Attached files
file | filename |
---|---|
EX-32 - FREDS INC | v168643_ex32.htm |
EX-31.2 - FREDS INC | v168643_ex31-2.htm |
EX-31.1 - FREDS INC | v168643_ex31-1.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
x
|
QUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
|
For the
quarterly period ended October 31, 2009.
OR
¨
|
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934.
|
For the
transition period from __________ to __________.
Commission
file number 001-14565
FRED'S,
INC.
(Exact
name of registrant as specified in its charter)
TENNESSEE
|
62-0634010
|
|
(State or Other Jurisdiction of
|
(I.R.S. Employer
|
|
Incorporation or Organization)
|
Identification Number)
|
4300 New
Getwell Road
Memphis,
Tennessee 38118
(Address
of Principal Executive Offices)
(901)
365-8880
(Registrant's
telephone number, including area code)
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No ¨.
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or such shorter period that the registrant was required to submit and
post such files). ¨ Yes ¨ No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer ¨
|
Accelerated
filer x
|
Non-accelerated
filer ¨
|
Smaller
reporting company ¨
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act. Yes ¨ No x.
The
registrant had 39,669,078 shares of Class A voting, no par value common stock
outstanding as of December 10, 2009.
FRED'S,
INC.
INDEX
Page No.
|
|
Part I - Financial
Information
|
|
Item
1 - Financial Statements:
|
|
Condensed
Consolidated Balance Sheets as of October 31, 2009 (unaudited) and January
31, 2009
|
3
|
Condensed
Consolidated Statements of Income for the Thirteen and Thirty-Nine Weeks
Ended
|
|
October
31, 2009 (unaudited) and November 1, 2008 (unaudited)
|
4
|
Condensed
Consolidated Statements of Cash Flows for the Thirty-Nine Weeks
Ended
|
|
October
31, 2009 (unaudited) and November 1, 2008 (unaudited)
|
5
|
Notes
to Condensed Consolidated Financial Statements (unaudited)
|
6-13
|
Item
2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
|
14-18
|
Item
3 – Quantitative and Qualitative Disclosure about Market
Risk
|
19
|
Item
4 – Controls and Procedures
|
19
|
Part II - Other Information
|
19-20
|
|
|
Item
1. Legal Proceedings
|
19
|
Item
1A. Risk Factors
|
19
|
Item
4. Submission of Matters to a Vote of Security Holders
|
|
Item
6. Exhibits
|
20
|
Signatures
|
20
|
Ex-31.1
Section 302 Certification of the CEO
|
|
Ex-31.2
Section 302 Certification of the CFO
|
|
Ex-32.
Section 906 Certification of the CEO and CFO
|
2
Part I – FINANCIAL
INFORMATION
Item
1. Financial Statements
FRED’S,
INC.
CONDENSED
CONSOLIDATED BALANCE SHEETS
(in
thousands, except for number of shares)
October 31, 2009
|
January 31,
|
|||||||
(unaudited)
|
2009
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 38,555 | $ | 35,128 | ||||
Receivables,
less allowance for doubtful accounts of $701 and $885,
respectively
|
31,723 | 28,857 | ||||||
Inventories
|
344,252 | 301,537 | ||||||
Other
non-trade receivables
|
20,153 | 15,782 | ||||||
Prepaid
expenses and other current assets
|
12,097 | 11,912 | ||||||
Total
current assets
|
446,780 | 393,216 | ||||||
Property
and equipment, at depreciated cost
|
139,247 | 138,036 | ||||||
Equipment
under capital leases, less accumulated amortization of $4,967 and
$4,928
|
||||||||
respectively
|
- | 39 | ||||||
Other
noncurrent assets, net
|
17,652 | 13,484 | ||||||
Total
assets
|
$ | 603,679 | $ | 544,775 | ||||
LIABILITIES AND SHAREHOLDERS’
EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Accounts
payable
|
$ | 119,965 | $ | 69,955 | ||||
Current
portion of indebtedness
|
753 | 243 | ||||||
Accrued
expenses and other
|
40,815 | 45,467 | ||||||
Deferred
income taxes
|
14,569 | 13,061 | ||||||
Income
taxes payable
|
- | 8,941 | ||||||
Total
current liabilities
|
176,102 | 137,667 | ||||||
Long-term
portion of indebtedness
|
4,197 | 4,866 | ||||||
Deferred
income taxes
|
1,750 | 1,328 | ||||||
Other
noncurrent liabilities
|
18,235 | 13,833 | ||||||
Total
liabilities
|
200,284 | 157,694 | ||||||
Commitments
and Contingencies
|
||||||||
Shareholders’
equity:
|
||||||||
Preferred
stock, nonvoting, no par value, 10,000,000 shares authorized, none
outstanding
|
- | - | ||||||
Preferred
stock, Series A junior participating nonvoting, no par
value,
|
||||||||
224,594
shares authorized, none outstanding
|
- | - | ||||||
Common
stock, Class A voting, no par value, 60,000,000 shares
authorized,
|
||||||||
40,088,028
and 39,940,148 shares issued and outstanding, respectively
|
138,573 | 136,877 | ||||||
Common
stock, Class B nonvoting, no par value, 11,500,000 shares
authorized,
|
||||||||
none
outstanding
|
- | - | ||||||
Retained
earnings
|
263,759 | 249,141 | ||||||
Accumulated
other comprehensive income
|
1,063 | 1,063 | ||||||
Total
shareholders’ equity
|
403,395 | 387,081 | ||||||
Total
liabilities and shareholders’ equity
|
$ | 603,679 | $ | 544,775 |
See
accompanying notes to condensed consolidated financial
statements.
3
FRED’S,
INC.
CONDENSED CONSOLIDATED
STATEMENTS OF INCOME
(unaudited)
(in
thousands, except per share amounts)
Thirteen Weeks Ended
|
Thirty-nine Weeks Ended
|
|||||||||||||||
October 31,
|
November 1,
|
October 31,
|
November 1,
|
|||||||||||||
2009
|
2008
|
2009
|
2008
|
|||||||||||||
Net
sales
|
$ | 422,438 | $ | 418,036 | $ | 1,315,032 | $ | 1,329,455 | ||||||||
Cost
of goods sold
|
299,569 | 293,850 | 942,444 | 948,937 | ||||||||||||
Gross
profit
|
122,869 | 124,186 | 372,588 | 380,518 | ||||||||||||
Depreciation
and amortization
|
6,530 | 6,367 | 19,457 | 20,229 | ||||||||||||
Selling,
general and administrative expenses
|
108,678 | 108,416 | 323,633 | 337,202 | ||||||||||||
Operating
income
|
7,661 | 9,403 | 29,498 | 23,087 | ||||||||||||
Interest
income
|
(59 | ) | (35 | ) | (137 | ) | (237 | ) | ||||||||
Interest
expense
|
118 | 94 | 383 | 546 | ||||||||||||
Income
before income taxes
|
7,602 | 9,344 | 29,252 | 22,778 | ||||||||||||
Provision
for income taxes
|
2,570 | 3,255 | 11,430 | 8,406 | ||||||||||||
Net
income
|
$ | 5,032 | $ | 6,089 | $ | 17,822 | $ | 14,372 | ||||||||
Net
income per share
|
||||||||||||||||
Basic
|
$ | 0.13 | $ | 0.15 | $ | 0.45 | $ | 0.36 | ||||||||
Diluted
|
$ | 0.13 | $ | 0.15 | $ | 0.45 | $ | 0.36 | ||||||||
Weighted
average shares outstanding
|
||||||||||||||||
Basic
|
39,914 | 39,830 | 39,901 | 39,801 | ||||||||||||
Effect
of dilutive stock options
|
68 | 40 | 88 | 23 | ||||||||||||
Diluted
|
39,982 | 39,870 | 39,989 | 39,824 | ||||||||||||
Dividends
per common share
|
$ | 0.03 | $ | 0.02 | $ | 0.08 | $ | 0.06 | ||||||||
Comprehensive
income:
|
||||||||||||||||
Net
income
|
$ | 5,032 | $ | 6,089 | $ | 17,822 | $ | 14,372 | ||||||||
Other
comprehensive income (expense), net of tax
|
||||||||||||||||
postretirement
plan adjustment
|
- | (10 | ) | - | (32 | ) | ||||||||||
Comprehensive
income
|
$ | 5,032 | $ | 6,079 | $ | 17,822 | $ | 14,340 |
See
accompanying notes to condensed consolidated financial
statements.
