------ ------------------
The medical care cost trend used in determining this obligation is 11.0%
effective December 1, 2001, decreasing annually before leveling at 5.0% in 2011.
To illustrate the trend rate used, increasing the health care cost trend by 1%
would increase the effect on the total of service cost and interest cost by $10
and the accumulated postretirement benefit obligation by $75. By decreasing the
health care cost trend by 1% would decrease the effect on the total of service
cost and interest cost by $9 and the accumulated postretirement benefit
obligation by $66. The discount rate used in calculating the obligation was
6.25% in 2003 and 7.00% in 2002. The net periodic benefit cost decreased in 2003
due to changes in actuarial assumptions regarding turnover, participation in the
plan, the medical inflation rate and the rate of contribution by participants.
The annual net postretirement cost is as follows:
For the Year Ended
----------------------------------------------------
January 31, February 1, February 2,
2004 2003 2002
-------------- -------------- -----------------
Service cost $ 36 $ 213 $ 140
Interest cost 45 152 123
Amortization of net gain from prior periods (1) - (17)
Amortization of unrecognized prior service cost (107) 1 1
-------------- -------------- -----------------
Net periodic postretirement benefit cost $ (27) $ 366 $ 247
============== ============== =================
The Company's policy is to fund claims as incurred.
NOTE 9 - NET INCOME PER SHARE
Basic earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Restricted stock is
considered contingently issuable and is excluded from the computation of basic
earnings per share.
A reconciliation of basic earnings per share to diluted earnings per share
follows:
Year Ended
---------------------------------------------------------------------------------------------------------
January 31, 2004 February 1, 2003 February 2, 2002
------------------------------------ ------------------------------------ -----------------------------
Per Per Per
Share Share Share
Income Shares Amount Income Shares Amount Income Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Basic EPS $33,721 38,754 $ .87 $28,216 38,255 $ .74 $19,629 35,330 $ .56
Effect of Dilutive
Securities 898 996 966
------------- ----------- ----------- ----------- ----------- ----------- ----------- --------- -------
Diluted EPS $33,721 39,652 $ .85 $28,216 39,251 $ .72 $19,629 36,296 $ .54
============= =========== =========== =========== =========== =========== =========== ========= =======
Options to purchase shares of common stock that were outstanding at the end of
the respective fiscal year were not included in the computation of diluted
earnings per share when the options' exercise prices were greater than the
average market price of the common shares. There were no such options
outstanding at the end of fiscal 2003 and 2001 and there were 84,938 such
options outstanding at February 1, 2003.
NOTE 10 - COMMITMENTS AND CONTINGENCIES
Commitments. The Company had commitments approximating $11.1 million at January
31, 2004 and $10.4 million at February 1, 2003 on issued letters of credit,
which support purchase orders for merchandise. Additionally, the Company had
outstanding letters of credit aggregating approximately $8.5 million at January
31, 2004 and $7.9 million at February 1, 2003 utilized as collateral for its
risk management programs.
Litigation. The Company is a party to several pending legal proceedings and
claims arising in the normal course of business. Although the outcome of the
proceedings and claims cannot be determined with certainty, management of the
Company is of the opinion that it is unlikely that these proceedings and claims
will have a material adverse effect on the financial statements as a whole.
However, litigation involves an element of uncertainty. Future developments
could cause these actions or claims to have a material adverse effect on the
results of the financial statements as a whole.
Note 11 - Sales Mix
The Company manages its business on the basis of one reportable segment. See
Note 1 for a brief description of the Company's business. As of January 31,
2004, all of the Company's operations were located within the United States. The
following data is presented in accordance with SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information."
