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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 29, 2000
Commission File Number 000-19288
FRED'S, INC.
(Exact Name of Registrant as Specified in its Charter)
TENNESSEE 62-0634010
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
4300 New Getwell Road
MEMPHIS, TENNESSEE 38118
(Address of Principal Executive Offices)
Registrant's telephone number, including area code (901) 365-8880
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Title of Each Class
-------------------
Class A Common Stock, no par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X].
As of April 24, 2000, there were 11,976,728 shares outstanding of the
Registrant's Class A no par value voting common stock. Based on the last
reported sale price of $14.625 per share on the NASDAQ Stock Market on April 24,
2000, the aggregate market value of the Registrant's Common Stock held by those
persons deemed by the Registrant to be non-affiliates was $175,159,647.
As of April 24, 2000, there were no shares outstanding of the Registrant's
Class B no par value non-voting common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Shareholders for the year ended January
29, 2000 are incorporated by reference into Part II, Items 5, 6, 7 and 8, and
into Part IV, Item 14.
Portions of the Company's Proxy Statement are incorporated by reference
into Part III, Items 11, 12 and 13.
Portions of the Company's Registration Statement on Form S-1 (file no.
33-45637) are incorporated as exhibits into Part IV.
With the exception of those portions that are specifically incorporated
herein by reference, the aforesaid documents are not to be deemed filed as part
of this report.
Cautionary Statement Regarding Forward-looking Information
Statements, other than those based on historical facts, that the Company expects
or anticipates may occur in the future are forward-looking statements which are
based upon a number of assumptions concerning future conditions that may
ultimately prove to be inaccurate. Actual events and results may materially
differ from anticipated results described in such statements. The Company's
ability to achieve such results is subject to certain risks and uncertainties,
including, but not limited to, economic and weather conditions which affect
buying patterns of the Company's customers, changes in consumer spending and the
Company's ability to anticipate buying patterns and implement appropriate
inventory strategies, continued availability of capital and financing,
competitive factors and other factors affecting business beyond the Company's
control. Consequently, all of the forward-looking statements are qualified by
these cautionary statements and there can be no assurance that the results or
developments anticipated by the Company will be realized or that they will have
the expected effects on the Company or its business or operations.
PART I
Item 1: Business
General
Fred's, Inc. ("Fred's" or the "Company"), founded in 1947, operates 293
discount general merchandise stores in ten states in the southeastern United
States. Fred's stores generally serve low, middle and fixed income families
located in small to medium sized towns (approximately 65% of Fred's stores are
in markets with populations of 15,000 or fewer people). One hundred and
eighty-two of the Company's stores have full service pharmacies. The Company
also markets goods and services to 26 franchised "Fred's" stores.
Fred's stores stock over 12,000 frequently purchased items which address
the everyday needs of its customers, including nationally recognized brand name
products, proprietary "Fred's" label products and lower priced off-brand
products. Fred's management believes its customers shop Fred's stores as a
result of the stores' convenient location and size, everyday low prices on key
products and regularly advertised departmental promotions and seasonal specials.
Fred's stores have average selling space of 14,015 square feet and had average
sales of $2,207,000 in fiscal 1999. No single store accounted for more than 1.0%
of sales during fiscal 1999.
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 182 of its stores.
Discount prices - The Company provides value and low prices to its
customers (i.e., a good "price-to-value relationship") through a
coordinated discount strategy and an Everyday Low Pricing program that
focuses on strong values day in and day out, while minimizing the Company's
reliance on promotional activities. As part of this strategy, Fred's
maintains low opening price points and competitive prices on key products
across all departments, and regularly offers seasonal specials and
departmental promotions supported by tabloid, television and radio
advertising.
Convenient shopper-friendly environment - Fred's stores are typically
located in convenient shopping and/or residential areas. Approximately 30%
of the Company's stores are freestanding as opposed to being located in
strip shopping center sites. Freestanding sites allow for easier access and
shorter distances to the store entrance, and will be the primary site
growth in the future. Fred's stores are of a manageable size and have an
understandable store layout, wide aisles and fast checkouts.
Expansion Strategy
The Company expects that expansion will occur primarily within its present
geographic area and will be focused in small to medium sized towns. The Company
may also enter larger metropolitan and urban markets where it already has a
market presence in the surrounding area.
Fred's added a net 10 stores in 1999, and anticipates opening a net of
twenty-five to thirty new stores in 2000. The Company's new store prototype has
14,000 square feet of space. Opening a new store currently costs between
$320,000 and $420,000 for inventory, furniture, fixtures, equipment and
leasehold improvements. The Company has 19 stand-alone Xpress locations which
sell pharmaceuticals and other health and beauty related items. These locations
range in size from 1,000 to 6,000 square feet, and enable the Company to enter a
new market with an initial investment of under $200,000. It is the Company's
intent to expand these locations into a full size Fred's location as market
conditions dictate. During 1999, the Company converted seven Xpress locations to
full size Fred's locations and anticipates converting up to seven more Xpress
locations during 2000.
A significant growth area for the Company has been its pharmacy business.
In 1999, the Company added a net 2 new pharmacies. During 2000, the Company
anticipates adding at least 20 additional pharmacies. Approximately 62% of
Fred's stores contain a pharmacy and sell prescription drugs. The Company's
primary mechanism for adding new pharmacies is through the acquisition of
prescription files from independent pharmacies. These acquisitions provide an
immediate sales benefit, and in many cases, the independent pharmacist will move
to Fred's, thereby providing continuity in the pharmacist-patient relationship.
The following tables set forth certain information with respect to stores
and pharmacies for each of the last five years:
1995 1996 1997 1998 1999
----------------------------------------------
Stores open at beginning of period 184 206 213 261 283
Stores opened/acquired during period 36 13 49 29 20
Stores closed during period (14) (6) (1) (7) (10)
-------------------------------------------------
Stores open at end of period 206 213 261 283 293
=================================================
Number of stores with Pharmacies at
End of period 92 101 141 180 182
=================================================
Square feet of selling space at end of
period (in thousands) 2,797 2,828 3,362 3,680 3,966
=================================================
Average square feet of selling space
per store 13,915 13,277 13,875 13,925 14,015
=================================================
Franchise stores at end of period 34 32 31 29 26
=================================================
Merchandising and Marketing
The business in which the Company is engaged is highly competitive. The
principal competitive factors include location of stores, price and quality of
merchandise, in-stock consistency, merchandise assortment and presentation, and
customer service. The Company competes for sales and store locations in varying
degrees with national, regional and local retailing establishments, including
department stores, discount stores, variety stores, dollar stores, discount
clothing stores, drug stores, grocery stores, outlet stores, warehouse stores
and other stores. Many of the largest retail merchandising companies in the
nation have stores in areas in which the Company operates.
Management believes that Fred's has a distinctive niche in that it offers a
wider variety of merchandise at a more attractive price-to-value relationship
than either a drug store or smaller variety/dollar store and is more
shopper-convenient than a larger discount store. The variety and depth of
merchandise offered at Fred's stores in high traffic departments, such as health
and beauty aids and paper and cleaning supplies, are comparable to those of
larger discount retailers. Management believes that its knowledge of regional
and local consumer preferences, developed in over fifty years of operation by
the Company and its predecessors, enables the Company to compete effectively in
its region.
Purchasing
The Company's primary non-prescription drug buying activities are directed
from the corporate office by three Vice Presidents-Merchandising who are
supported by a staff of 19 buyers and assistants. The buyers and assistants are
participants in an incentive compensation program, which is based upon various
factors primarily relating to gross margin returns on inventory controlled by
each individual buyer. The Company believes that adequate alternative sources of
products are available for these categories of merchandise.
During 1999 all of the Company's prescription drugs were purchased
individually by its pharmacies and shipped direct from a pharmaceutical
wholesaler. On November 24, 1999, the company entered into a supply agreement
with Bergen Brunswig Drug Company to be Fred's new primary pharmaceutical
wholesaler and to provide substantially all of the company's prescription drugs.