4
FRED’S,
INC.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in
thousands)
For the Thirty-Nine Weeks Ended
|
||||||||
October 31, 2009
|
November 1, 2008
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
income
|
$ | 17,822 | $ | 14,372 | ||||
Adjustments
to reconcile net income to net cash flows from operating
activities:
|
||||||||
Depreciation
and amortization
|
19,457 | 20,229 | ||||||
Net
gain (loss) on asset disposition
|
156 | (850 | ) | |||||
Provision
for store closures and asset impairment
|
- | 419 | ||||||
Stock-based
compensation
|
1,417 | 1,249 | ||||||
Recovery
of uncollectible receivables
|
(184 | ) | (143 | ) | ||||
LIFO
reserve increase
|
1,424 | 2,738 | ||||||
Deferred
income tax expense
|
1,945 | 6,421 | ||||||
Income
tax benefit upon exercise of stock options
|
23 | 14 | ||||||
Provision
for post retirement medical
|
- | (32 | ) | |||||
(Increase)
decrease in operating assets:
|
||||||||
Trade
receivables
|
(4,570 | ) | 2,451 | |||||
Insurance
receivables
|
- | 834 | ||||||
Inventories
|
(44,139 | ) | (55,563 | ) | ||||
Other
assets
|
(185 | ) | (1,644 | ) | ||||
Increase
(decrease) in operating liabilities:
|
||||||||
Accounts
payable and accrued expenses
|
45,359 | 53,967 | ||||||
Income
taxes payable
|
(3,697 | ) | - | |||||
Other
noncurrent liabilities
|
(3,362 | ) | 1,374 | |||||
Net
cash provided by operating activities
|
31,466 | 45,836 | ||||||
Cash
flows from investing activities:
|
||||||||
Capital
expenditures
|
(18,368 | ) | (14,386 | ) | ||||
Proceeds
from asset dispositions
|
106 | 2,163 | ||||||
Insurance
recoveries for replacement assets
|
- | 384 | ||||||
Asset
acquisition, net (primarily intangibles)
|
(6,692 | ) | (2,713 | ) | ||||
Net
cash used in investing activities
|
(24,954 | ) | (14,552 | ) | ||||
Cash
flows from financing activities:
|
||||||||
Payments
of indebtedness and capital lease obligations
|
(159 | ) | (418 | ) | ||||
Proceeds
from revolving line of credit
|
- | 215,213 | ||||||
Payments
on revolving line of credit
|
- | (245,848 | ) | |||||
Excess
tax charges from stock-based compensation
|
(23 | ) | (14 | ) | ||||
Proceeds
from exercise of stock options and employee stock purchase
plan
|
301 | 421 | ||||||
Cash
dividends paid
|
(3,204 | ) | (2,396 | ) | ||||
Net
cash used in financing activities
|
(3,085 | ) | (33,042 | ) | ||||
Increase
(decrease) in cash and cash equivalents
|
3,427 | (1,758 | ) | |||||
Cash
and cash equivalents:
|
||||||||
Beginning
of year
|
35,128 | 10,266 | ||||||
End
of year
|
$ | 38,555 | $ | 8,508 | ||||
Supplemental
disclosures of cash flow information:
|
||||||||
Interest
paid
|
$ | 246 | $ | 364 | ||||
Income
taxes paid
|
$ | 20,265 | $ | 1,377 | ||||
Non-cash
investing and financial activities:
|
||||||||
Assets
acquired through term loan
|
$ | - | $ | 274 | ||||
Common
stock issued for purchase of capital assets
|
$ | - | $ | - |
See
accompanying notes to condensed consolidated financial
statements.
5
FRED'S,
INC.
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE
1: BASIS OF PRESENTATION
Fred's,
Inc. and subsidiaries (“We”, “Our”, “Us” or “Company”) operates, as of October
31, 2009, 665 discount general merchandise stores, including 24 franchised
Fred's stores, in 15 states in the southeastern United States. 299 of
the stores have full service pharmacies.
The
accompanying unaudited consolidated financial statements have been prepared in
accordance with U.S. generally accepted accounting principles (“GAAP”) for
interim financial information and are presented in accordance with the
requirements of Form 10-Q and therefore do not include all information and notes
necessary for a fair presentation of financial position, results of operations
and cash flows in conformity with GAAP. The statements do reflect all
adjustments (consisting of only normal recurring accruals) which are, in the
opinion of management, necessary for a fair presentation of financial position
in conformity with GAAP. The statements should be read in conjunction
with the Notes to the Consolidated Financial Statements for the fiscal year
ended January 31, 2009 incorporated into Our Annual Report on Form
10-K.
The
results of operations for the thirteen and thirty-nine week periods ended
October 31, 2009 are not necessarily indicative of the results to be expected
for the full fiscal year.
NOTE
2: RECENT ACCOUNTING PRONOUNCEMENTS
In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of SFAS No. 162” (“FASB ASC 105”). FASB ASC 105 modifies the GAAP
hierarchy by establishing only two levels of GAAP, authoritative and
nonauthoritative accounting literature. Effective July 2009, the FASB Accounting
Standards Codification (“ASC”), also known collectively as the “Codification”,
is considered the single source of authoritative U.S. accounting and reporting
standards, except for additional authoritative rules and interpretive releases
issued by the SEC. The Codification was developed to organize GAAP
pronouncements by topic so that users can more easily access authoritative
accounting guidance. FASB ASC 105 became effective for the third quarter of
fiscal year 2009. All other accounting standards references have been updated in
this report with ASC references.
In May
2009, the FASB issued FASB ASC 855, “Subsequent Events”, which establishes
general standards of accounting for and disclosure of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. FASB ASC 855 requires issuers to reflect in
their financial statements and disclosures the effects of subsequent events that
provide additional evidence about conditions at the balance sheet date.