The Company's sales mix by major category during the last 3 years was as
follows:
2003 2002 2001
------ ------ ------
Pharmaceuticals................................. 32.4% 33.2% 34.4%
Household Goods................................. 23.6% 23.0% 22.4%
Apparel and Linens.............................. 14.2% 13.6% 12.3%
Food and Tobacco Products....................... 10.2% 9.6% 9.5%
Health and Beauty Aids.......................... 8.8% 9.0% 9.4%
Paper and Cleaning Supplies..................... 8.1% 8.4% 8.3%
Sales to Franchised Fred's Stores............... 2.7% 3.2% 3.7%
------ ------ ------
Totals 100.0% 100.0% 100.0%
====== ====== ======
Note 12 - QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
---------------- --------------- --------------- ---------------
Year Ended January 31, 2004
Net sales $ 310,689 $ 302,270 $ 311,668 $ 378,023
Gross profit 87,948 84,944 91,191 103,902
Net income 7,857 4,385 9,028 12,451
Net income per share
Basic 0.21 0.11 0.23 0.32
Diluted 0.20 0.11 0.23 0.31
Cash dividends paid per share 0.02 0.02 0.02 0.02
Year Ended February 1, 2003
Net sales $ 258,427 $ 256,470 $ 263,197 $ 325,324
Gross profit 69,425 69,638 75,994 89,920
Net income 6,275 3,667 7,408 10,866
Net income per share
Basic 0.17 0.09 0.19 0.28
Diluted 0.16 0.09 0.19 0.28
Cash dividends paid per share 0.02 0.02 0.02 0.02
Item 9: Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
The information required by this item is incorporated herein by reference
to Form 8-K dated May 14, 2002, filed on May 14, 2002.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures. The Company, under the supervision and
with the participation of the Company's management, including the Chief
Executive Officer and the Chief Financial Officer, evaluated the effectiveness
of the Company's disclosure controls and procedures (as defined in Rule
13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended
(the "Exchange Act")) as of January 31, 2004. Based on that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded that, as
of January 31, 2004, the Company's disclosure controls and procedures are
effective for the purposes set forth in the definition thereof in Exchange Act
Rule 13a-15(e).
(b) Changes in Internal Control Over Financial Reporting. There have been no
changes during the quarter ended January 31, 2004 in the Company's internal
control over financial reporting (as defined in Exchange Act Rule 13a-15(f))
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
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 Company:
Name Age Positions and Offices
--------------------------------------------------------
Michael J. Hayes (1) 62 Director, Chairman of the Board, Chief
Executive Officer
John R. Eisenman (1) 62 Director
Roger T. Knox (1) 66 Director
John Reier (1) 64 President and Director
Thomas H. Tashjian (1) 49 Director
John A. Casey 57 Executive Vice President - Pharmacy
Operations
Jerry A Shore 51 Executive Vice President and Chief
Financial Officer
Charles A. Brunjes 44 Executive Vice-President - General
Merchandise Manager
Dennis K Curtis 44 Executive Vice-President - Store
Operation
Charles S. Vail 61 Corporate Secretary, Vice President -
Legal Services and General Counsel
(1) Five directors, constituting the entire Board of Directors, are to be
elected at the Annual Meeting to serve one year or until their successors are
elected.
Michael J. Hayes was elected a director of the Company in January 1987. Mr.
Hayes served as Managing Director of the Company from October 1989 until March
2002 when he was elected Chairman of the Board. He has been Chief Executive
Officer since October 1989. He was previously employed by Oppenheimer & Company,
Inc. in various capacities from 1976 to 1985, including Managing Director and
Executive Vice President - Corporate Finance and Financial Services.
John R. Eisenman is involved in real estate investment and development with
REMAX Island Realty, Inc., located in Hilton Head Island, South Carolina. Mr.
Eisenman has been engaged in commercial and industrial real estate brokerage and
development since 1983. Previously, he founded and served as President of
Sally's, a chain of fast food restaurants from 1976 to 1983, and prior thereto
held various management positions in manufacturing and in securities brokerage.
Roger T. Knox is President Emeritus of the Memphis Zoological Society and
was its President and Chief Executive Officer from January 1989 thru March 2003.
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 1987 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. Mr. Knox is also a director of Hancock Fabrics,
Inc.
