Attached files
file | filename |
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EX-32 - FREDS INC | v196256_ex32.htm |
EX-31.2 - FREDS INC | v196256_ex31-2.htm |
EX-31.1 - FREDS INC | v196256_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 July 31, 2010.
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 39,214,341 shares of Class A voting, no
par value common stock outstanding as of September
8, 2010.
FRED'S,
INC.
INDEX
Page No.
|
||
Part I - Financial
Information
|
||
Item
1 - Financial Statements:
|
||
Condensed
Consolidated Balance Sheets as of July 31, 2010 (unaudited) and January
30, 2010
|
3
|
|
Condensed
Consolidated Statements of Income for the Thirteen and Twenty-Six Weeks
Ended July 31, 2010 (unaudited) and August 1, 2009
(unaudited)
|
4
|
|
Condensed
Consolidated Statements of Cash Flows for the Twenty-Six Weeks
Ended July 31, 2010 (unaudited) and August 1, 2009
(unaudited)
|
5
|
|
Notes
to Condensed Consolidated Financial Statements (unaudited)
|
6-11
|
|
Item
2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
|
12-16
|
|
Item
3 – Quantitative and Qualitative Disclosure about Market
Risk
|
17
|
|
Item
4 – Controls and Procedures
|
17
|
|
Part II - Other Information
|
17-18
|
|
Item
1. Legal Proceedings
|
||
Item
1A. Risk Factors
|
||
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
||
Item
6. Exhibits
|
||
Signatures
|
19-22
|
|
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)
July 31, 2010
|
January 30,
|
|||||||
(unaudited)
|
2010
|
|||||||
ASSETS
|
||||||||
Current
assets:
|
||||||||
Cash
and cash equivalents
|
$ | 46,872 | $ | 54,742 | ||||
Receivables,
less allowance for doubtful accounts of $976 and $764,
respectively
|
28,758 | 28,893 | ||||||
Inventories
|
314,802 | 294,024 | ||||||
Other
non-trade receivables
|
22,237 | 25,193 | ||||||
Prepaid
expenses and other current assets
|
11,880 | 10,945 | ||||||
Total
current assets
|
424,549 | 413,797 | ||||||
Property
and equipment, at depreciated cost
|
138,662 | 137,569 | ||||||
Equipment
under capital leases, less accumulated amortization of $4,967 and $4,928
respectively
|
- | - | ||||||
Intangibles
|
18,006 | 16,035 | ||||||
Other
noncurrent assets, net
|
3,808 | 4,040 | ||||||
Total
assets
|
$ | 585,025 | $ | 571,441 | ||||
LIABILITIES AND SHAREHOLDERS’
EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Accounts
payable
|
$ | 89,858 | $ | 87,393 | ||||
Current
portion of indebtedness
|
174 | 718 | ||||||
Accrued
expenses and other
|
43,989 | 39,621 | ||||||
Deferred
income taxes
|
19,733 | 19,373 | ||||||
Total
current liabilities
|
153,754 | 147,105 | ||||||
Long-term
portion of indebtedness
|
4,114 | 4,179 | ||||||
Deferred
income taxes
|
987 | 2,009 | ||||||
Other
noncurrent liabilities
|
17,057 | 17,209 | ||||||
Total
liabilities
|
175,912 | 170,502 | ||||||
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,
39,214,341 and 39,363,462 shares issued and outstanding,
respectively
|
129,854 | 131,685 | ||||||
Common
stock, Class B nonvoting, no par value, 11,500,000 shares authorized,
none outstanding
|
- | - | ||||||
Retained
earnings
|
278,355 | 268,350 | ||||||
Accumulated
other comprehensive income
|
904 | 904 | ||||||
Total
shareholders’ equity
|
409,113 | 400,939 | ||||||
Total
liabilities and shareholders’ equity
|
$ | 585,025 | $ | 571,441 |
See
accompanying notes to condensed consolidated financial
statements.