Disclosures should include the nature of the event and either an estimate of its
financial effect or a statement that an estimate cannot be made. This
standard also requires issuers to disclose the date through which they have
evaluated subsequent events and whether the date corresponds with the release of
their financial statements. The Company adopted FASB ASC 855 as of the
interim period ended August 1, 2009. The Company has evaluated
subsequent events through December 10, 2009, the date it filed this quarterly
report on Form 10-Q. As the requirements under FASB ASC 855 are consistent
with its current practice, the implementation of this standard did not have an
impact on the Company’s consolidated financial statements.
In June
2008, the FASB issued FASB ASC 260, which addresses whether instruments granted
in share-based payment transactions are participating securities prior to
vesting and therefore need to be included in the earnings allocation in
computing earnings per share (EPS) under the two-class method described in FASB
ASC 260, “Earnings Per Share”. This FASB ASC is effective for
fiscal periods beginning after December 15, 2008. The Company adopted
FASB ASC 260 in the quarter ended May 2, 2009 and determined that it had no
significant impact on its results of operations or financial
position.
6
In
September 2006, the FASB issued FASB ASC 820, “Fair Value Measurements and
Disclosures”. FASB ASC 820 provides a single definition of fair
value, together with a framework for measuring it, and requires additional
disclosure about the use of fair value to measure assets and
liabilities. FASB ASC 820 also emphasizes that fair value is a
market-based measurement, not an entity-specific measurement, and sets out a
fair value hierarchy with the highest priority being quoted prices in active
markets. Under FASB ASC 820, fair value measurements are required to
be disclosed by level within that hierarchy. FASB ASC 820 is
effective for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. However, FASB ASC 820-10-65-1,
issued in February 2008, delays the effective date of FASB ASC 820 for all
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis, to fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years. The Company adopted FASB ASC 820 effective
February 3, 2008, and its adoption did not have a material effect on its results
of operations or financial position. The Company has also evaluated
FASB ASC 820-10-65-1 and determined that it will have no impact on its results
of operations or financial position. In October 2008, the FASB issued
ASC 820-10-65-2, “Determining the Fair Value of a Financial Asset When the
Market for That Asset Is Not Active”. FASB ASC 820-10-65-2 clarifies the
application of FASB ASC 820 when the market for a financial asset is inactive.
The guidance in FASB ASC 820-10-65-2 is effective immediately and has no
effect on our financial statements. In April 2009, the FASB issued
ASC 820-10-65-4, “Determining Fair Value When the Level and Volume of Activity
for the Asset or Liability have Significantly Decreased and Identifying
Transactions That Are Not Orderly” which further clarifies the principles
established by FASB ASC 820. The guidance is effective for the
periods ending after June 15, 2009 with early adoption permitted for the periods
ending after March 15, 2009. The Company has evaluated FASB ASC
820-10-65-4 and determined that it will have no impact on its results of
operations or financial position.
NOTE
3: INVENTORIES
Merchandise
inventories are valued at the lower of cost or market using the retail first-in,
first-out (“FIFO”) method for goods in our stores and the cost
FIFO method for goods in our distribution centers. The retail inventory
method is a reverse mark-up, averaging method which has been widely used in the
retail industry for many years. This method calculates a cost-to-retail ratio
that is applied to the retail value of inventory to determine the cost value of
inventory and the resulting cost of goods sold and gross margin. The assumption
that the retail inventory method provides for valuation at lower of cost or
market and the inherent uncertainties therein are discussed in the following
paragraphs.
In order
to assure valuation at the lower of cost or market, the retail value of our
inventory is adjusted on a consistent basis to reflect current market
conditions. These adjustments include increases to the retail value of inventory
for initial markups to set the selling price of goods or additional markups to
adjust pricing for inflation and decreases to the retail value of inventory for
markdowns associated with promotional, seasonal or other declines in the market
value. Because these adjustments are made on a consistent basis and are based on
current prevailing market conditions, they approximate the carrying value of the
inventory at net realizable value (“market value”). Therefore, after applying
the cost to retail ratio, the cost value of our inventory is stated at the lower
of cost or market as is prescribed by GAAP.
Because
the approximation of market value under the retail inventory method is based on
estimates such as markups, markdowns and inventory losses (“shrink”), there
exists an inherent uncertainty in the final determination of inventory cost and
gross margin. In order to mitigate that uncertainty, the Company has a formal
review by product class which considers such variables as current market trends,
seasonality, weather patterns and age of merchandise to ensure that markdowns
are taken currently, or a markdown reserve is established to cover future
anticipated markdowns. This review also considers current pricing trends and
inflation to ensure that markups are taken if necessary. The estimation of
shrink is a significant element in approximating the carrying value of
inventory at net realizable value, and as such the following paragraph describes
our estimation method as well as the steps we take to mitigate the risk of this
estimate in the determination of the cost value of inventory.
The
Company calculates shrink based on actual inventory losses occurring as a
result of physical inventory counts during each fiscal period and estimated
inventory losses occurring between yearly physical inventory counts. The
estimate for shrink occurring in the interim period between physical counts is
calculated on a store-specific basis and is based on history, as well as
performance on the most recent physical count. It is calculated by multiplying
each store’s shrink rate, which is based on the previously mentioned factors, by
the interim period’s sales for each store. Additionally, the overall estimate
for shrink is adjusted at the corporate level to a three-year historical average
to ensure that the overall shrink estimate is the most accurate approximation of
shrink based on the Company’s overall history of shrink. The three-year
historical estimate is calculated by dividing the “book to physical” inventory
adjustments for the trailing 36 months by the related sales for the same
period. In order to reduce the uncertainty inherent in the shrink calculation,
the Company first performs the calculation at the lowest practical level (by
store) using the most current performance indicators. This ensures a more
reliable number, as opposed to using a higher level aggregation or percentage
method. The second portion of the calculation ensures that the extreme negative
or positive performance of any particular store or group of stores does not skew
the overall estimation of shrink. This portion of the calculation removes
additional uncertainty by eliminating short-term peaks and valleys that could
otherwise cause the underlying carrying cost of inventory to fluctuate
unnecessarily. The Company has not experienced any significant change in shrink
as a percentage of sales from year to year during the subject reporting
periods.
7
Management
believes that the Company’s Retail Inventory Method provides an inventory
valuation which reasonably approximates cost and results in carrying inventory
at the lower of cost or market. For pharmacy inventories, which were
approximately $29.1 million, and $30.8 million at October 31, 2009 and
January 31, 2009 respectively, cost was determined using the retail last-in,
first-out (“LIFO”) method in which inventory cost is maintained using the Retail
Inventory Method, then adjusted by application of the Producer Price Index
published by the U.S. Department of Labor for the cumulative annual
periods. The current cost of inventories exceeded the LIFO cost by
approximately $20.6 million at October 31, 2009 and $19.1 million at
January 31, 2009.
The
Company has historically included an estimate of inbound freight and certain
general and administrative costs in merchandise inventory as prescribed by GAAP.
These costs include activities surrounding the procurement and storage of
merchandise inventory such as merchandise planning and buying, warehousing, and
various administrative functions related to those activities such as accounting,
information technology and human resources. The total amount of procurement and
storage costs and inbound freight included in merchandise inventory at October
31, 2009 is $20.4 million, with the corresponding amount of
$19.0 million at January 31, 2009.