John D. Reier is President and a Director. Mr. Reier joined the Company in
May of 1999 as President and was elected a Director of the Company in August
2000. Prior to joining the company, Mr. Reier was President and Chief Executive
Officer of Sunny's Great Outdoors Stores, Inc. from 1997 to 1999, and was
President, Chief Operating Officer, Senior Vice President of Merchandising, and
General Merchandise Manager at Family Dollar Stores, Inc. from 1987 to 1997.
Thomas H. Tashjian was elected a director of the Company in March 2001. Mr.
Tashjian is a private investor. Mr. Tashjian has served as a managing director
and consumer group leader at Banc of America Montgomery Securities in San
Francisco. Prior to that, Mr. Tashjian held similar positions at First Manhattan
Company, Seidler Companies, and Prudential Securities. Mr. Tashjian's earlier
retail operating experience was in discount retailing at the Ayrway Stores,
which were acquired by Target, and in the restaurant business at Noble Roman's.
John A. Casey has served as Executive Vice President - Pharmacy Operations
since February 1997. Mr. Casey joined the Company in 1979 and has served in
various positions in Pharmacy Operations. Mr. Casey is a registered Pharmacist.
Jerry A. Shore joined the Company in April 2000 as Executive Vice President
and Chief Financial Officer. Prior to joining the Company, Mr. Shore was
employed by Wang's International, a major importing and wholesale distribution
company as Chief Financial Officer from 1989 to 2000, and in various financial
management capacities with IPS Corp., and Caterpillar, Inc. from 1975 to 1989.
Charles A. Brunjes was promoted to Executive Vice-President - General
Merchandise Manager in July 2003. Mr. Brunjes joined the Company in July 2000 as
Senior Vice-President of Store Operations. Prior to joining the Company, Mr.
Brunjes was employed by Family Dollar as Vice-President of Store Development.
Dennis K. Curtis was promoted to Executive Vice-President in July 2003.
Prior to this position, Mr. Curtis joined the Company in 1980 as a management
trainee in store operations. Mr. Curtis was recently held the position of Senior
Vice-President - Divisional Merchandising Manager of Hardlines.
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.
The remainder of the information required by this item is incorporated herein by
reference to the proxy statement for our 2004 annual meeting.
Item 11: Executive Compensation
Information required by this item is incorporated herein by reference to
the proxy statement for our 2004 annual meeting.
Item 12: Security Ownership of Certain Beneficial Owners and Management
Information required by this item is incorporated herein by reference to
the proxy statement for our 2004 annual meeting.
Item 13: Certain Relationships and Related Transactions
Information required by this item is incorporated herein by reference to
the proxy statement for our 2004 annual meeting.
ITEM 14. Principal Accountants Fees and Services
Information required by this item is incorporated herein by reference to
the proxy statement for our 2004 annual meeting.
PART IV
Item 15: Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Consolidated Financial Statements (See Item 8)
Report of Independent Auditors - Ernst & Young LLP.
(a)(2) Financial Statement Schedules Schedule 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:
3.1 Certificate of Incorporation, as amended [incorporated herein by
reference to Exhibit 3.1 to the registration statement on Form
S-8 as filed with the Securities and Exchange Commission ("SEC")
on March 18, 2003 (SEC File No. 333-103904) (such registration
statement, the "Form S-8")].
3.2 By-laws, as amended [incorporated herein by reference to Exhibit
3.2 to the Form S-8].
4.1 Specimen Common Stock Certificate [incorporated herein by
reference to Exhibit 4.2 to Pre-Effective Amendment No. 3 to the
Registration Statement on Form S-1 (SEC File No. 33-45637) (such
Registration Statement, the "Form S-1")].
4.2 Preferred Share Purchase Plan [incorporated herein by reference
to the Company's Report on Form 10-Q for the quarter ended
October 31, 1998].
10.1 Form of Fred's, Inc. Franchise Agreement [incorporated herein by
reference to Exhibit 10.8 to the Form S-1].
10.2 401(k) Plan dated as of May 13, 1991 [incorporated herein by
reference to Exhibit 10.9 to the Form S-1].