3
CONDENSED
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in
thousands, except per share amounts)
Thirteen Weeks Ended
|
Twenty-Six Weeks Ended
|
|||||||||||||||
July 31,
|
August 1,
|
July 31,
|
August 1,
|
|||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
sales
|
$ | 449,467 | $ | 434,214 | $ | 921,114 | $ | 892,594 | ||||||||
Cost
of goods sold
|
323,531 | 313,472 | 658,229 | 642,875 | ||||||||||||
Gross
profit
|
125,936 | 120,742 | 262,885 | 249,719 | ||||||||||||
Depreciation
and amortization
|
7,227 | 6,489 | 14,190 | 12,927 | ||||||||||||
Selling,
general and administrative expenses
|
110,473 | 106,097 | 227,277 | 214,955 | ||||||||||||
Operating
income
|
8,236 | 8,156 | 21,418 | 21,837 | ||||||||||||
Interest
income
|
(60 | ) | (55 | ) | (120 | ) | (78 | ) | ||||||||
Interest
expense
|
117 | 133 | 227 | 265 | ||||||||||||
Income
before income taxes
|
8,179 | 8,078 | 21,311 | 21,650 | ||||||||||||
Provision
for income taxes
|
3,221 | 3,838 | 8,162 | 8,860 | ||||||||||||
Net
income
|
$ | 4,958 | $ | 4,240 | $ | 13,149 | $ | 12,790 | ||||||||
Net
income per share
|
||||||||||||||||
Basic
|
$ | 0.13 | $ | 0.11 | $ | 0.34 | $ | 0.32 | ||||||||
Diluted
|
$ | 0.13 | $ | 0.11 | $ | 0.34 | $ | 0.32 | ||||||||
Weighted
average shares outstanding
|
||||||||||||||||
Basic
|
39,179 | 39,914 | 39,164 | 39,904 | ||||||||||||
Effect
of dilutive stock options
|
61 | 72 | 53 | 97 | ||||||||||||
Diluted
|
39,240 | 39,986 | 39,217 | 40,001 | ||||||||||||
Dividends
per common share
|
$ | 0.04 | $ | 0.03 | $ | 0.08 | $ | 0.05 | ||||||||
Comprehensive
income:
|
||||||||||||||||
Net
income
|
$ | 4,958 | $ | 4,240 | $ | 13,149 | $ | 12,790 | ||||||||
Other
comprehensive income (expense), net of tax postretirement plan
adjustment
|
- | - | - | - | ||||||||||||
Comprehensive
income
|
$ | 4,958 | $ | 4,240 | $ | 13,149 | $ | 12,790 |
See
accompanying notes to condensed consolidated financial
statements.
4
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in
thousands)
Twenty-Six Weeks Ended
|
||||||||
July 31, 2010
|
August 1, 2009
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
income
|
$ | 13,149 | $ | 12,790 | ||||
Adjustments
to reconcile net income to net cash flows from operating
activities:
|
||||||||
Depreciation
and amortization
|
14,190 | 12,927 | ||||||
Net
loss (gain) on asset disposition
|
258 | (19 | ) | |||||
Stock-based
compensation
|
896 | 996 | ||||||
Provision
(recovery) for uncollectible receivables
|
212 | (84 | ) | |||||
LIFO
reserve increase
|
944 | 591 | ||||||
Deferred
income tax (benefit) expense
|
(833 | ) | 509 | |||||
Income
tax benefit upon exercise of stock options
|
6 | 26 | ||||||
(Increase)
decrease in operating assets:
|
||||||||
Trade
and non-trade receivables
|
(3,913 | ) | 39 | |||||
Insurance
receivables
|
13 | - | ||||||
Inventories
|
(21,722 | ) | (7,971 | ) | ||||
Other
assets
|
545 | 1,450 | ||||||
Increase
(decrease) in operating liabilities:
|
||||||||
Accounts
payable and accrued expenses
|
6,833 | 17,994 | ||||||
Income
taxes payable
|
5,507 | 84 | ||||||
Other
noncurrent liabilities
|
(13 | ) | (5,722 | ) | ||||
Net
cash provided by operating activities
|
16,072 | 33,610 | ||||||
Cash
flows from investing activities:
|
||||||||
Capital
expenditures
|
(13,245 | ) | (11,920 | ) | ||||
Proceeds
from asset dispositions
|
140 | 15 | ||||||
Insurance
recoveries for replacement assets
|
47 | - | ||||||
Asset
acquisition, net (primarily intangibles)
|
(4,405 | ) | (3,555 | ) | ||||
Net
cash used in investing activities
|
(17,463 | ) | (15,460 | ) | ||||
Cash
flows from financing activities:
|
||||||||
Payments
of indebtedness and capital lease obligations
|
(609 | ) | (105 | ) | ||||
Excess
tax charges from stock-based compensation
|
(6 | ) | (26 | ) | ||||
Proceeds
from exercise of stock options and employee stock purchase
plan
|
257 | 205 | ||||||
Repurchase
of shares
|
(2,977 | ) | - | |||||
Cash
dividends paid
|
(3,144 | ) | (2,002 | ) | ||||
Net
cash used in financing activities
|
(6,479 | ) | (1,928 | ) | ||||
(Decrease)
increase in cash and cash equivalents
|
(7,870 | ) | 16,222 | |||||
Cash
and cash equivalents:
|
||||||||
Beginning
of year
|
54,742 | 35,128 | ||||||
End
of year
|
$ | 46,872 | $ | 51,350 | ||||
Supplemental
disclosures of cash flow information:
|
||||||||
Interest
paid
|
$ | 57 | $ | 184 | ||||
Income
taxes paid
|
$ | 2,419 | $ | 14,360 |
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 July 31,
2010, 674 discount general merchandise stores, including 24 franchised Fred's
stores, in 15 states in the southeastern United States. 315 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 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 30, 2010 incorporated into Our Annual Report on Form
10-K.
The
results of operations for the thirteen and twenty-six week periods ended July
31, 2010 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. In February 2010, the FASB issued Accounting Standards Update
2010-09 (ASU), which addresses a potential conflict with disclosure date
requirements provided by the SEC. The ASU amends FASB ASC 855 by
requiring an entity to evaluate subsequent events through the date the financial
statements are issued. The requirements under FASB ASC 855 are
consistent with our current practice and implementation of this standard did not
have an impact on the Company’s consolidated financial statements.
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 first-in,
first-out (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 U.S.
GAAP.
6
Because
the approximation of net realizable value (market value) under the retail
inventory method is based on estimates such as markups, markdowns and inventory
losses (shrink), there exists an inherent uncertainty in the final determination
of inventory cost and gross margin. In order to mitigate that uncertainty, the
Company has a formal review by product class which considers such variables as
current market trends, seasonality, weather patterns and age of merchandise to
ensure that markdowns are taken currently, or a markdown reserve is established
to cover future anticipated markdowns. This review also considers current
pricing trends and inflation to ensure that markups are taken if necessary. The
estimation of inventory losses (shrink) is a significant element in
approximating the carrying value of inventory at net realizable value, and as
such the following paragraph describes our estimation method as well as the
steps we take to mitigate the risk of this estimate in the determination of the
cost value of inventory.
The
Company calculates inventory losses (shrink) based on actual inventory
losses occurring as a result of physical inventory counts during each fiscal
period and estimated inventory losses occurring between yearly physical
inventory counts. The estimate for shrink occurring in the interim period
between physical counts is calculated on a store-specific basis and is based on
history, as well as performance on the most recent physical count. It is
calculated by multiplying each store’s shrink rate, which is based on the
previously mentioned factors, by the interim period’s sales for each store.