NOTE
4: STOCK-BASED COMPENSATION
The
Company accounts for its stock-based compensation plans in accordance with FASB
ASC 718 “Compensation – Stock Compensation”. Under FASB ASC 718,
stock-based compensation expense is based on awards ultimately expected to vest,
and therefore has been reduced for estimated forfeitures. Forfeitures are
estimated at the time of grant based on the Company’s historical forfeiture
experience and will be revised in subsequent periods if actual forfeitures
differ from those estimates.
FASB ASC
718 also requires the benefits of income tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow as required prior to FASB ASC 718.
A summary
of the Company’s stock-based compensation (a component of selling and general
and administrative expenses) and related income tax benefit is as follows (in thousands):
Thirteen Weeks Ended
|
Thirty-nine Weeks Ended
|
|||||||||||||||
October 31,
2009
|
November 1,
2008
|
October 31,
2009
|
November 1,
2008
|
|||||||||||||
Stock
option expense
|
$ | 235 | $ | (85 | ) | $ | 775 | $ | 564 | |||||||
Restricted
stock expense
|
133 | 197 | 482 | 552 | ||||||||||||
ESPP
expense
|
53 | 44 | 160 | 133 | ||||||||||||
Total
stock-based compensation
|
$ | 421 | $ | 156 | $ | 1,417 | $ | 1,249 | ||||||||
Income
tax benefit on stock-based compensation
|
$ | 83 | $ | 79 | $ | 298 | $ | 305 |
8
The fair
value of each option granted during the thirteen and thrirty-nine week periods
ended October 31, 2009 and November 1, 2008, respectively, are estimated on the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Thirteen Weeks Ended
|
Thirty-nine Weeks Ended
|
|||||||||||||||
October 31,
2009
|
November 1,
2008
|
October 31,
2009
|
November 1,
2008 |
|||||||||||||
Stock Options
|
||||||||||||||||
Expected
volatility
|
41.8 | % | 39.0 | % | 42.6 | % | 40.2 | % | ||||||||
Risk-free
interest rate
|
2.7 | % | 3.4 | % | 2.6 | % | 3.4 | % | ||||||||
Expected
option life (in years)
|
5.84 | 5.84 | 5.84 | 5.84 | ||||||||||||
Expected
dividend yield
|
0.55 | % | 0.50 | % | 0.55 | % | 0.45 | % | ||||||||
Weighted
average fair value at grant date
|
$ | 5.11 | $ | 5.87 | $ | 4.63 | $ | 4.66 | ||||||||
Employee Stock Purchase
Plan
|
||||||||||||||||
Expected
volatility
|
64.9 | % 1 | 33.5 | % | 77.6 | % 1 | 37.4 | % | ||||||||
Risk-free
interest rate
|
0.1 | % | 3.1 | % | 0.1 | % | 3.1 | % | ||||||||
Expected
option life (in years)
|
0.75 | 0.75 | 0.5 | 0.5 | ||||||||||||
Expected
dividend yield
|
0.51 | % | 0.51 | % | 0.34 | % | 0.34 | % | ||||||||
Weighted
average fair value at grant date
|
$ | 3.94 | $ | 2.54 | $ | 3.77 | $ | 2.39 |
The
following is a summary of the methodology applied to develop each
assumption:
Expected Volatility -
This is a measure of the amount by which a price has fluctuated or is expected
to fluctuate. The Company uses actual historical changes in the market value of
our stock to calculate expected price volatility because management believes
that this is the best indicator of future volatility. The Company calculates
weekly market value changes from the date of grant over a past period
representative of the expected life of the options to determine volatility. An
increase in the expected volatility will increase compensation
expense.
Risk-free Interest
Rate - This is the yield of a U.S. Treasury zero-coupon bond issue
effective at the grant date with a remaining term equal to the expected life of
the option. An increase in the risk-free interest rate will increase
compensation expense.
Expected Lives - This
is the period of time over which the options granted are expected to remain
outstanding and is based on historical experience. Options granted have a
maximum term of seven and one-half years. An increase in the expected life will
increase compensation expense.
Dividend Yield – This
is based on the historical yield for a period equivalent to the expected life of
the option. An increase in the dividend yield will decrease
compensation expense.
Forfeiture Rate -
This is the estimated percentage of options granted that are expected to be
forfeited or cancelled before becoming fully vested. This estimate is based on
historical experience. An increase in the forfeiture rate will decrease
compensation expense.
9
Employee
Stock Purchase Plan
The 2004
Employee Stock Purchase Plan (the “2004 Plan”), which was approved by Fred’s
stockholders, permits eligible employees to purchase shares of our common stock
through payroll deductions at the lower of 85% of the fair market value of the
stock at the time of grant or 85% of the fair market value at the time of
exercise. There were 43,576 shares issued during the thirty-nine
weeks ended October 31, 2009. There are 1,410,928 shares approved to
be issued under the 2004 Plan and as of October 31, 2009, there were 1,107,287
shares available.
Stock
Options
The
following table summarizes stock option activity during the
thirty-nine weeks ended October 31, 2009:
Options
|
Weighted
Average
Exercise Price
|
Weighted Average
Remaining
Contractual Life
(Years)
|
Aggregate
Intrinsic
Value
(Thousands)
|
|||||||||||||
Outstanding
at January 31, 2009
|
1,138,111 | $ | 15.13 | 3.9 | $ | 11 | ||||||||||
Granted
|
361,891 | $ | 11.20 | |||||||||||||
Forfeited
/ Cancelled
|
(102,853 | ) | $ | 18.90 | ||||||||||||
Exercised
|
(600 | ) | $ | 13.25 | ||||||||||||
Outstanding
at October 31, 2009
|
1,396,549 | $ | 13.84 | 3.6 | $ | 699 | ||||||||||
Exercisable
at October 31, 2009
|
784,442 | $ | 15.60 | 2.1 | $ | 163 |
The
aggregate intrinsic value in the table above represents the total pre-tax
intrinsic value (the difference between Fred’s closing stock price of $11.84 on
the last trading day of the period ended October 31, 2009 and the exercise price
of the option multiplied by the number of in-the-money options) that would have
been received by the option holders had all option holders exercised their
options on that date. As of October 31, 2009, total unrecognized
stock-based compensation expense net of estimated forfeitures related to
non-vested stock options was approximately $1.4 million, which is expected to be
recognized over a weighted average period of approximately 4.0
years. The total fair value of options vested during the thirty-nine
weeks ended October 31, 2009 was $1.1 million.