During 1999, approximately 30% of the Company's total purchases were made from
its pharmaceutical wholesalers. Although there are alternative wholesalers that
supply pharmaceutical products, the Company operates under a purchase and supply
contract with one supplier as its primary wholesaler. Accordingly, the unplanned
loss of this particular supplier could have a short-term gross margin impact on
the Company's business until an alternative wholesaler arrangement could be
implemented.
Sales Mix
Sales of merchandise through Company owned stores and to franchised Fred's
locations are the only significant industry segment of which the Company is a
part.
The Company's sales mix by major category during 1999 was as follows:
Pharmaceuticals...................................................30.6%
Household Goods...................................................21.8%
Apparel and Linens................................................13.5%
Health and Beauty Aids............................................11.9%
Food and Tobacco Products........................................ 9.0%
Paper and Cleaning Supplies...................................... 8.3%
Sales to Franchised Fred's Stores..................................4.9%
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 1999 the average customer transaction size was approximately $14.72,
and the number of customer transactions totaled approximately 43 million.
Products sold under the "Fred's" private label program, including household
cleaning supplies, health and beauty aids, disposable diapers, pet foods, paper
products and a variety of beverage and other products, constituted approximately
5% of total sales in 1999. Private label products afford the Company higher than
average gross margins while providing the customer with lower priced products
that are of a quality comparable to that of competing branded products. An
independent laboratory testing program is used for substantially all of the
Company's private label products.
As previously mentioned, the Company sells merchandise to its 26 franchised
"Fred's" stores. These sales during the last three years totaled $32,850,000 in
1999, $35,766,000 in 1998, and $37,700,000 in 1997 representing 4.9%, 6.0%, and
7.7% of total revenue, respectively. Franchise and other fees totaling
$1,761,000 in 1999, $1,957,000 in 1998,and $1,967,000 in 1997 have been earned
by Fred's. These fees represent a reimbursement for use of the Fred's name and
other administrative cost incurred on behalf of the franchised stores. The
Company does not intend 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 1.4% of net sales in 1999. The
Company uses direct mail, television, radio and newspaper advertising to promote
its merchandise, special promotional events and a discount retail image. During
1999, the Company eliminated the distribution of two major circulars, and now
distributes thirteen major advertising circulars per year.
The Company's buyers have discretion to mark down slow moving items. The
Company runs regular clearances of seasonal merchandise and conducts sales and
promotions of particular items. The Company also encourages its store managers
to create in-store advertising displays and signage in order to increase
customer traffic and impulse purchases. The store managers, with corporate
approval, are permitted to tailor the price structure at their particular store
to meet competitive conditions within each store's marketing area. Store and
Pharmacy Operations
All Fred's stores and pharmacies are open six days a week (Monday through
Saturday), and many stores are open seven days a week. Store hours are generally
from 9:00 a.m. to 9:00 p.m.; however, certain stores are open only until 6:00
p.m. Each Fred's store is managed by a full-time store manager and those stores
with a pharmacy are also managed by a full-time pharmacist. The Company's
seventeen district managers supervise the management and operation of Fred's
stores and pharmacies.
Fred's operates 182 in-store pharmacies which offer brand name and generic
pharmaceuticals and are staffed by licensed pharmacists. The addition of
acquired pharmacies in the Company's stores has resulted in increased store
sales and sales per selling square foot. Management believes that in-store
pharmacies increase customer traffic and repeat visits and are an integral part
of the store's operation.
The Company has an incentive compensation plan for store managers,
pharmacists and district managers based on meeting or exceeding targeted profit
percentage contributions. Various factors included in determining profit
percentage contribution are gross profits and controllable expenses at the store
level. Management believes that this incentive compensation plan, together with
the Company's store management training program, are instrumental in maximizing
store performance.
Inventory Control and Distribution
Inventory Control
The Company's computerized central management information system (known as
"AURORA," which stands for Automation Utilizing Replenishment Ordering and
Receiving Accuracy) maintains a daily SKU level inventory and current and
historical sales information for each store and the distribution center. This
system is supported by in-store point-of-sale ("POS") cash registers which
capture SKU and other data at the time of sale for daily transmission to the
Company's central data processing center. Data received from the stores is used
to automatically replenish frequently purchased merchandise on a weekly basis
and to assist the Company's buyers in their decision making process.
Distribution
The Company has an 850,000 square foot centralized distribution center in
Memphis, Tennessee (see "Properties" below). During 1998, the Company completed
a $12 million project to modernize and automate its distribution center. This
project, including implementation of a new warehouse management computer system,
has increased the center's capacity sufficiently to accommodate the Company's
store expansion plans for the next several years. Approximately 60% of the
merchandise received by Fred's stores in 1999 was shipped through the
distribution center, with the remainder (primarily pharmaceuticals, certain
snack food items, greeting cards, beverages and tobacco products) being shipped
directly to the stores by suppliers. For distribution, the Company uses owned
and leased trailers and tractors, as well as common carriers.
Seasonality
The Company's business is seasonal to a certain extent. Generally, the
highest volume of sales and net income occurs in the fourth fiscal quarter and
the lowest volume occurs during the second fiscal quarter.
Employees
At January 29, 2000, the Company had approximately 7,010 full-time and
part-time employees, comprising 710 corporate and distribution center employees
and 6,300 store employees. The number of employees varies during the year,
reaching a peak during the Christmas selling season. The Company's labor force
is not subject to a collective bargaining agreement. Management believes it has
good relationships with its employees.
Item 2: Properties
As of January 29, 2000, the geographical distribution of the Company's 293
locations was as follows:
State Number of Stores
--------------------------------------------------
Mississippi 86
Tennessee 59
Arkansas 57
Alabama 32
Louisiana 25
Georgia 23
Kentucky 3
North Carolina 2
Missouri 5
Florida 1
The Company owns the real estate and the buildings for 57 locations, and
owns the buildings at five locations which are subject to ground leases. The
Company leases the remaining 231 locations from third parties pursuant to leases
that provide for monthly rental payments primarily at fixed rates (although a
number of leases provide for additional rent based on sales). Store locations
range in size from 1,000 square feet to 27,000 square feet. Two hundred and four
of the locations are in strip centers or adjoined with a downtown shopping
district, with the remainder being free-standing.
It is anticipated that existing buildings and buildings to be developed by
others will be available for lease to satisfy the Company's expansion program in
the near term. It is management's intention to enter into leases of relatively
moderate length with renewal options, rather than entering into long-term
leases. The Company will thus have maximum relocation flexibility in the future,
since continued availability of existing buildings is anticipated in the
Company's market areas.
The Company owns its distribution center and corporate headquarters
situated on a 60 acre site in Memphis, Tennessee. The site contains the
distribution center with approximately 850,000 square feet of space, and 250,000
square feet of office and retail space. Presently, the Company utilizes 90,000
square feet of office space and 22,000 square feet of retail space at the site.
The retail space is operated as a Fred's store and is used to test new products,
merchandising ideas and technology.
Item 3: Legal Proceedings
The Company is party to several pending legal proceedings and claims.
Although the outcome of the proceedings and claims cannot be determined with
certainty, management of the Company is of the opinion that it is unlikely that
these proceedings and claims will have a material effect on the results of
operations, cash flows, or the financial condition of the Company.
Item 4: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended January 29, 2000.
PART II
Item 5: Market for the Registrant's Common Equity and Related Stockholder
Matters
The information required by this item is incorporated herein by reference
to Page 29 of the Annual Report to Shareholders for the year ended January 29,
2000 (the "Annual Report to Shareholders").
Item 6: Selected Financial Data
The selected financial data for the five years ended January 29, 2000,
which appears on page 8 of the Annual Report to Shareholders is incorporated
herein by reference.
Item 7: Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of financial condition and results of
operations appearing on pages 9 through 13 of the Annual Report to Shareholders
is incorporated herein by reference.
Item 7a: Quantitative and Qualitative Disclosure about Market Risk
The Company has no holdings of derivative financial or commodity
instruments as of January 29, 2000. The Company is exposed to financial market
risks, including changes in interest rates. All borrowings under the Company's
Revolving Credit Agreement bear interest at 1.5% below prime rate or a
LIBOR-based rate. An increase in interest rates of 100 basis points would not
significantly affect the Company's income. All of the Company's business is
transacted in U.S. dollars and, accordingly, foreign exchange rate fluctuations
have never had a significant impact on the Company, and they are not expected to
in the foreseeable future.