Additionally, the overall estimate for shrink is adjusted at the corporate level
to a three-year historical average to ensure that the overall shrink estimate is
the most accurate approximation of shrink based on the Company’s overall history
of shrink. The three-year historical estimate is calculated by dividing the
“book to physical” inventory adjustments for the trailing 36 months by the
related sales for the same period. In order to reduce the uncertainty inherent
in the shrink calculation, the Company first performs the calculation at the
lowest practical level (by store) using the most current performance indicators.
This ensures a more reliable number, as opposed to using a higher level
aggregation or percentage method. The second portion of the calculation ensures
that the extreme negative or positive performance of any particular store or
group of stores does not skew the overall estimation of shrink. This portion of
the calculation removes additional uncertainty by eliminating short-term peaks
and valleys that could otherwise cause the underlying carrying cost of inventory
to fluctuate unnecessarily. The Company has not experienced any significant
change in shrink as a percentage of sales from year to year during the subject
reporting periods. 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
$30.2 million at July 31, 2010 and January 30, 2010, respectively, cost was
determined using the retail LIFO (last-in, first-out) 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 $22.5 million at July 31, 2010 and
$21.6 million at January 30, 2010.
The
Company has historically included an estimate of inbound freight and certain
general and administrative costs in merchandise inventory as prescribed by GAAP.
These costs include activities surrounding the procurement and storage of
merchandise inventory such as merchandise planning and buying, warehousing,
accounting, information technology and human resources, as well as inbound
freight. The total amount of procurement and storage costs and inbound freight
included in merchandise inventory at July 31, 2010 is $19.5 million, with
the corresponding amount of $17.4 million at January 30, 2010.
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.
7
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
|
Twenty-Six Weeks Ended
|
|||||||||||||||
July 31, 2010
|
August 1, 2009
|
July 31, 2010
|
August 1, 2009
|
|||||||||||||
Stock
option expense
|
$ | 152 | $ | 280 | $ | 323 | $ | 540 | ||||||||
Restricted
stock expense
|
333 | 176 | 503 | 350 | ||||||||||||
ESPP
expense
|
35 | 53 | 70 | 106 | ||||||||||||
Total
stock-based compensation
|
$ | 520 | $ | 509 | $ | 896 | $ | 996 | ||||||||
Income
tax benefit on stock-based compensation
|
$ | 139 | $ | 101 | $ | 235 | $ | 216 |
The fair
value of each option granted during the thirteen and twenty-six week periods
ended July 31, 2010 and August 1, 2009, respectively, are estimated on the date
of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Thirteen Weeks Ended
|
Twenty-Six Weeks Ended
|
|||||||||||||||
July 31, 2010
|
August 1, 2009
|
July 31, 2010
|
August 1, 2009
|
|||||||||||||
Stock Options
|
||||||||||||||||
Expected
volatility
|
41.7 | % | 42.6 | % | 42.0 | % | 42.6 | % | ||||||||
Risk-free
interest rate
|
3.1 | % | 2.6 | % | 3.1 | % | 2.6 | % | ||||||||
Expected
option life (in years)
|
5.84 | 5.84 | 5.84 | 5.84 | ||||||||||||
Expected
dividend yield
|
0.61 | % | 0.55 | % | 0.63 | % | 0.55 | % | ||||||||
Weighted
average fair value at grant date
|
$ | 4.84 | $ | 4.58 | $ | 4.86 | $ | 4.58 | ||||||||
Employee Stock Purchase
Plan
|
||||||||||||||||
Expected
volatility
|
31.5 | % | 73.5 | %1 | 31.9 | % | 83.9 | %1 | ||||||||
Risk-free
interest rate
|
0.6 | % | 0.1 | % | 0.6 | % | 0.1 | % | ||||||||
Expected
option life (in years)
|
0.50 | 0.50 | 0.38 | 0.38 | ||||||||||||
Expected
dividend yield
|
0.46 | % | 0.34 | % | 0.35 | % | 0.26 | % | ||||||||
Weighted
average fair value at grant date
|
$ | 2.43 | $ | 3.78 | $ | 2.31 | $ | 3.68 |
1.
|
The
increase in expected volatility in 2009 is due to the fluctuation of the
stock price during the first and second quarter of
2009.
|
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.