Restricted
Stock
The
following table summarizes restricted stock activity during the
thirty-nine weeks ended October 31, 2009:
Number of Shares
|
Weighted Average
Grant Date Fair
Value
|
|||||||
Non-vested
Restricted Stock at January 31, 2009
|
352,784 | $ | 12.39 | |||||
Granted
|
52,843 | $ | 12.62 | |||||
Forfeited
/ Cancelled
|
(29,071 | ) | $ | 13.99 | ||||
Vested
|
(23,530 | ) | $ | 15.11 | ||||
Non-vested
Restricted Stock at October 31, 2009
|
353,026 | $ | 12.12 |
The
aggregate pre-tax intrinsic value of restricted stock outstanding as of October
31, 2009 is $4.2 million with a weighted average remaining contractual life of
5.7 years. The unrecognized compensation expense net of estimated
forfeitures, related to the outstanding stock is approximately $2.5 million,
which is expected to be recognized over a weighted average period of
approximately 5.3 years. The total fair value of restricted stock
awards that vested during the thirty-nine weeks ended October 31, 2009 was
$355.8 thousand.
10
NOTE
5: PROPERTY AND EQUIPMENT
Property
and Equipment are carried at cost. Depreciation is recorded using the
straight-line method over the estimated useful lives of the
assets. Improvements to leased premises are amortized using the
straight-line method over the shorter of the initial term of the lease or the
useful life of the improvement. Leasehold improvements added late in
the lease term are amortized over the shorter of the remaining term of the lease
(including the upcoming renewal option, if the renewal is reasonably assured) or
the useful life of the improvement. Assets under capital leases are
amortized in accordance with the Company’s normal depreciation policy for owned
assets or over the lease term (regardless of renewal options), if shorter, and
the charge to earnings is included in depreciation expense in the consolidated
financial statements. Gains or losses on the sale of assets are
recorded as a component of operating income.
The
following illustrates the breakdown of the major categories within Property and
Equipment:
October 31, 2009
|
January 31,
|
|||||||
(unaudited)
|
2009
|
|||||||
Property
and equipment, at cost:
|
||||||||
Buildings
and building improvements
|
$ | 94,752 | $ | 91,826 | ||||
Leasehold
improvements
|
54,204 | 49,775 | ||||||
Automobiles
and vehicles
|
5,543 | 5,223 | ||||||
Airplane
|
4,697 | 4,697 | ||||||
Furniture,
fixtures and equipment
|
238,942 | 230,272 | ||||||
398,138 | 381,793 | |||||||
Less:
Accumulated depreciation and amortization
|
(265,719 | ) | (251,002 | ) | ||||
132,419 | 130,791 | |||||||
Construction
in progress
|
295 | 912 | ||||||
Land
|
6,533 | 6,333 | ||||||
Total
Property and equipment, at depreciated cost
|
$ | 139,247 | $ | 138,036 |
NOTE
6: EXIT AND DISPOSAL ACTIVITIES
Store
closures that are deemed exit and disposal related, will be accounted for in
accordance with FASB ASC 420, “Exit or Disposal Cost Obligations” as
follows. None of the 9 store closures in 2009 were exit and disposal
related.
Inventory Impairment
The
Company will record a below-cost inventory adjustment to reduce the value of
inventory to the lower of cost or market in stores that are planned for
closure. The adjustment would be recorded in cost of goods sold in
the Condensed Consolidated Statement of Income. There is no
outstanding inventory impairment for exit and disposal related
activity.
Fixed Asset
Impairment
For
planned store closures, the Company will record a fixed asset impairment charge
for assets identified for disposal. There is no outstanding fixed
asset impairment for exit and disposal related activity.
11
Lease
Termination
For store
closures where a lease obligation still exists, we record the estimated future
liability associated with the rental obligation on the cease use date (when the
store is closed). Liabilities are established at the cease use date
for the present value of any remaining operating lease obligations, net of
estimated sublease income, and at the communication date for severance and other
exit costs, as prescribed by FASB ASC 420. Key assumptions in calculating the
liability include the timeframe expected to terminate lease agreements,
estimates related to the sublease potential of closed locations, and estimation
of other related exit costs. If actual timing and potential termination costs or
realization of sublease income differ from our estimates, the resulting
liabilities could vary from recorded amounts. These liabilities are reviewed
periodically and adjusted when necessary.
During
the first three quarters of fiscal 2009, we incurred an additional $0.1 million
in rent expense related to the revision in the estimate of buyout amounts and
the extension of the timeframe expected to terminate the remaining lease
agreements of the fiscal 2008 store closures. We also utilized $2.1
million, leaving $1.5 million in the reserve at October 31, 2009.
The
following table illustrates the exit and disposal activity related to the store
closures discussed in the previous paragraphs (in millions):
Balance at
January 31,
2009
|
Additions
FY09
|
Utilized
FY09
|
Balance at
October 31,
2009
|
|||||||||||||
Lease
contract termination liability
|
3.5 | 0.1 | 2.1 | 1.5 | ||||||||||||
$ | 3.5 | $ | 0.1 | $ | 2.1 | $ | 1.5 |
NOTE
7: ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive
income consists of two components, net income and other comprehensive income
(loss). Other comprehensive income (loss) refers to gains and losses
that under GAAP are recorded as an element of shareholders’ equity but are
excluded from net income. The Company’s accumulated other
comprehensive income includes the unrecognized prior service costs, transition
obligations and actuarial gains/losses associated with our postretirement
benefit plan.
The
following table illustrates the activity in accumulated other comprehensive
income:
Thirty-nine Weeks Ended
|
Year Ended
|
|||||||||||
(in thousands)
|
October 31,
2009
|
November 1,
2008
|
January 31,
2009
|
|||||||||
Accumulated
other comprehensive income
|
$ | 1,063 | $ | 1,040 | $ | 1,040 | ||||||
Amortization
of postretirement benefit
|
- | (32 | ) | 23 | ||||||||
Ending
balance
|
$ | 1,063 | $ | 1,008 | $ | 1,063 |
12
NOTE 8:
RELATED PARTY TRANSACTIONS
Atlantic
Retail Investors, LLC, which is partially owned by Michael J. Hayes, a director
of the Company, owns the land and buildings occupied by twelve FRED’S
stores. The terms and conditions regarding the leases on these
locations are consistent in all material respects with other stores leases of
the Company. The total rental payments related to these leases were
$299.4 thousand and $974.4 thousand for the thirteen and thirty-nine week
periods ended October 31, 2009.
13
Item
2:
Management's
Discussion and Analysis of Financial
Condition and Results of
Operations
GENERAL
Executive
Overview
Recognizing
our pharmacy department as a key differentiating factor to other small-box
discount retailers, we have accelerated our growth strategy in this area and are
aggressively pursuing opportunities to acquire independent pharmacies within our
targeted markets. Our emphasis will continue to be on
acquisitions and prescription file buys, but cold starts will be employed where
it makes sense to do so. As we mentioned previously, we began
offering our Prescription Plus $4 generic program to all pharmacies in the
chain. We piloted this program on a limited basis last year and found
it to be a traffic driver, and thus rolled it out to all pharmacies in the first
quarter. We are pleased with this deployment and its effect on our
prescription count.
Our Own
Brand initiative continues to be a key strategy for the Company in terms of
building customer loyalty and increasing gross margin. We have
reached an Own Brand penetration rate of approximately 16% of total consumable
sales, and that number will continue to grow throughout the remainder of the
year as new Own Brand products are introduced. Our commitment to
quality in our Own Brand products is resonating with our customers and they
continue to make the switch to our “Fred’s Brand”. We are continuing
to add new products to our Own Brand line on an ongoing basis, with new items in
chemicals and food introduced in the second quarter of 2009.