Item 8: Financial Statements and Supplementary Data
The consolidated financial statements appearing on pages 14 through 26 of
the Annual Report to Shareholders are incorporated herein by reference.
Item 9: Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10: Directors and Executive Officers of the Registrant
The following information is furnished with respect to each of the
directors and executive officers of the Registrant:
Name Age Positions and Offices
- ---- --- ---------------------
Michael J. Hayes(1) 58 Director, Managing Director (2), Chief Executive Officer
David A. Gardner(1) 52 Director and Managing Director (2)
John R. Eisenman(1) 58 Director
Roger T. Knox(1) 62 Director
John Reier 59 President
Edwin C. Boothe 42 Executive Vice President and Chief Operating Officer
John A. Casey 53 Executive Vice President - Pharmacy Operations
Jerry A Shore 47 Executive Vice President and Chief Financial Officer
Charles S. Vail 57 Corporate Secretary, Vice President - Legal Services and General Counsel
(1) Four directors, constituting the entire Board of Directors, are to be
elected at the Annual Meeting to serve one year or until their successors
are elected.
(2) According to the By-laws of the Company, the Managing Directors (Messrs.
Hayes and Gardner) are the chief executive officers of the Company and have
general supervisory responsibility for the business of the Company.
Michael J. Hayes was elected a director of the Company in January 1987 and
has been a Managing Director of the Company since October 1989. Mr. Hayes has
been Chief Executive Officer since October 1989. He was previously employed by
Oppenheimer & Company, Inc. in various capacities from 1976 to 1985, including
Managing Director and Executive Vice President - Corporate Finance and Financial
Services.
David A. Gardner was elected a director of the Company in January 1987 and
has been a Managing Director of the Company since October 1989. Mr. Gardner has
been President of Gardner Capital Corporation, a real estate and venture capital
investment firm since April 1980. Additionally, Mr. Gardner is a director of
Organogenesis, Inc., Wynd Communications Corporation, NumeriX, LLC and Joyce
International, Inc.
John R. Eisenman is involved in real estate investment and development with
REMAX Island Realty, Inc., located in Hilton Head Island, South Carolina. Mr.
Eisenman has been engaged in commercial and industrial real estate brokerage and
development since 1983. Previously, he founded and served as President of
Sally's, a chain of fast food restaurants from 1976 to 1983, and prior thereto
held various management positions in manufacturing and in securities brokerage.
Roger T. Knox has served the Memphis Zoological Society as its President
and Chief Executive Officer since January 1989. Mr. Knox was the President and
Chief Operating Officer of Goldsmith's Department Stores, Inc. (a full-line
department store in Memphis and Jackson, Tennessee) from 1983 to 1989 and its
Chairman of the Board and Chief Executive Officer from 1987 to 1989. Prior
thereto, Mr. Knox was with Foley's Department Stores in Houston, Texas for 20
years. Additionally, Mr. Knox is a director of Hancock Fabrics, Inc.
John Reier is President. Mr. Reier joined the company in May of 1999. 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.
Edwin C. Boothe is Executive Vice President and Chief Operating Officer.
Mr. Boothe joined the Company in 1975 and has served in various positions in
Store Operations and Loss Prevention, and was elected to Chief Operating Officer
in January 1998.
John A. Casey is Executive Vice President - Pharmacy Operations. Mr. Casey
joined the Company in 1979 and has served in various positions in Pharmacy
Operations. Mr. Casey is a registered Pharmacist.
Jerry A. Shore joined the Company in April 2000 as Executive Vice President
and Chief Financial Officer. Prior to joining the Company, Mr. Shore was
employed by Wang's International, a major importing and wholesale distribution
company, as Chief Financial Officer from 1989 to 2000, and in various financial
management capacities with IPS Corp., and Caterpillar, Inc. from 1975 to 1989.
Charles S. Vail has served the Company as General Counsel since 1973, as
Corporate Secretary since 1975, and as Vice President - Legal since 1984. Mr.
Vail joined the Company in 1968.
Item 11: Executive Compensation
Information regarding executive compensation is incorporated herein by
reference from the information on pages 6 through 9 of the Company's Proxy
Statement, which will be filed within 120 days of the registrant's fiscal year
end.
Item 12: Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners and
management is incorporated herein by reference from pages 2 and 3 of the
Company's Proxy Statement, which will be filed within 120 days of the
Registrant's fiscal year end.
Item 13: Certain Relationships and Related Transactions
This information is incorporated herein by reference from the information
under the caption "Compensation Committee Interlocks and Insider Participation"
on page 10 of the Company's Proxy Statement, which will be filed within 120 days
of the Registrant's fiscal year end.
PART IV
Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a)(1) Consolidated Financial Statements
The following consolidated financial statements are incorporated herein by
reference from pages 14 through 26 of the Annual Report to Shareholders for
the year ended January 29, 2000.
Report of Independent Accountants.
Consolidated Statements of Income for the years ended January 29,
2000, January 30, 1999, and January 31, 1998.
Consolidated Balance Sheets as of January 29, 2000, and January 30,
1999.
Consolidated Statements of Changes in Shareholders' Equity for the
years ended January 29, 2000, January 30, 1999, and January 31, 1998.
Consolidated Statements of Cash Flows for the years ended January 29,
2000, January 30, 1999, and January 31, 1998.
Notes to Consolidated Financial Statements.
(a)(2) Financial Statement Schedules
Report of Independent Accountants on Financial Statement Schedules for each
of the three years for the period ended January 29, 2000.
II Valuation and qualifying accounts
(a)(3) Those exhibits required to be filed as Exhibits to this Annual
Report on Form 10-K pursuant to Item 601 of Regulation S-K are as
follows:
2.1 Asset Purchase Agreement between CVS Revco D.S., Inc., Fred's
Stores of Tennessee, Inc., CVS Corporation and Fred's, Inc.,
dated as of October 10, 1997 [incorporated herein by reference to
Exhibit 2.1 to the Company's Current Report on Form 8-K dated
December 1, 1997].
2.2 Letter Agreement between CVS Revco D.S., Inc., Fred's Stores of
Tennessee, Inc., CVS Corporation and Fred's, Inc. dated as of
November 1, 1997 [incorporated herein by reference to Exhibit 2.2
to the Company's Current Report on Form 8-K dated December 1,
1997].
3.1 Certificate of Incorporation, as amended [incorporated herein by
reference to Exhibit 3.1 to the Form S-1 as filed with the
Securities and Exchange Commission February 7, 1992 (SEC File No.
33-45637) (the "Form S-1")].
3.2 By-laws, as amended [incorporated herein by reference to Exhibit
3.2 to the Form S-1].
4.1 Specimen Common Stock Certificate [incorporated herein by
reference to Exhibit 4.2 to Pre-Effective Amendment No. 3 to the
Form S-1].
9.1 Baddour, Inc. (Registrant changed its name to "Fred's, Inc." in
1991) Shareholders Agreement dated as of June 28, 1986
[incorporated herein by reference to Exhibit C, pages C-1 through
C-42 to Baddour, Inc.'s Report on Form 8-K dated July 1, 1986]
10.2 Form of Fred's, Inc. Franchise Agreement [incorporated herein by
reference to Exhibit 10.8 to the Form S-1].
10.3 401(k) Plan dated as of May 13, 1991 [incorporated herein by
reference to Exhibit 10.9 to the Form S-1].
10.4 Employee Stock Ownership Plan (ESOP) dated as of January 1, 1987
[incorporated herein by reference to Exhibit 10.10 to the Form
S-1].
*10.5 Incentive Stock Option Plan dated as of December 22, 1986
[incorporated herein by reference to Exhibit 10.11 to the Form
S-1].