8
Dividend Yield – This
is based on the historical yield for a period equivalent to the expected life of
the option. An increase in the dividend yield will decrease
compensation expense.
Forfeiture Rate -
This is the estimated percentage of options granted that are expected to be
forfeited or cancelled before becoming fully vested. This estimate is based on
historical experience. An increase in the forfeiture rate will decrease
compensation expense.
Employee
Stock Purchase Plan
The 2004
Employee Stock Purchase Plan (the “2004 Plan”), which was approved by Fred’s
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 30,018 shares issued during the twenty-six weeks
ended July 31, 2010. There are 1,410,928 shares approved to be issued
under the 2004 Plan and as of July 31, 2010, there were 1,060,495 shares
available.
Stock
Options
The
following table summarizes stock option activity during the twenty-six weeks
ended July 31, 2010:
Options
|
Weighted
Average
Exercise
Price
|
Weighted
Average
Remaining
Contractual
Life
(Years)
|
Aggregate
Intrinsic
Value
(Thousands)
|
|||||||||||||
Outstanding
at January 30, 2010
|
1,261,330 | $ | 13.91 | 3.1 | $ | 73 | ||||||||||
Granted
|
26,250 | $ | 11.13 | |||||||||||||
Forfeited
/ Cancelled
|
(51,650 | ) | $ | 15.81 | ||||||||||||
Exercised
|
(1,400 | ) | $ | 13.25 | ||||||||||||
Outstanding
at July 31, 2010
|
1,234,530 | $ | 13.78 | 2.7 | $ | 293 | ||||||||||
Exercisable
at July 31, 2010
|
835,788 | $ | 15.17 | 1.7 | $ | 80 |
The
aggregate intrinsic value in the table above represents the total pre-tax
intrinsic value (the difference between Fred’s closing stock price of $10.84 on
the last trading day of the period ended July 31, 2010 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 July 31, 2010, total unrecognized
stock-based compensation expense net of estimated forfeitures related to
non-vested stock options was approximately $674 thousand, which is expected to
be recognized over a weighted average period of approximately 3.2
years. The total fair value of options vested during the twenty-six
weeks ended July 31, 2010 was $471 thousand.
Restricted
Stock
The
following table summarizes restricted stock activity during the
twenty-six weeks ended July 31, 2010:
Number
of Shares
|
Weighted
Average
Grant
Date Fair
Value
|
|||||||
Non-vested
Restricted Stock at January 30, 2010
|
346,510 | $ | 12.01 | |||||
Granted
|
124,494 | $ | 13.83 | |||||
Forfeited
/ Cancelled
|
(11,207 | ) | $ | 10.21 | ||||
Vested
|
(5,658 | ) | $ | 13.34 | ||||
Non-vested
Restricted Stock at July 31, 2010
|
454,139 | $ | 12.50 |
The
aggregate pre-tax intrinsic value of restricted stock outstanding as of July 31,
2010 is $4.9 million with a weighted average remaining contractual life
of 4.8 years. The unrecognized compensation expense net of
estimated forfeitures, related to the outstanding stock is approximately
$3.3 million, which is expected to be recognized over a weighted average
period of approximately 4.5 years. The total fair value of
restricted stock awards that vested during the twenty-six weeks ended July 31,
2010 was $74.7 thousand.
9
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:
July 31, 2010
|
||||||||
(unaudited)
|
January 30, 2010
|
|||||||
Property
and equipment, at cost:
|
||||||||
Buildings
and building improvements
|
$ | 96,588 | $ | 95,844 | ||||
Leasehold
improvements
|
58,909 | 55,078 | ||||||
Automobiles
and vehicles
|
5,172 | 5,273 | ||||||
Airplane
|
4,697 | 4,697 | ||||||
Furniture,
fixtures and equipment
|
237,731 | 240,883 | ||||||
403,097 | 401,775 | |||||||
Less:
Accumulated depreciation and amortization
|
(271,357 | ) | (271,185 | ) | ||||
131,740 | 130,590 | |||||||
Construction
in progress
|
172 | 446 | ||||||
Land
|
6,750 | 6,533 | ||||||
Total
Property and equipment, at depreciated cost
|
$ | 138,662 | $ | 137,569 |
NOTE
6: EXIT AND DISPOSAL ACTIVITIES
Store
closures that occurred during 2008 and 2009 are deemed exit and disposal related
and will be accounted for in accordance with the applicable accounting guidance,
as follows.