Expense
reduction and containment continues to be a key focus of the Company, especially
in light of current economic conditions. We are aggressively pursuing
cost reductions in all functional areas and are also continuously reviewing
internal processes to find efficiencies and/or redundancies and drive
unnecessary costs and expenses out of the business. These efforts are
being coordinated at the Executive Level and close attention is being paid not
to sacrifice service to our customers. These efforts resulted in a 80
basis point reduction in expenses as a percentage of sales on a year to date
basis in 2009 compared to the same period last year.
Improving
inventory productivity has been a key focus throughout FY 2009.
Initiatives set in motion in FY 2008, such as reducing the store fixture profile
to remove inventory displayed above eye level, improvement in seasonal buying to
reduce pack away inventory and continuous improvement in the line review
process, have resulted in a 7.7% reduction in total company inventory from
the same period last year. This reduction in inventory was
accomplished without jeopardizing our in-stock positions or the merchandise
selection available to our customers.
Also in
the third quarter, we continued refining our real estate site selection and
store layout programs. We continue to improve the interior layout of
our stores so that our customers experience more open customer spaces, more
logical product flow and a more consistent and meaningful price message, all of
which are intended to provide a more pleasurable shopping trip. We
also continue to hone our real estate strategy so that the proper site is
selected to support our targeted demographics, thus driving traffic and
sales. Many of these efforts culminated in the third quarter with the
grand opening of our “Pilot Store of the Future”.
Throughout
2009, we have continued with capital improvements in infrastructure, including
new stores as well as existing store expansion and remodels, distribution center
upgrades and further development of our information technology
capabilities. Technology upgrades have been made in the areas of
direct store delivery systems, in-store systems, and pharmacy
systems.
As
previously reported, the Company expects total earnings per diluted share for
2009 to be in the range of $0.62 to $0.69. These earnings projections
include the following significant events affecting the balance of the
year:
|
·
|
The
third year incremental raising of the federal minimum wage which will
negatively impact our labor expense by approximately $2.3 million,
effective July 24, 2009.
|
|
·
|
The
continued product mix shift to basic and consumable items, coupled with
intense pharmacy competition, will continue to negatively affect gross
margin.
|
|
·
|
The
positive margin impact of our Own Brand initiatives as mentioned in
previous paragraphs.
|
14
Key
factors that will be critical to the Company’s future success include managing
the strategy for opening new stores and pharmacies, including the ability to
open and operate efficiently, maintaining high standards of customer service,
maximizing efficiencies in the supply chain, controlling working capital needs
through improved inventory turnover, managing the effects of inflation or
deflation, controlling product mix, increasing operating margin through improved
gross margin and leveraging operating costs, and generating adequate cash flow
to fund the Company’s future needs.
Other
factors that will affect Company performance in 2009 include the continuing
management of the impacts of the changing regulatory environment in which our
pharmacy department operates. Additionally, we believe that the
prolonged recession and elevated unemployment rate continue to place tremendous
economic pressure on the consumer. However, we also continue to
believe that our affordable pricing and value proposition make us an attractive
destination to wary consumers.
CRITICAL
ACCOUNTING POLICIES AND ESTIMATES
The
Company’s discussion and analysis of its financial condition and results of
operations are based upon the Company’s condensed financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The critical accounting matters that are particularly
important to the portrayal of the Company’s financial condition and results of
operations and require some of management’s most difficult, subjective and
complex judgments are described in detail in the Company’s Annual Report on
Form 10-K for the fiscal year ended January 31, 2009. The preparation of
condensed financial statements requires the Company to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses, and related disclosure of contingent assets and liabilities. On an
ongoing basis, the Company evaluates its estimates, including those related to
inventories, income taxes, insurance reserves, contingencies and litigation. The
Company bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
RESULTS
OF OPERATIONS
THIRTEEN WEEKS ENDED OCTOBER
31, 2009 AND NOVEMBER 1, 2008
Sales
Net sales
for the third quarter of 2009 increased to $422.4 million from $418.0 million in
2008, a quarter-over-quarter increase of $4.4 million or 1.1%. Sales
in the quarter were adversely affected by layaway sales of $3.6 million, a
significant increase over the $.6 million of layaway sales in the third quarter
of 2008, which were deferred until the merchandise is picked up in the fourth
quarter. Excluding sales from stores closed in 2008 ($2.7 million),
total sales were up $7.1 million or 1.7% over the third quarter last
year. On a comparable store basis, sales in the third quarter
increased 1.0% ($3.9 million) compared with a 1.4% ($3.2 million) increase in
the same period last year.
The
Company’s 2009 front store (non-pharmacy) sales decreased 1.7% over 2008 front
store sales. Excluding the front store sales from stores closed in
2008 ($2.7 million), sales decreased .7% over the third quarter last
year. Although front store sales growth declined in the quarter in
categories such as candy, prepaid products, hardware and health and beauty aids,
we did experience sales increases in the more discretionary categories such as
tobacco, greeting cards and electronics.
The
Company’s pharmacy sales were 35.6% of total sales in the third quarter of 2009
compared to 33.7% of total sales in the same quarter last year and continue to
rank as the largest sales category within the Company. The total sales in this
department, including the Company’s mail order operation which we closed during
the first quarter of 2009, increased 6.6% over 2008, with third party
prescription sales representing approximately 93% of total pharmacy sales, the
same as in the prior year. The Company’s pharmacy department continues to
benefit from an ongoing program of purchasing prescription files from
independent pharmacies as well as the addition of pharmacy departments in
existing store locations.
Sales to
FRED’S 24 franchised locations during the third quarter of 2009 decreased to
$9.9 million (2.5% of sales) from $10.2 million (2.4% of sales) in
2008. The decrease in quarter over quarter franchise sales resulted
from the ongoing economic challenges impacting our customers’ disposable
income. The Company does not intend to expand its franchise network
in the future.
15
The sales
mix for the period, unadjusted for deferred layaway sales, was 35.1%
Pharmaceuticals, 20.8% Household Goods, 16.5% Food and Tobacco, 9.8% Paper and
Cleaning Supplies, 7.4% Apparel and Linens, 7.9% Health and Beauty Aids, and
2.5% Franchise. The sales mix for the same period last year was 33.7%
Pharmaceuticals, 21.7% Household Goods, 16.4% Food and Tobacco, 9.9% Paper and
Cleaning Supplies, 7.7% Apparel and Linens, 8.2% Health and Beauty Aids, and
2.4% Franchise.
For the
quarter, comparable store customer traffic decreased 1.4% over the same quarter
last year while the average customer ticket increased 2.4% to
$18.95.
Gross
Profit
Gross
profit for the third quarter of 2009 decreased to $122.9 million from $124.2
million in 2008, a quarter-over-quarter decline of $1.3 million or
1.1%. Gross margin, measured as a percentage of sales, declined to
29.1% from 29.7% in the same quarter last year. Gross margin was unfavorably
impacted by continued competitive pressures, higher promotional markdowns, an
unfavorable shift in the product mix toward lower margin basic and consumable
products while being favorably impacted by an increase in vendor dollar
consideration. Also, the markdowns recognized in the closing of 9
underperforming stores in the quarter had an unfavorable impact on gross
margin. This impact was partially offset by higher general
merchandise department markup and improved shrink experience.