10.6 Lease Agreement by and between Hogan Motor Leasing, Inc. and
Fred's, Inc. dated February 5, 1992 for the lease of truck
tractors to Fred's, Inc. and the servicing of those vehicles and
other equipment of Fred's, Inc. [incorporated herein by reference
to Exhibit 10.15 to Pre-Effective Amendment No. 1 to the Form
S-1].
10.7 Revolving Loan and Credit Agreement between Fred's, Inc. and
Union Planters National Bank dated as of May 15, 1992
[incorporated herein by reference to the Company's report on Form
10-Q for the quarter ended May 2, 1992].
*10.8 1993 Long Term Incentive Plan dated as of January 21, 1993
[incorporated herein by reference to the Company's report on Form
10-Q for the quarter ended July 31, 1993].
*Management Compensatory Plan
10.9 Modification Agreement between Fred's, Inc. and Union Planters
National Bank dated as of May 31, 1995 (modifies the Revolving
Loan and Credit Agreement included as Exhibit 10.7) [incorporated
herein by reference to the Company's report on Form 10-Q for the
quarter ended July 29, 1995].
10.10 Second Modification Agreement between Fred's, Inc. and Union
Planters National Bank dated as of July 31, 1995 (modifies the
Revolving Loan and Credit Agreement included as Exhibit 10.7)
[incorporated herein by reference to the Company's report on Form
10-Q for the quarter ended July 29, 1995].
10.11 Seasonal Overline Revolving Credit Agreement between Fred's,
Inc. and Union Planters National Bank dated as of July 23, 1996
[incorporated herein by reference to the Company's report on Form
10-Q for the quarter ended August 3, 1996].
10.12 Addendum to Leasing Agreement and form of schedules 2 through 6
of Schedule A by and between Hogan Motor Leasing, Inc. and
Fred's, Inc. dated December 19, 1996 (modifies the Lease
Agreement included as Exhibit 10.6) [incorporated herein by
reference to the Company's report on Form 10-K for the year ended
February 1, 1997].
10.13 Third Modification Agreement between Fred's, Inc. and Union
Planters National Bank dated as of February 28, 1997 (modifies
the Revolving Loan and Credit Agreement included as Exhibit 10.7)
[incorporated herein by reference to the Company's report on Form
10-K for the year ended February 1, 1997].
10.14 Term Loan Agreement between Fred's, Inc. and Union Planters
National Bank dated as of May 5, 1998 [incorporated herein by
reference to the Company's Report on Form 10-Q for the quarter
ended May 2, 1998].
10.15 Fourth Modification Agreement between Fred's, Inc. and Union
Planters National Bank dated as of September 1998. [Incorporated
herein by reference to the Company's Report on Form 10-Q for the
quarter ended August 1, 1998].
10.16 Preferred Share Purchase Plan [Incorporated herein by reference
to the Company's Report on Form 10-Q for the quarter ended
October 31, 1998].
10.17 Seasonal Overline Agreement between Fred's, Inc. and Union
Planters National Bank dated as of February 3, 1999.
[Incorporated herein by reference to the Company's Report on Form
10-Q for the quarter ended May 1, 1999.]
10.18 Seasonal Overline Agreement between Fred's, Inc. and Union
Planters National Bank dated s of May 12, 1999. [Incorporated
herein by reference to the Company's Report on From 10-Q for the
quarter ended May 1, 1999.]
10.19 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.]
10.20 Seasonal Overline Agreement between Fred's, Inc. and Union
Planters National Bank dated as of August 3, 1999. [Incorporated
herein by reference to the Company's Report on Form 10-Q for the
quarter ended July 31, 1999.]
10.21 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.]
**10.22 Addendum to Leasing Agreement and Form of Schedules 7 through
8 of Schedule A, by and between Hogan Motor Leasing, Inc. and
Fred's, Inc dated September 20, 1999. [Modifies the Lease
Agreement included as Exhibit 10.6]
**10.23 Revolving Loan Agreement between Fred's, Inc. and Union
Planters Bank, NA and Suntrust Bank dated April 3, 2000.
**13.1 Annual report to shareholders for the year ended January 29,
2000 (to the extent incorporated herein by reference).
**21.1 Subsidiaries of Registrant
**23.1 Consent of PricewaterhouseCoopers LLP
**27. Financial Data Schedule
** Filed herewithin
(b) Reports on Form 8-K
None
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 24th day of
April, 2000.
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 24th day of April, 2000.
Signature Title
/s/ Michael J. Hayes Director, Managing Director,
-------------------------- Chief Executive Officer
Michael J. Hayes
/s/ David A. Gardner Director and Managing Director
--------------------------
David A. Gardner
/s/ Roger T. Knox Director
--------------------------
Roger T. Knox
/s/ John R. Eisenman Director
--------------------------
John R. Eisenman
(a)(1) Consolidated Financial Statements
Fred's, Inc.
Consolidated Financial Statements
January 29, 2000
Report of Independent Accountants
To the Board of Directors and Shareholders of Fred's, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Fred's, Inc. and its subsidiaries at January 29, 2000 and January 30, 1999, and
the results of their operations and their cash flows for each of the three years
in the period ended January 29, 2000, in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1 to the consolidated financial statements, the Company
changed its method of accounting for pharmacy inventories during the year ended
January 30, 1999.
PricewaterhouseCoopers LLP
Memphis, TN
March 13, 2000
except for Note 5, as
to which the date
is April 3, 2000
Fred's, Inc.
Consolidated Balance Sheets
(in thousands, except for number of shares)
January 29, January 30,
2000 1999
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 3,036 $ 2,406
Receivables, less allowance for doubtful accounts of $452
($644 at January 30, 1999) 10,911 8,931
Inventories 141,612 126,577
Deferred income taxes 3,002 3,783
Other current assets 1,865 1,367
------------------- -------------------
Total current assets 160,426 143,064
Property and equipment, at depreciated cost 73,459 68,923
Equipment under capital leases, less accumulated amortization of
$856 ($501 at January 30, 1999) 1,835 1,578
Deferred income taxes 866 2,598
Other noncurrent assets, net 3,636 4,594
------------------- -------------------
Total assets $ 240,222 $ 220,757
=================== ===================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 39,653 $ 46,767
Current portion of indebtedness 30,306 11,606
Current portion of capital lease obligations 430 308
Accrued liabilities 9,680 10,776
Income taxes payable 650 826
------------------- -------------------
Total current liabilities 80,719 70,283
Long-term portion of indebtedness 10,027 10,264
Capital lease obligations 1,734 1,557
Other noncurrent liabilities 1,829 1,670
------------------- -------------------
Total liabilities 94,309 83,774
------------------- -------------------
Commitments and contingencies (Notes 7 and 11)
Shareholders' equity:
Common stock, Class A voting, no par value, 11,988,276 shares
issued and outstanding (11,946,772 shares at January 30, 1999) 67,326 66,951
Retained earnings 78,902 70,596
Deferred compensation on restricted stock incentive plan (315) (564)
------------------- -------------------
Total shareholders' equity 145,913 136,983
------------------- -------------------
$ 240,222 $ 220,757
==================== ==================
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statements of Income
(in thousands, except share and per share amounts)
For the Years Ended
-------------------
January 29, January 30, January 31,
2000 1999 1998
---- ---- ----
Net sales $ 665,777 $ 600,902 $ 492,236
Cost of goods sold 478,138 436,523 357,135
------------- ------------------ ------------------
Gross profit 187,639 164,379 135,101
Selling, general and administrative expenses 168,696 149,668 119,590
------------- ------------------ ------------------
Operating income 18,943 14,711 15,511
Interest expense (income), net 2,504 1,106 (149)
------------- ------------------ ------------------
Income before taxes 16,439 13,605 15,660
Income taxes 5,737 4,775 5,873
------------- ------------------ ------------------
Net income $ 10,702 $ 8,830 $ 9,787
============= ================== ==================
Net income per share
Basic $ .90 $ .75 $ .84
============= ================== ==================
Diluted $ .89 $ .73 $ .83
============= ================== ==================
Weighted average shares outstanding
Basic 11,827 11,798 11,670
============= ================== ==================