Inventory Impairment
The
Company recorded 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 was 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 at July 31,
2010.
Fixed Asset
Impairment
For
planned store closures, the Company recorded a fixed asset impairment charge for
assets identified for disposal. There is no outstanding fixed asset
impairment for exit and disposal related activity at July 31, 2010.
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, “Exit or Disposal Cost Obligations”.
Key assumptions in calculating the liability include the timeframe expected to
terminate lease agreements, estimates related to the sublease potential of
closed locations, and 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.
10
During
the first half of fiscal 2010, we incurred an additional $0.5 million in rent
expense related to the revision of the estimated amount of the remaining lease
liability for the fiscal 2008 store closures. We also utilized $0.7
million, leaving $.9 million in the reserve at July 31, 2010.
The
following table illustrates the exit and disposal activity related to the store
closures discussed in the previous paragraphs (in millions):
Balance at
January 30,
2010
|
Additions
|
Utilization
|
Ending Balance
July 31, 2010
|
|||||||||||||
Lease
contract termination liability
|
$ | 1.1 | $ | 0.5 | $ | 0.7 | $ | 0.9 |
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:
Twenty-Six Weeks Ended
|
Year Ended
|
|||||||||||
(in thousands)
|
July 31, 2010
|
August 1, 2009
|
January 30, 2010
|
|||||||||
Accumulated
other comprehensive income
|
$ | 904 | $ | 1,063 | $ | 904 | ||||||
Amortization
of postretirement benefit
|
- | - | - | |||||||||
Ending
balance
|
$ | 904 | $ | 1,063 | $ | 904 |
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 was
$639.7 thousand for the quarter ended July 31, 2010.
11
Item
2:
Management's
Discussion and Analysis of Financial
Condition and Results of
Operations
GENERAL
Executive
Overview
During
the second quarter of 2010, we continued the implementation of our Core 5
Program. The Core 5 Program is a key strategic initiative was
designed to highlight key categories within our stores that differentiate us
from our competition. The Core 5 categories - Home, Celebration, Pet,
Pharmacy and Paper and Chemical - are strong trip driving departments in which
FRED’S has a clear and marketable advantage versus small box
competitors. Additionally, these categories have high household
penetration and resonate with customers across multiple
demographics. This initiative is also intended to shift our product
mix toward the more discretionary, higher margin categories and away from the
lower margin consumable categories, thus driving higher margin and leading to
increased operating profit. The implementation of the Core 5 Program
requires a moderate refresh of the store to address space allocation, product
placement and adjacencies and signage in the Core 5 categories. The
implementation is also accompanied by an extensive direct mail marketing
campaign timed to coincide with the refresh of the store and then continuing for
six months thereafter. Through the second quarter of 2010, we have
implemented the Core 5 Program in 109 stores to date and plan to implement the
program in approximately 200 stores by the end of FY 2010.
Our
Pharmacy department is one of our Core 5 categories and is a key differentiating
factor from other small-box discount retailers. As such, 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 file buys, but cold starts will
be employed where it makes sense to do so.
Another
key focus in the first half of 2010 has been improvement of our store in-stock
position. Recognizing in-stock position as one of the fundamental
drivers of our business, we have dedicated significant resources to improving
the tools we use to monitor and measure in-stock position in our
stores. As an extension of this initiative, we have made significant
improvements to our freight flow processes to ensure that product is in the
store and available for our customers. Improvement in store in-stock
position will continue to be a key initiative in FY 2010, and additional
enhancements that are currently in development, both in terms of freight flow
processes and in-stock measurement, will be deployed later in the
year.