Selling, General and Administrative
Expenses
Selling,
general and administrative expenses, including depreciation and amortization,
increased to $115.2 million in 2009 (27.3% of sales) from $114.8 million in 2008
(27.5% of sales).
Operating Income
Operating
income decreased to $7.7 million in the third quarter of 2009 (1.8% of sales)
from $9.4 million in 2008 (2.2% of sales) due primarily to a decrease in gross
profit of $1.3 million (1.1% of sales), as described in the Gross Profit section
above, as well as the increase in selling, general and administrative expenses
of $.4 million.
Interest
Expense
The
Company incurred net interest expense of $0.1 million in the third quarter of
2009 and 2008.
Income
Taxes
For the
third quarter of 2009, the effective income tax rate was 33.8%, as compared to
34.8% in the third quarter of 2008. The decrease in the effective tax rate
was primarily due to increased benefits from employment related federal tax
credits.
Net Income
As a
result of the fluctuations described in the preceding sections, net income
decreased 17.4% to $5.0 million (or $.13 per diluted share) in the third quarter
of 2009 from $6.1 million (or $.15 per diluted share) during the same period
last year. While net sales increased by $4.4 million, the reduction
in gross margin of $1.3 million and the increase in selling, general and
administrative expenses of $.4 million over the same period last year, more than
offset this favorability.
THIRTY-NINE WEEKS ENDED
OCTOBER 31, 2009 AND NOVEMBER 1, 2008
Sales
Net sales
decreased to $1,315.0 million in 2009 from $1,329.5 million in 2008, a
year-over-year decline of $14.4 million or 1.1%, reflecting the Company’s store
closing program coupled with the ongoing economic challenges impacting our
customers’ disposable income. Excluding sales from stores closed in
2008 ($40.3 million), total sales increased 2.0% ($25.9 million) over last
year. This increase was attributable to an increase in comparable
store sales of .8% ($10.4 million) and increase in non-comparable store sales of
1.2% ($15.5 million).
The
Company’s 2009 front store (non-pharmacy) sales decreased 3.8% over 2008 front
store sales. Excluding the front store sales from stores closed in
2008 ($40.3 million), sales increased .9% over last year. Although
front store sales growth declined in the first three quarters in the more
discretionary categories such as home furnishings, health and beauty aids,
housewares and footwear, we did experience sales increases in consumable
categories such as tobacco, food and pets as well as in greeting
cards.
The
Company’s pharmacy sales were 33.8% of total sales in the first three quarters
of 2009 compared to 32.0% of total sales in the same period last year and
continue to rank as the largest sales category within the Company. The total
sales in this department, including the Company’s mail order operation, which we
closed during the first quarter of 2009, increased 4.6% over 2008, with third
party prescription sales representing approximately 93% of total pharmacy sales,
the same as in the prior year. The Company’s pharmacy department continues to
benefit from an ongoing program of purchasing prescription files from
independent pharmacies as well as the addition of pharmacy departments in
existing store locations.
16
Sales to
FRED’S 24 franchised locations during the first three quarters of 2009 decreased
to $29.4 million (2.3% of sales) from $30.2 million (2.3% of sales) in
2008. The decrease in year-over-year franchise sales were a result of
the ongoing economic challenges impacting our customers’ disposable
income.
The sales
mix for the period, unadjusted for deferred layaway sales, was 33.7%
Pharmaceuticals, 22.7% Household Goods, 16.4% Food and Tobacco, 9.5% Paper and
Cleaning Supplies, 7.7% Apparel and Linens, 7.7% Health and Beauty Aids, and
2.3% Franchise. The sales mix for the same period last year was 32.0%
Pharmaceuticals, 23.9% Household Goods, 15.7% Food and Tobacco, 8.6% Apparel and
Linens, 9.4% Paper and Cleaning Supplies, 8.1% Health and Beauty Aids, and 2.3%
Franchise.
For the
year, comparable store customer traffic was flat over the same period last year
while the average customer ticket increased 0.8% to $19.02.
Gross
Profit
Gross
profit for the first three quarters of 2009 decreased to $372.6 million from
$380.5 million in 2008, a year-over-year decline of $7.9 million or
2.1%. Gross margin, measured as a percentage of sales, declined to
28.3% from 28.6% last year. Gross margin was unfavorably impacted by
continued competitive pressures, higher promotional markdowns, an unfavorable
shift in the product mix toward lower margin basic and consumable products while
being favorably impacted by an increase in vendor dollar
consideration.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses, including depreciation and amortization,
decreased to $343.1 million in 2009 (26.1% of sales) from $357.4 million in 2008
(26.9% of sales). This 80 basis point expense leverage resulted
primarily from the effect of our store closures in fiscal 2008 ($8.9 million),
lowering distribution costs ($3.6 million) and managing costs in our stores by
reducing utility expense ($2.0 million) with the installation of Energy
Management Systems.
Operating
Income
Operating
income increased 27.8% to $29.5 million in the first three quarters of 2009
(2.2% of sales) from $23.1 million in 2008 (1.7% of sales) due primarily to a
reduction in selling, general and administrative expenses as the Company did not
incur expenses related to store closures in the first three quarters of this
year as well as continued focus on managing costs in our stores and distribution
centers, as described in the Selling, General and Administrative Expenses
section above. This favorability in expenses was partially offset by
a decrease in gross profit of $7.9 million, a year-over-year decline of 2.1%, as
described in the Gross Profit section above.
Interest
Expense
The
Company incurred net interest expense of $0.2 million and $0.3 million in the
first three quarters of 2009 and 2008, respectively.
Income
Taxes
For the
first three quarters of 2009, the effective income tax rate was 39.1%, as
compared to 36.9% for the same period last year. The increase in the
effective tax rate was primarily due to the final assessment and settlement in
the second quarter of the Internal Revenue Service exam for tax years 2004 –
2007. We anticipate the tax rate for the last quarter of the year to be in
the range of 35% to 37%.
Net
Income
As a
result of the fluctuations described in the preceding sections, net income
increased 24.0% to $17.9 million (or $.45 per diluted share) in the first three
quarters of 2009 from $14.4 million (or $.36 per diluted share) during the same
period last year. While net sales decreased by $14.4 million and
gross profit decreased $7.9 million over the same period last year, the
improvement in selling, general and administrative expenses as a percent of
sales $14.3 million more than offset this unfavorability.
17
LIQUIDITY
AND CAPITAL RESOURCES
Due to
the seasonality of our business and the continued increase in the number of
stores and pharmacies, inventories are generally lower at year-end than at each
quarter-end of the following year.
Cash
provided by operating activities totaled $31.5 million during the thirty-nine
week period ended October 31, 2009 compared to $45.9 million in the same period
of the prior year. While cash was used for the purchase of
inventories, we generated operating cash flow through quarterly income and from
our ongoing initiative to better manage our Accounts Payable
processes.