Diluted 12,072 12,078 11,863
============= ================== ==================
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statement of Changes in Shareholders' Equity
(in thousands, except share data)
Common Stock Retained Deferred
Shares Amount Earnings Compensation Total
------ ------ -------- ------------ -----
Balance, February 1, 1997 9,328,822 $ 63,369 $ 56,364 $ (154) $ 119,579
Cash dividends paid ($.17 per share) (1,999) (1,999)
Repurchase of shares (80)
Issuance of restricted stock 56,491 507 (507)
Exercises of stock options 97,557 1,211 1,211
Other issuances 18,046 300 300
Amortization of deferred compensation
on restricted stock incentive plan 173 173
Tax benefit on exercise of stock
options 313 313
Five-for-four stock split 2,365,953 (5) (5)
Net income 9,787 9,787
-- ---- --------- ---------- ------------- ------------ ----------
Balance, January 31, 1998 11,866,789 65,700 64,147 (488) 129,359
Cash dividends paid ($.20 per share) (2,381) (2,381)
Repurchase of shares (30) -
Issuance of restricted stock 46,182 752 (362) 390
Cancellation of restricted stock (5,500) (38) 38 -
Exercises of stock options 39,331 329 329
Amortization of deferred compensation
on restricted stock incentive plan 248 248
Tax benefit on exercise of stock
options 208 208
Net income 8,830 8,830
-- ---- --------- ---------- ------------- ------------ ----------
Balance, January 30, 1999 11,946,772 66,951 70,596 (564) 136,983
Cash dividends paid ($.20 per share) (2,396) (2,396)
Issuance of restricted stock 9,900 124 (124)
Cancellation of restricted stock (5,700) (118) 118
Other issuances 1,714 30 30
Exercises of stock options 35,590 296 296
Amortization of deferred compensation
on restricted stock incentive plan 255 255
Tax benefit on exercise of stock
options 43 43
Net income 10,702 10,702
-- ---- --------- ---------- ------------- ------------ ----------
Balance, January 29, 2000 11,988,276 $ 67,326 $ 78,902 $ (315) $ 145,913
=== ==== ========== ========== ============= ============= ===========
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Consolidated Statements of Cash Flows
(in thousands)
For the Years Ended
January 29, January 30, January 31,
2000 1999 1998
---- ---- ----
Cash flows from operating activities:
Net income $ 10,702 $ 8,830 $ 9,787
Adjustments to reconcile net income to net cash flows
from operating activities:
Depreciation and amortization 11,830 8,939 7,112
Provision for uncollectible receivables 80 124 589
LIFO Reserve 100 3,108 -
Deferred income taxes 2,513 2,344 (652)
Amortization of deferred compensation on restricted
stock incentive plan 255 248 173
Issuance of restricted stock - 390 -
Gain on sale of fixed assets (41) - (114)
(Increase) decrease in assets:
Receivables (2,060) (1,969) (3,182)
Inventories (15,135) (14,664) (16,852)
Other assets (847) (2,354) (1,099)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities (8,210) (3,712) 25,137
Income taxes payable (176) (890) 68
Other noncurrent liabilities 159 175 1
-------------- -------------- -----------------
Net cash (used in) provided by operating activities (830) 569 20,968
-------------- -------------- -----------------
Cash flows from investing activities:
Capital expenditures (14,848) (23,266) (9,696)
Proceeds from dispositions of property and equipment 215 - 279
Acquisition, net of cash acquired - - ( 12,850)
-------------- -------------- -----------------
Net cash used in investing activities (14,633) (23,266) (22,267)
-------------- -------------- -----------------
Cash flows from financing activities:
Reduction of indebtedness and capital lease obligations (2,139) (556) (1,487)
Proceeds from revolving line of credit, net of payments 18,040 10,200 -
Proceeds from term loan 2,249 12,000 -
Proceeds from exercise of options 296 329 1,211
Tax benefit upon exercise of stock options 43 208 313
Payment of cash for dividends and fractional shares (2,396) (2,381) (2,004)
-------------- -------------- -----------------
Net cash provided by (used in) financing activities 16,093 19,800 (1,967)
-------------- -------------- -----------------
Increase (decrease) in cash and cash equivalents 630 (2,897) (3,266)
Cash and cash equivalents:
Beginning of year 2,406 5,303 8,569
-------------- -------------- -----------------
End of year $ 3,036 $ 2,406 $ 5,303
-------------- -------------- -----------------
Supplemental disclosures of cash flow information:
Interest paid $ 2,399 $ 1,239 $ 346
Income taxes paid $ 3,810 $ 2,828 $ 6,154
Non cash investing and financing activities:
Assets acquired through capital lease obligations $ 612 $ 509 $ 1,290
Common stock issued for acquisition $ 30 $ - $ 300
See accompanying notes to consolidated financial statements.
Fred's, Inc.
Notes to Consolidated Financial Statements
NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
Description of business. The primary business of Fred's, Inc. (the "Company") is
the sale of general merchandise through its 293 retail discount stores located
in the southeastern United States. In addition, the Company sells general
merchandise to its 26 franchisees.
Consolidated financial statements. The consolidated financial statements include
the accounts of the Company and its subsidiaries. All significant intercompany
accounts and transactions are eliminated.
Fiscal year. The Company utilizes a 52 - 53 week accounting period which ends on
the Saturday closest to January 31. Fiscal years 1999, 1998 and 1997, as used
herein, refer to the years ended January 29, 2000, January 30, 1999, and January
31, 1998, respectively.
Use of estimates. The preparation of financial statements in accordance with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Actual results could differ from those estimates.
Inventories. Wholesale inventories are stated at the lower of cost or market
using the FIFO (first-in, first-out) method. Retail inventories are stated at
the lower of cost or market as determined by the retail inventory method. For
pharmacy inventories, which comprise approximately 18% and 16% of the retail
inventories at January 29, 2000 and January 30, 1999, respectively, cost was
determined using the LIFO (last-in, first-out) method. For the remainder of the
retail inventories, the FIFO (first- in, first-out) method was applied. The
current cost of inventories exceeded the LIFO cost by approximately $3,208,000
at January 29, 2000 and $3,108,000 at January 30, 1999.
During the fourth quarter of fiscal 1998, the Company adopted the LIFO method of
accounting for its pharmacy inventories. The change was made to address the
significant inflation experienced in pharmacy inventory costs during 1998 and
provide for a better matching of costs and revenues. Net income for the year
ended January 30, 1999 was reduced by $2,017,000 as a result of this adoption.
Depreciation and amortization. Depreciation is computed using the straight-line
method over the estimated useful lives of buildings, furniture, fixtures and
equipment. Leasehold costs and improvements are amortized over the lesser of
their estimated useful lives or the remaining lease terms. Average useful lives
are as follows: buildings and improvements - 8 to 30 years; furniture and
fixtures - 5 to 10 years; and equipment - 3 to 10 years. Amortization on
equipment under capital leases is computed on a straight-line basis over the
terms of the leases.
Fred's, Inc.
Notes to Consolidated Financial Statements
Selling, general and administrative expenses. The Company includes buying,
warehousing, transportation and occupancy costs in selling, general and
administrative expenses.
Advertising. The Company charges advertising, including production costs, to
expense on the first day of the advertising period. Advertising expense for
1999, 1998, and 1997 was $8,926,000, $9,621,000, and $7,383,000, respectively.
Preopening costs. The Company charges to expense the preopening costs of new
stores as incurred. These costs are primarily labor to stock the store,
preopening advertising, store supplies and other expendable items.
Revenue Recognition. The Company markets goods and services through Company
owned stores and 26 franchised stores. Sales are recorded at Company owned
stores when sold to the public. Sales to franchised stores are recorded when
purchased from the Company's warehouse. 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 cost incurred on behalf of the franchised stores. Total
franchise income for 1999, 1998, and 1997 was $1,761,000, $1,957,000, and
$1,967,000, respectively.