10.3 Employee Stock Ownership Plan (ESOP) dated as of January 1, 1987
[incorporated herein by reference to Exhibit 10.10 to the Form
S-1].
10.4 Lease Agreement by and between Hogan Motor Leasing, Inc. and
Fred's, Inc. dated February 5, 1992 for the lease of truck
tractors to Fred's, Inc. and the servicing of those vehicles and
other equipment of Fred's, Inc. [incorporated herein by reference
to Exhibit 10.15 to Pre-Effective Amendment No. 1 to the Form
S-1].
*10.5 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].
***10.6 Term Loan Agreement between Fred's, Inc. and First American
National Bank dated as of April 23, 1999 [incorporated herein by
reference to the Company's Report on Form 10-Q for the quarter
ended May 1, 1999].
***10.7 Prime Vendor Agreement between Fred's Stores of Tennessee, Inc.
and Bergen Brunswig Drug Company, dated as of November 24, 1999
[incorporated herein by reference to Company's Report on Form
10-Q for the quarter ended October 31, 1999].
***10.8 Addendum to Leasing Agreement and Form of Schedules 7 through 8
of Schedule A, by and between Hogan Motor Leasing, Inc. and
Fred's, Inc dated September 20, 1999 (modifies the Lease
Agreement included as Exhibit 10.4) [incorporated herein by
reference to the Company's report on Form 10-K for the year ended
January 29, 2000].
***10.9 Revolving Loan Agreement between Fred's, Inc.and Union Planters
Bank, NA and Suntrust Bank dated April 3, 2000 [incorporated
herein by reference to the Company's report on Form 10-K for year
ended January 29, 2000].
***10.10 Loan modification agreement dated May 26, 2000 (modifies the
Revolving Loan Agreement included as Exhibit 10.9) [incorporated
herein by reference to the Company's report on Form 10-K for the
year ended January 29, 2000].
***10.11 Seasonal Overline Agreement between Fred's, Inc. and Union
Planters National Bank dated as of October 11, 2000 [incorporated
herein by reference to the Company's Report on Form 10-Q for the
quarter ended October 28, 2000].
***10.12 Second Loan modification agreement dated April 30, 2002 (modifies
the Revolving Loan and Credit Agreement included as exhibit
10.9). [incorporated herein by reference to the Company's Report
on Form 10-Q for the quarter ended August 3, 2002].
10.15 Third loan modification agreement dated July 31, 2003 (modified
the Revolving Loan and Credit Agreement dated April 3, 2000.)
[incorporated herein by reference to the Company's Report on Form
10-Q for the quarter ended August 2, 2003].
**21.1 Subsidiaries of Registrant
**23.1 Consent of Ernst & Young LLP
**23.2 Consent of PricewaterhouseCoopers LLP
**31.1 Certification of Chief Executive Officer pursuant to Exchange
Rule 13a-14(a) of the Securities Exchange Act.
**31.2 Certification of Chief Financial Officer pursuant to Exchange
Rule 13a-14(a) of the Securities Exchange Act.
**32. Certification of Chief Financial Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350.
(b) Reports on Form 8-K
None.
* Management Compensatory Plan
** Filed herewith
*** (SEC File No. under the Securities Exchange Act of 1934 is 00-19288)
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-48380, 33-67606, 333-103904, and Form S-3 Nos. 333-68478 and
333-83918) of Fred's, Inc. of our report dated April 5, 2004, with respect to
the consolidated financial statements of Fred's, Inc. included in this Annual
Report (Form 10-K) for the year ended January 31, 2004.
Our audit also included the financial statement schedule of Fred's, Inc. listed
in Item 15(a) as of January 31, 2004 and February 1, 2003. This schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audit. In our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the information set
forth therein as of January 31, 2004 and February 1, 2003 and for the years then
ended.
/s/ Ernst & Young LLP
April 14, 2004
Memphis, Tennessee
Exhibit 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-3 (No. 33-68478 and No. 333-83918) and Form S-8 (No.