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 18.7% of total consumable sales, and
that number will continue to grow throughout 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 additional new items in food and health and
beauty aids introduced in the second quarter of 2010.
While our
Own Brand or FRED’S Brand products continue to be a focus in 2010, we have
implemented several national brands in our stores, such as Coke, Purina and
Energizer. These national brands appeal to our customers and provide
them with a more complete shopping trip. Throughout the year, we will
be evaluating more name brands that are the most popular with our customers and
will be adding those that complement our current product mix.
Gross
margin improvement continues to be a key focus of the Company, as highlighted
above with our Core 5 and Own Brand strategies. We are aggressively
pursuing product sourcing improvements and cost reductions across all product
lines in order to reduce overall product costs and, in turn, raise our gross
margin. Additionally, we have implemented new processes intended to
control both promotional and clearance markdowns. We also continue to
make improvements in our loss prevention processes and procedures, and those
improvements are leading to reduced shrinkage in our stores and, consequently,
higher gross margin. These efforts resulted in a 20 basis point
improvement in gross margin in the second quarter of 2010 when compared to the
second quarter of last year.
Over the
remainder of 2010, we intend to continue with capital improvements in
infrastructure, including new stores as well as existing store expansion and
remodels, including Core 5 refreshes, distribution center upgrades and further
development of our information technology capabilities. Technology
upgrades will be made in the areas of Human Resource and Payroll systems,
in-store systems, and pharmacy systems.
As
previously reported in the second quarter press release filed August 26, 2010,
the Company expects total earnings per diluted share for 2010 to be in the range
of $0.72 to $0.79.
12
Key
factors that will be critical to the Company’s future success include the
successful execution of our Core 5 program, as well as 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, controlling 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 2010 include the continuing
management of the impacts of the changing regulatory environment in which our
pharmacy department operates. Additionally, we believe that the
protracted elevation in the unemployment rate continues 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 30, 2010. 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 July
31, 2010 and August 1, 2009
Sales
Net sales
for the quarter of 2010 increased to $449.5 million from $434.2 million in 2009,
a year-over-year increase of $15.3 million or 3.5%. On a comparable
store basis, sales increased 2.5% ($10.5 million) compared with a 1.3% ($6.5
million) decrease in the same period last year.
The
Company’s 2010 front store (non-pharmacy) sales increased 2.2% over
2009. We experienced sales increases in categories such as small
appliances, health aids, beverage, home furnishings and
electronics.
The
Company’s pharmacy sales were 33.6% of total sales ($151.2 million) in 2010
compared to 32.8% of total sales ($142.1 million) in the prior year and continue
to rank as the largest sales category within the Company, an increase of .8%
over 2009. The total sales in this department increased 6.4% over 2009 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 2010 decreased to $9.0 million (2.0% of
sales) from $9.2 million (2.1% of sales) in 2009. The Company does
not intend to expand its franchise network.
13
The
following table illustrates the sales mix unadjusted for deferred layaway
sales:
Thirteen Weeks Ended
|
||||||||
July 31, 2010
|
August 1, 2009
|
|||||||
Pharmaceuticals
|
33.6 | % | 32.8 | % | ||||
Household
Goods
|
23.9 | % | 23.6 | % | ||||
Food
and Tobacco
|
17.0 | % | 16.7 | % | ||||
Paper
and Cleaning Supplies
|
8.6 | % | 9.5 | % | ||||
Health
and Beauty Aids
|
7.7 | % | 7.5 | % | ||||
Apparel
and Linens
|
7.2 | % | 7.8 | % | ||||
Franchise
|
2.0 | % | 2.1 | % | ||||
100.0 | % | 100.0 | % |
For the
quarter, comparable store customer traffic decreased .8% over last year while
the average customer ticket increased 1.7% to $19.17.