Other intangibles assets. Other identifiable intangible assets which are
included in other noncurrent assets primarily represents amounts associated with
acquired pharmacies and are being amortized over five years. These intangibles,
net of accumulated amortization, totaled $3,559,000 at January 29, 2000,
$4,521,000 at January 30, 1999, and $3,742,000 at January 31, 1998. Amortization
expense for 1999, 1998 and 1997 was $1,307,000, $1,214,000, and $739,000,
respectively.
Cash and cash equivalents. Cash on hand and in banks, together with other highly
liquid investments having original maturities of three months or less, are
classified as cash equivalents. Included in accounts payable is outstanding
checks in excess of funds on deposit which totaled $14,089,000 at January 29,
2000 and $15,818,000 at January 30, 1999.
Financial instruments. At January 29, 2000, 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.
Fred's, Inc.
Notes to Consolidated Financial Statements
Business segments. The Company has one reportable operating segment, its sales
of merchandise through its Company owned stores and to franchised Fred's
locations, which are organized around the products sold and markets served.
Comprehensive income. The Company discloses all comprehensive income items in
accordance with Statement of Financial Accounting Standards No. 130. Reporting
Comprehensive Income. Comprehensive income does not differ from the consolidated
net income presented in the consolidated statements of income.
Reclassifications. Certain prior year amounts have been reclassified to conform
to the 1998 presentation.
Recent Accounting Pronouncements. In June 1999, the FASB issued SFAS No. 137,
Accounting for Derivative Instruments and Hedging Activities - Deferral of the
effective date of FASB Statement No. 133, which deferred the effective date
provisions of SFAS No. 133 for the company to the first quarter of 2001. The
Company does not believe this new standard will have an impact on its financial
statements since it currently has no derivative instruments.
NOTE 2 - ACQUISITION
Effective October 10, 1997, the Company executed an Asset Purchase Agreement for
the purchase of inventory and other selected assets of CVS Revco D.S., Inc. for
$12.85 million in cash. Tangible assets acquired consisted of inventory of $9.7
million and fixed assets of $2.0 million. The remaining purchase price was
allocated to identifiable intangible assets acquired.
NOTE 3 - PROPERTY AND EQUIPMENT
Property and equipment, at cost, consist of the following (in thousands):
1999 1998
---- ----
Buildings and improvements $ 65,660 $ 63,975
Furniture, fixtures and equipment 81,424 71,612
------------ ------------
147,084 135,587
Less accumulated depreciation and amortization (78,018) (70,966)
------------ ------------
69,066 64,621
Land 4,393 4,302
------------ ------------
$ 73,459 $ 68,923
============ ============
Depreciation expense totaled $10,168,000, $7,442,000, and $6,115,000 for 1999,
1998 and 1997, respectively.
Fred's, Inc.
Notes to Consolidated Financial Statements
NOTE 4 - ACCRUED LIABILITIES
The components of accrued liabilities are as follows (in thousands):
1999 1998
---- ----
Payroll and benefits $ 2,992 $ 2,761
Sales and use taxes 1,726 1,909
Insurance 2,904 3,328
Other 2,058 2,778
------------ -----------
$ 9,680 $ 10,776
============ ===========
NOTE 5 - INDEBTEDNESS
On May 15, 1992, the Company and a bank entered into a Revolving Loan and Credit
Agreement (the "Agreement"). The Agreement, as amended, provides the Company
with an unsecured revolving line of credit commitment of up to $15 million, and
is also supplemented with $15 million of seasonal overline capabilities and
bears interest at 1.5% below prime rate or a LIBOR-based rate. Under the most
restrictive covenants of the Agreement, the Company is required to maintain
specified shareholders' equity and net income levels. There were $28,240,000 and
$10,200,000 borrowings outstanding under the Agreement at January 29, 2000 and
January 30, 1999, respectively. The Company is required to pay a commitment fee
to the bank at a rate per annum equal to .18% on the unutilized portion of the
revolving line commitment over the term of the Agreement.
On April 3, 2000, a new Revolving Loan and Credit Agreement (the "Agreement")
was entered into to replace the May 15, 1992 Revolving Loan and Credit
Agreement, as amended. The new Agreement increases the revolving line of credit
commitment to $40 million and the term of the Agreement extends to April 3,
2003. All other provisions of the Agreement are essentially the same as the May
15, 1992 Agreement, as amended.
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 millionto finance the replacement of the Company's
mainframe computer system. The Loan Agreement bears interest of 6.15% per annum
and matures on April 15, 2003. Borrowings outstanding under this agreement at
January 29, 2000 were $1,828,000 and the principal maturity on this loan is as
follows: $562,500 in fiscal 2000; $562,500 in fiscal 2001; $562,500 in fiscal
2002; $140,500 in fiscal 2003.
On May 5, 1998, the Company and a bank entered into a Loan Agreement (the "Loan
Agreement"). The Loan Agreement provided the Company with an unsecured term loan
of $12 million to finance the modernization and automation of the Company's
distribution center and corporate facilities. The Loan Agreement bears interest
of 6.82% per annum and matures on November 1, 2005. Under the most restrictive
covenants of the Loan Agreement, the Company is required to maintain specified
shareholders' equity and net income levels. Borrowings outstanding under this
Loan Agreement totaled $10,265,000 at January 29, 2000 and $11,670,000 at
January 30, 1999. The principal maturity under this Agreement for debt
outstanding at January 29, 2000 is as follows: $1,503,358 in fiscal 2000;
$1,612,742 in fiscal 2001; $1,727,860 in fiscal 2002; $1,851,199 in fiscal 2003;
$1,983,338 in fiscal 2004; and $1,586,503 thereafter.
Interest expense for 1999, 1998 and 1997 totaled $2,504,000, $1,206,000 and
$343,000, respectively.
NOTE 6 - INCOME TAXES
Deferred income taxes are provided for the tax effects of temporary differences
between the financial reporting basis and income tax basis of the Company's
assets and liabilities. The provision for income taxes consists of the following
(in thousands):
1999 1998 1997
---- ---- ----
Current
Federal $ 3,224 $ 2,639 $ 6,225
State - (208) 300
3,224 2,431 6,525
----------- ------------- ----------
Deferred
Federal 2,116 1,974 (840)
State 397 370 188
----------- ------------- ----------
2,513 2,344 (652)
----------- ------------- ----------
$ 5,737 $ 4,775 $ 5,873
=========== ============= ==========
Fred's, Inc.
Notes to Consolidated Financial Statements
Deferred tax assets (liabilities) are comprised of the following (in thousands):
1999 1998
---- ----
Current deferred tax assets:
Inventory valuation methods $ 758 $ 861
Accrual for inventory shrinkage 672 1,028
Allowance for doubtful accounts 285 358
Insurance accruals 990 1,160
Other 749 1,084
----------- ---------------
Gross current deferred tax assets 3,454 4,491
Deferred tax asset valuation allowance (182) (328)
----------- ---------------
3,272 4,163
Current deferred tax liabilities (270) (380)
----------- ---------------
Net current deferred tax asset $ 3,002 $ 3,783
=========== ===============
1999 1998
---- ----
Noncurrent deferred tax assets:
Net operating loss carryforwards $ 1,421 $ 1,028
Postretirement benefits other than pensions 694 634
Restructuring costs 82 229
Other 1,583 1,759
----------- ---------------
Gross noncurrent deferred tax assets 3,780 3,650
Deferred tax asset valuation allowance (1,239) (700)
----------- ---------------
2,541 2,950
Noncurrent deferred tax liabilities:
Depreciation (1,648) (319)
Other (27) (33)
----------- ---------------
Gross noncurrent deferred tax liabilities (1,675) (352)
----------- ---------------
Net noncurrent deferred tax asset $ 866 $ 2,598
=========== ===============
The ultimate realization of these assets is dependent upon the generation of
future taxable income sufficient to offset the related deductions and loss
carryforwards within the applicable carryforward periods as described below. The
valuation allowance is based upon management's conclusion that certain tax
carryforward items will expire unused. During 1999 and 1998, the valuation
allowance increased $393,000 and $98,000, respectively, as the result of the
company generating additional net operating loss carry forwards in certain
states. The release of valuation allowance of $206,000 for the year ended
January 31, 1998 resulted from the Company's ability to assure utilization of
certain state net operating loss carry forwards and tax credits that were
originally anticipated to expire unused.