Cash used
in investing activities totaled $25.0 million, and consisted primarily of
expenditures related to existing stores ($12.6 million), pharmacy acquisitions
($6.7 million), capital expenditures associated with the store and pharmacy
expansion program ($2.2 million) and technology and other corporate expenditures
($3.6 million). During the first nine months of 2009, we opened 11
stores and 18 pharmacies and closed 9 stores and 3 pharmacies. In 2009, the
Company is planning capital expenditures totaling approximately $21.4
million. Expenditures are planned totaling approximately $13.5
million for upgrades, remodels, or new stores and pharmacies; $3.9 million for
technology upgrades $2.4 million for distribution center equipment and capital
replacements and $1.6 million for other corporate expenditures. In
addition, the Company also plans expenditures of $5.0 million for the
acquisition of customer lists and other pharmacy related items. Depreciation
expense for 2009 will be approximately $26.0 million.
Cash used
by financing activities totaled $3.1 million and included $3.2 million for the
payment of cash dividends and was offset by $0.3 million in proceeds from the
exercise of stock options and employee stock purchase plan. There
were $5.0 million in borrowings outstanding at October 31, 2009 related to real
estate mortgages compared to $5.1 million at January 31, 2009.
We
believe that sufficient capital resources are available in both the short-term
and long-term through currently available cash and cash generated from future
operations and, if necessary, the ability to obtain additional
financing.
FORWARD-LOOKING
STATEMENTS
Other
than statements based on historical facts, many of the matters discussed in this
Form 10-Q relate to events which we expect or anticipate may occur in the
future. Such statements are defined as “forward-looking statements”
under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”),
15 U.S.C. Sections 77z-2 and 78u-5. The Reform Act created a safe
harbor to protect companies from securities law liability in connection with
forward-looking statements. We intend to qualify both our written and
oral forward-looking statements for protection under the Reform Act and any
other similar safe harbor provisions.
The words
“believe”, “anticipate”, “project”, “plan”, “expect”, “estimate”, “objective”,
“forecast”, “goal”, “intend”, “will likely result”, or “will continue” and
similar expressions generally identify forward-looking
statements. All forward-looking statements are inherently uncertain,
and concern matters that involve risks and other factors that may cause the
actual performance of the Company to differ materially from the performance
expressed or implied by these statements. Therefore, forward-looking
statements should be evaluated in the context of these uncertainties and risks,
including but not limited to:
|
·
|
Economic
and weather conditions which affect buying patterns of our customers and
supply chain efficiency.
|
|
·
|
Changes
in consumer spending and our ability to anticipate buying patterns and
implement appropriate inventory
strategies.
|
|
·
|
Continued
availability of capital and
financing.
|
|
·
|
Competitive
factors.
|
|
·
|
Changes
in reimbursement practices for
pharmaceuticals.
|
|
·
|
Governmental
regulation.
|
|
·
|
Increases
in fuel and utility rates.
|
|
·
|
Potential
adverse results in the Fair Labor Standards Act (“FSLA”) litigation
described under Legal Proceedings on page
20.
|
|
·
|
Other
factors affecting business beyond our control, including (but not limited
to) those discussed under Part 1, ITEM 1A “Risk Factors” of the Company’s
Annual Report on Form 10-K for the fiscal year ended January 31,
2009.
|
Consequently,
all forward-looking statements are qualified by this cautionary
statement. Readers should not place undue reliance on any
forward-looking statements. We undertake no obligation to update any
forward-looking statement to reflect events or circumstances arising after the
date on which it was made.
18
Item
3.
QUANTITATIVE
AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We have
no holdings of derivative financial or commodity instruments as of October 31,
2009. We are exposed to financial market risks, including changes in
interest rates. All borrowings under our 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
our income. All of our business is transacted in U.S. dollars and,
accordingly, foreign exchange rate fluctuations have not had a significant
impact on us, and they are not expected to in the foreseeable
future.
Item
4.
CONTROLS
AND PROCEDURES
(a) Conclusion Regarding the
Effectiveness of Disclosure Controls and Procedures. As of the end of the period
covered by this report, the Company carried out an evaluation, under the
supervision and with the participation of our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the Company’s disclosure controls and
procedures (as defined in Rules 13a-15(e) under the Securities and Exchange Act
of 1934, as amended (the “Exchange Act”)). Based on that evaluation,
the Chief Executive Officer and the Chief Financial Officer concluded that the
Company’s disclosure controls and procedures are effective to ensure that
information required to be disclosed by the issuer in the reports that it files
or submits under the Act (15 U.S.C. 78 et seq.) is recorded, processed,
summarized and reported, within the time periods specified in the Commission’s
rules and forms. Additionally, they concluded that our disclosure
controls and procedures are designed to ensure that information required to be
disclosed by the Company in the reports that the Company is required to file or
submit under the Exchange Act is accumulated and communicated to management,
including the Chief Executive Officer and the Chief Financial Officer, as
appropriate to allow timely decisions regarding required
disclosures.
(b) Changes in Internal Control
over Financial Reporting. There have been no changes during the quarter
ended October 31, 2009 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
II. OTHER INFORMATION
Item
1. Legal Proceedings
In July
2008, a lawsuit styled Jessica Chapman, on behalf of herself and others
similarly situated, v. FRED’S Stores of Tennessee, Inc. was filed in the United
States District Court for the Northern District of Alabama, Southern Division,
in which the plaintiff alleges that she and other female assistant store
managers are paid less than comparable males and seeks compensable damages,
liquidated damages, attorney fees and court costs. The plaintiff
filed a motion seeking collective action. Briefs have been filed and
oral arguments have been conducted, but the court has not yet
ruled. The Company believes that all assistant managers have been
properly paid and that the matter is not appropriate for collective action
treatment. Discovery has not yet begun. The Company is and
will continue to vigorously defend this matter. In accordance with
FASB ASC 450, “Contingencies”, the Company does not feel that a loss in this
matter is probable or reasonably estimated. Therefore, we have not
recorded a liability for this case.
In
addition to the matters disclosed above, the Company is party to several pending
legal proceedings and claims arising in the normal course of
business. Although the outcome of the proceedings and claims cannot
be determined with certainty, management of the Company is of the opinion that
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 energy 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
1A. Risk Factors
The risk
factors listed in Part I, “Item 1A. Risk Factors” in the Annual Report on Form
10-K for the fiscal year ended January 31, 2009, should be considered with the
information provided elsewhere in this Quarterly Report on Form 10-Q, which
could materially adversely affect the business, financial condition or results
of operations. There have been no material changes to the risk factors as
previously disclosed in such Annual Report on Form 10-K.
19
Item
6. Exhibits
Exhibits:
|
31.1
|
Certification
of Chief Executive Officer.
|
|
31.2
|
Certification
of Chief Financial Officer.
|
|
32
|
Certification
of Chief Executive Officer and Chief Financial Officer pursuant to rule
13a–14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section
1350.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
FRED'S,
INC.
|
|
Date: December 10, 2009
|
/s/ Bruce A. Efird
|
Bruce
A. Efird
|
|
Chief
Executive Officer and President
|
|
Date: December 10, 2009
|
/s/ Jerry A. Shore
|
Jerry
A. Shore
|
|
Chief
Financial
Officer
|
20