33-48380, No. 33-67606 and No. 333-103904) of Fred's, Inc. of our report dated
March 15, 2002, except for the effects of the 3-for-2 stock split effected on
July 1, 2003 as described in Note 7 as to which the date is April 14, 2004,
relating to the consolidated statements of income, shareholders' equity and cash
flows and financial statement schedule for the year ended February 2, 2002,
which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLP
Memphis, Tennessee
April 15, 2004
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 (in thousands):
Year ended February 2, 2002 $516 $142 $ (1) $ 657
Year ended February 1, 2003 $657 $318 $ (-) $ 975
Year ended January 31, 2004 $975 $462 $ (-) $1,437
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 14th day of
April, 2004.
FRED'S, INC.
By: /s/ Michael J. Hayes
-------------------------------------
Michael J. Hayes, Chief Executive
Officer
By: /s/ Jerry A. Shore
-------------------------------------
Jerry A. Shore, Executive Vice
President and Chief Financial Officer
(Principal Accounting and Financial
Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on this 14th day of April, 2004.
Signature Title
--------- -----
/s/ Michael J. Hayes Director, Chairman of the Board,
- -------------------------- Chief Executive Officer
Michael J. Hayes
/s/ Roger T. Knox Director
- --------------------------
Roger T. Knox
/s/ John R. Eisenman Director
- --------------------------
John R. Eisenman
/s/ John D. Reier President and Director
- --------------------------
John D. Reier
/s/ Thomas H. Tashjian Director
- --------------------------
Thomas H. Tashjian
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 14th day of
April, 2004.
FRED'S, INC.
By: /s/ Michael J. Hayes
----------------------------------------
Michael J. Hayes, Chief Executive
Officer
By: /s/ Jerry A. Shore
----------------------------------------
Jerry A. Shore, Executive Vice
President and Chief Financial
Officer (Principal Accounting and
Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on this 14th day of April, 2004.
Signature Title
--------- -----
/s/ Michael J. Hayes
- ---------------------------- Director, Chairman of the Board,
Michael J. Hayes Chief Executive Officer
/s/ Roger T. Knox
- ---------------------------- Director
Roger T. Knox
/s/ John R. Eisenman
- ---------------------------- Director
John R. Eisenman
/s/ John D. Reier
- ---------------------------- President and Director
John D. Reier
/s/ Thomas H. Tashjian
- ---------------------------- Director
Thomas H. Tashjian
Exhibit 31.1
Certification of Chief Executive Officer
I, Michael J. Hayes, certify that:
1. I have reviewed this annual report on Form 10-K of Fred's, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designated under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
b) Designated such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors:
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: April 14, 2004
/s/ Michael J. Hayes
-------------------------------------
Michael J. Hayes
Chief Executive Officer
Exhibit 31.2
Certification of Chief Financial Officer
I, Jerry A. Shore, certify that:
1. I have reviewed this annual report on Form 10-K of Fred's, Inc.
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designated under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
b) Designated such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any changes in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors:
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: April 14, 2004
/s/ Jerry A. Shore
-------------------------------------
Jerry A. Shore
Executive Vice President and
Chief Financial Officer
Exhibit 32
Certification of Chief Executive Officer AND CHIEF FINANCIAL OFFICER
Pursuant to Section 18 U.S.C. Section 1350
In connection with this annual report on Form 10-K of Fred's, Inc. each of the
undersigned, Michael J. Hayes and Jerry A Shore, certifies, pursuant to Section
18 U.S.C. Section 1350, that:
1. The report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
2. The information contained in this report fairly presents, in all
material respects, the financial condition and results of operations
of Fred's, Inc.
Date: April 14, 2004 /s/ Michael J. Hayes
------------------------------------
Michael J. Hayes
Chief Executive Officer
/s/ Jerry A. Shore
------------------------------------
Jerry A Shore
Executive Vice President and
Chief Financial Officer
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, Inc.
National Equipment Management and Leasing, Inc.
Fred's Capital Finance, Inc.
Insurance Value Protection Group, LTD