Fred's, Inc.
Notes to Consolidated Financial Statements
At January 29, 2000, the Company has certain net operating loss carry forwards
which were acquired in reorganizations and purchase transactions which are
available to reduce income taxes, subject to usage limitations. These carry
forwards total approximately $36,687,000 for state income tax purposes, and
expire at various times during the period 2001 through 2021. If certain
substantial changes in the Company's ownership should occur, there would be an
annual limitation on the amount of carry forwards which can be utilized.
A reconciliation of the statutory Federal income tax rate to the effective tax
rate is as follows:
1999 1998 1997
---- ---- ----
Income tax provision at statutory rate 35.0% 35.0% 35.0%
State income taxes, net of federal benefit 1.6 0.8 3.4
Change in valuation allowance - 0.7 (1.3)
Surtax Exemptions (1.0) (1.0) (1.0)
Other (0.7) (0.4) 1.4
---- ---- ---
34.9% 35.1% 37.5%
NOTE 7 - LONG-TERM LEASES
The Company leases certain of its store locations under noncancelable operating
leases expiring at various dates through 2029. Many of these leases contain
renewal options and require the Company to pay taxes, maintenance, insurance and
certain other operating expenses applicable to the leased properties. In
addition, the Company leases various equipment under noncancelable operating
leases and certain transportation equipment under capital leases. Total rent
expense under operating leases was $15,329,000, $13,618,000, and $10,239,000 for
1999, 1998 and 1997, respectively. Amortization expense on assets under capital
lease for 1999, 1998 and 1997 was $355,000, $283,000, and $258,000,
respectively.
Fred's, Inc.
Notes to Consolidated Financial Statements
Future minimum rental payments under all operating and capital leases as of
January 29, 2000 are as follows (in thousands):
Operating Capital
Leases Leases
------ ------
2000 $ 14,738 $ 741
2001 12,842 741
2002 11,032 741
2003 8,618 364
2004 6,021 255
Thereafter 13,465 142
-------------- -----------
Total minimum lease payments $ 66,716 2,984
==============
Imputed interest (820)
-----------
Present value of net minimum lease payments, including
-----------
$430 classified as current portion of capital lease obligations $ 2,164
===========
NOTE 8 - SHAREHOLDERS' EQUITY
The Company has 30 million shares of Class A voting common stock authorized. The
Company's authorized capital also consists of 11.5 million shares of Class B
nonvoting common stock, of which no shares have been issued. In addition, the
Company has authorized 10 million shares of preferred stock, of which no shares
have been issued.
Effective October 12, 1998 the Company adopted a Shareholders Rights Plan which
granted a dividend of one preferred share purchase right ("the Right") for each
common share outstanding at that date. Each Right represents the right to
purchase one-hundredth of a preferred share of stock at a preset price to be
exercised when any one individual, firm, corporation or other entity acquires
15% or more of the Company's common stock. The Rights will become dilutive at
the time of exercise and will expire, if unexercised, on October 12, 2008.
On November 20, 1997, the board of directors approved a five-for-four stock
split to be effective on December 19, 1997 for shareholders of record on
December 5, 1997. The split resulted in the issuance of 2,365,953 shares of
common stock. All per share data included herein have been restated to reflect
the stock split.
NOTE 9 - EMPLOYEE BENEFIT PLANS
Incentive stock option plan. The Company has a long-term incentive plan under
which an aggregate of 1,168,750 shares may be granted. These options expire five
years from the date of grant. Options outstanding at January 29, 2000 expire in
2000 through 2004.
A summary of activity in the plan follows:
1999 1998 1997
---- ---- ----
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
------- ----- ------- ----- ------- -----
Outstanding at beginning
of year 490,139 $ 13.40 411,298 $ 8.55 297,113 $ 10.60
Granted 136,750 11.82 150,695 25.61 364,355 8.61
Canceled (26,101) 14.79 (32,523) 12.46 (16,353) 9.81
Expired (1,744) 11.33 - - (120,778) 14.45
Exercised (35,590) 8.38 (39,331) 8.42 (113,039) 10.65
------- ---- ------- ---- -------- -----
Outstanding at end of year 563,454 13.13 490,139 13.40 411,298 8.55
======= ===== ======= ===== ======= ====
Exercisable at end of year 169,313 9.10 152,483 9.85 90,115 10.70
======= ==== ======= ==== ====== =====
The weighted average remaining contractual life of all outstanding options was
2.9 years at January 29, 2000.
Fred's, Inc.
Notes to Consolidated Financial Statements
The following table summarizes information about stock options outstanding at
January 29, 2000:
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 29, 2000 (in Years) Price January 29, 2000 Price
--------------- ---------------- ---------- ----- ---------------- -----
$5.90 to $8.00 247,951 2.0 $ 7.15 131,160 $ 7.09
$11.00 to $17.90 189,228 3.8 $ 12.69 34,053 $ 14.85
$22.75 to $25.88 126,275 3.2 $ 25.54 4,100 $ 25.50
------- -------
563,454 169,313
======= =======
The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees and related interpretations in accounting for its
plans. Accordingly, no compensation expense has been recognized for its
stock-based compensation. Had compensation cost for the Company's stock option
plan been determined based on the fair value at the grant date for awards in
1999, 1998 and 1997 consistent with the method prescribed by SFAS No. 123,
Accounting for Stock- Based Compensation, the Company's operating results for
1999, 1998 and 1997 would have been reduced to the pro forma amounts indicated
below:
(in thousands, except per share data) 1999 1998 1997
- ------------------------------------- ---- ---- ----
Net income
As reported $ 10,702 $ 8,830 $ 9,787
Pro forma 10,363 8,322 9,492
Basic earnings per share
As reported 0.90 0.75 0.84
Pro forma 0.88 0.71 0.81
Diluted earnings per share
As reported 0.89 0.73 0.83
Pro forma 0.86 0.69 0.80
Fred's, Inc.
Notes to Consolidated Financial Statements
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions using grants in 1999, 1998 and 1997, respectively:
1999 1998 1997
---- ---- ----
Average expected life (years) 3.0 3.0 3.0
Average expected volatility 43.3% 41.5% 37.6%
Risk-free interest rates 4.8% 5.5% 6.0%
Dividend yield 1.5% 1.3% 2.4%
The weighted average grant-date fair value of options granted during 1999, 1998
and 1997 was $4.17, $7.85, and $2.40 respectively.
Restricted Stock. During 1999, 1998 and 1997, the Company issued a net of 4,200,
40,682, and 56,491 restricted shares, respectively. Compensation expense related
to the shares issued is recognized over the period for which restrictions apply.
Employee stock ownership plan. The Company has a non-contributory employee stock
ownership plan for the benefit of qualifying employees who have completed one
year of service and attained the age of 18. Benefits are fully vested upon
completion of seven years of service. The Company has not made any contributions
to the plan since 1996.
Salary reduction profit sharing plan. The Company has a defined contribution
profit sharing plan for the benefit of qualifying employees who have completed
one year of service and attained the age of 21. Participants may elect to make
contributions to the plan up to a maximum of 15% of their compensation. Company
contributions are made at the discretion of the Company's Board of Directors.
Participants are 100% vested in their contributions and earnings thereon.
Contributions by the Company and earnings thereon are fully vested upon
completion of seven years of service. The Company's contributions for the years
ended January 29, 2000, January 30, 1999, and January 31, 1998 were $96,000,
$83,000, and $65,000, respectively.
Fred's, Inc.
Notes to Consolidated Financial Statements
Postretirement benefits. The Company provides certain health care benefits to
its full-time employees that retire between the ages of 58 and 65 with certain
specified levels of credited service. Health care coverage options for retirees
under the plan are the same as those available to active employees. The
Company's change in benefit obligation based upon an actuarial valuation is as
follows:
For the Year Ended
------------------
January 29, January 30, January 31,
2000 1999 1998
---- ---- ----
(in thousands)
Benefit obligation at beginning of year $ 1,252 $ 1,132 $ 1,235
Service cost 127 103 97
Interest cost 91 85 83
Participant contributions - 4 2
Amendments - - (7)
Actuarial (gain) loss (17) (67) (258)
Benefits paid (76) (5) (20)
----------------- ---------------- ----------------
Benefit obligation at end of year $ 1,377 $ 1,252 $ 1,132
================= ================ ================
A reconciliation of the Plan's funded status to accrued benefit cost follows:
January 29, January 30, January 31,
2000 1999 1998
(in thousands)
Funded status $ (1,377) $ (1,252) $ (1,132)
Unrecognized net actuarial loss (gain) (406) (405) (356)
Unrecognized prior service cost (6) (6) (7)
----------------- ---------------- ----------------
Accrued benefit costs $ (1,789) $ (1,663) $ (1,495)
================ ================ ================
The medical care cost trend used in determining this obligation is 10.0%
effective February 1, 1997, decreasing annually before leveling at 6.5% in 2003.
This trend rate has a significant effect on the amounts reported. To illustrate,
increasing the health care cost trend by 1% would increase the accumulated
postretirement benefit obligation by $202,000. The discount rate used in
calculating the obligation was 7.75% in 1999, 6.75% in 1998 and 7.5% in 1997.
Fred's, Inc.
Notes to Consolidated Financial Statements
The annual net postretirement cost is as follows:
For the Year Ended
------------------
January 29, January 30, January 31,
2000 1999 1998
---- ---- ----
(in thousands)
Service cost $ 127 $ 103 $ 97
Interest cost 91 85 83
Amortization of net loss (gain) from prior periods (17) (21) (19)
Amortization of unrecognized prior service cost 1 1 -
--------------- --------------- ---------------
Net periodic postretirement benefit cost $ 202 $ 168 $ 161
=============== =============== ===============
The Company's policy is to fund claims as incurred.
NOTE 10 - NET INCOME PER SHARE
Basic earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Restricted stock is
considered contingently issuable and is excluded from the computation of basic
earnings per share.
A reconciliation of basic earnings per share to diluted earnings per share
follows (in thousands, except per share data):
Year Ended
January 29, 2000 January 31, 1999 January 31, 1998
Per-Share Per-Share Per-Share
Income Shares Amount Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------ ------ ------ ------
Basic EPS $10,702 11,827 $ .90 $ 8,830 11,798 $ .75 $ 9,787 11,670 $ .84
------- ------ ---------- ------- ------ ---------- ------- ------ ----------
Effect of Dilutive
Securities
Restricted stock 108 79 42
Stock options 137 201 151
------- ------ ---------- ------- ------ ---------- ------- ------ ----------
Diluted EPS $10,702 12,072 $ .89 $ 8,830 12,078 $ .73 $ 9,787 11,863 $ .83
======= ====== ========== ======= ====== ========== ======= ====== ==========
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Commitments. At January 29, 2000, the Company had commitments approximating
$5,695,000 on issued letters of credit which support purchase orders for
merchandise. Additionally, the Company had outstanding letters of credit
aggregating $2,240,000 utilized as collateral for their risk management
programs.
Litigation. The Company is a party to several pending legal proceedings and
claims in the normal course of business. Although the outcome of the proceedings
and claims cannot be determined with certainty, management of the Company is of
the opinion that it is unlikely that these proceedings and claims will have a
material adverse effect on the results of operations, cash flows, or the
financial condition of the Company.
NOTE 12 - OTHER EXPENSES
During the fourth quarter of 1996, the Company recorded a $2,860,000 accrual for
the closure of certain underperforming stores and the repositioning of certain
merchandise categories. This charge included an accrual for closed facility
lease obligations of $1,156,000. The remaining lease obligation at January 29,
2000 represents remaining future base payments required on one location that has
been closed.
The 1999 activity in this reserve is as follows:
January 31, January 30, January 29,
1998 1999 Payments 2000
---- ---- -------- ----
Lease obligations $ 666 $ 400 $ (185) $ 215
Fred's, Inc.
Notes to Consolidated Financial Statements
NOTE 13 - QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(in thousands, except per share data)
Year Ended January 29, 2000
- ---------------------------
Net sales $ 154,934 $ 156,498 $ 158,049 $ 196,296
Gross profit 44,319 43,952 47,117 52,251
Net income 2,886 1,037 2,896 3,883
Net income per share
Basic 0.24 0.09 0.24 0.33
Diluted 0.24 0.09 0.24 0.32
Cash dividends paid per share 0.05 0.05 0.05 0.05
Year Ended January 30, 1999(1)
- ------------------------------
Net sales $ 144,156 $ 141,635 $ 142,339 $ 172,772
Gross profit 37,869 38,614 41,449 46,447
Net income 2,286 1,430 2,568 2,546
Net income per share
Basic 0.19 0.12 0.22 0.22
Diluted 0.19 0.12 0.21 0.21
Cash dividends paid per share 0.05 0.05 0.05 0.05
(1) The quarterly data for the year ended January 30, 1999 includes the impact
of the accounting change described in Note 1.
Report of Independent Accountants on
Financial Statement Schedules
To the Board of Directors
of Fred's, Inc.
Our audits of the consolidated financial statements referred to in our report
dated March 13, 2000, except for Note 5, as to which the date is April 3,
2000, appearing in the 1999 Annual Report to Shareholders of Fred's, Inc.
(which report and consolidated financial statements are incorporated by
reference in this Annual Report on Form 10-K) also included an audit of the
financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our
opinion, the financial statement schedule presents fairly, in all material
respects, the information set forth therein when read in conjunction with the
related consolidated financial statements.
PricewaterhouseCoopers LLP
Memphis, TN
March 13, 2000
Schedule II - Valuation and Qualifying Accounts
Balance at Charged to Balance at
Beginning Costs and Deductions End
of Period Expenses Write-offs of Period
Allowance for doubtful Accounts:
Year ended January 31, 1998 946 860 (1,040) 766
Year ended January 30, 1999 766 124 (246) 644
Year ended January 29, 2000 644 80 (272) 452
EXHIBIT 10.22
SCHEDULE A TO LEASING AGREEMENT SCHEDULE NO. 7
PAGE 1 OF 2
Between Hogan Motor Leasing Inc. (Hogan) and Fred's, Inc. (Customer) LEASE DATED 1/31/92
LOCATION OF HOGAN FACILITY: Memphis, TN
Veh.# Date of Term VEHICLE DESCRIPTION Licensed Orig. Deprec. Est. Fixed Mileage Refrig.
Del. in Yrs Weight Value Annual Charge per Rate Maint
Mileage Wk/Mo per Rate
Mile per Hr.
Yr. & Model & Serial # Monthly
Make Type Amt.
L-5386 1/13/00 6 2000 8100 T/A 1HSHCAHR7YH298330 80,000 $67,980 $610 75,000 $331.75/wk $.06/Mi N/A
Navistar Tractor
L-5387 1/13/00 " " " 1HSHCAHR9YH298331 " " " " " " "
L-5388 1/13/00 " " " 1HSHCAHR0YH298332 " " " " " " "
L-5389 1/13/00 " " " 1HSHCAHR2YH298333 " " " " " " "
L-5390 1/13/00 " " " 1HSHCAHR4YH298334 " " " " " " "
L-5391 1/13/00 " " " 1HSHCAHR6YH298335 " " " " " " "
(Side One)
NOTE: The above (6) six vehicles will replace vehicle #'s L-387, L-5235, L-5237, L-5238, L-5239 and L-5240.
1. If prior to the date that a Vehicle is placed in service of the Customer,
the purchase price of the Vehicle has been increased by the manufacturer of
the Vehicle, then the original agreed value as set forth in the Schedule A
and the fixed lease charge per week for that Vehicle shall be adjusted
upward accordingly.
2. Liability Insurance Responsibility: [ ] Hogan [X] Customer
Limits: Check only one block and complete the appropriate blank(s).
X Combined Single Limits $ 1,000,000 per occurrence
---- -----------------
Bodily Injury $ per person
---- -----------------
Bodily Injury $ per occurrence
-----------------
Property Da