Gross Profit
Gross
profit for the second quarter of 2010 increased to $125.9 million in 2010 from
$120.7 million in 2009, a year-over-year increase of $5.2 million or
4.3%. Gross margin, measured as a percentage of sales, increased to
28.0% in 2010 from 27.8% in 2009. The improvement in gross
margin was primarily due to higher initial markup from the improving product mix
and the improvement in store shrink.
Selling, General and Administrative
Expenses
Selling,
general and administrative expenses, including depreciation and amortization,
increased to $117.7 million in 2010 (26.2% of sales) from $112.6 million in 2009
(25.9% of sales). This 30 basis point expense deleveraging was
primarily due to the increase in pharmacy labor ($3.1 million) associated with
new pharmacies opened in the last twelve months.
Operating Income
Operating
income increased $.08 million in 2010 (1.8% of sales) from $8.2 million in 2009
(1.9% of sales). The $5.1 million increase in selling, general and
administrative expenses as detailed in the Selling, General and Administrative
Expenses section above, offset nearly all of the gross profit increase of $5.2
million that is detailed in the Gross Profit section above.
Interest Expense,
Net
Net
interest expense for the quarter totaled $.06 million or less than .1% of
sales compared to $.08 million in 2009, which was also less than .1% of
sales.
Income
Taxes
The
effective income tax rate was 39.4% in 2010 compared to 47.5% in 2009. The
decrease in the effective tax rate was primarily due to the final assessment and
settlement of the Internal Revenue Service exam for tax years 2004 - 2007 during
the second quarter of 2009. The effective income tax rate for the quarter was
higher than expected due primarily to tax credits not yet approved by
Congress.
Net Income
Net
income increased to $5.0 million ($.13 per diluted share) in 2010 from $4.2
million ($.11 per diluted share) in 2009. The increase in net income
is primarily attributable to the higher tax expense ($.6 million) incurred in
the second quarter of 2009 for the final assessment and settlement of the
Internal Revenue Service exam as detailed in the Income Taxes section
above.
Twenty-Six Weeks Ended July
31, 2010 and August 1, 2009
Sales
Net sales
increased to $921.1 million from $892.6 million in 2009, a year-over-year
increase of $28.5 million or 3.2%. On a comparable store basis, sales
increased 2.3% ($20.3 million) compared with a .8% increase ($6.5 million) in
the same period last year.
The
Company’s 2010 front store (non-pharmacy) sales increased 2.2% over
2009. We experienced sales increases in categories such as small
appliances, lawn and garden, beverage, electronics and home
furnishings.
14
The
Company’s pharmacy sales were 33.8% of total sales ($310.5 million) in 2010
compared to 33.1% of total sales ($294.9 million) in the prior year and continue
to rank as the largest sales category within the Company, an increase of .7%
over 2009. The total sales in this department increased 5.3% over 2009 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 2010 decreased to $18.8 million (2.0% of
sales) from $19.4 million (2.2% of sales) in 2009. The Company does
not intend to expand its franchise network.
The
following table illustrates the sales mix unadjusted for deferred layaway
sales:
Twenty-Six Weeks Ended
|
||||||||
July 31, 2010
|
August 1, 2009
|
|||||||
Pharmaceuticals
|
33.8 | % | 33.1 | % | ||||
Household
Goods
|
24.0 | % | 23.5 | % | ||||
Food
and Tobacco
|
16.7 | % | 16.4 | % | ||||
Paper
and Cleaning Supplies
|
8.6 | % | 9.3 | % | ||||
Apparel
and Linens
|
7.5 | % | 7.8 | % | ||||
Health
and Beauty Aids
|
7.4 | % | 7.7 | % | ||||
Franchise
|
2.0 | % | 2.2 | % | ||||
100.0 | % | 100.0 | % |
For the
first half, comparable store customer traffic increased .1% over last year while
the average customer ticket increased 2.2% to $19.64.
Gross Profit
Gross
profit for first half increased to $262.9 million in 2010 from $249.7 million in
2009, a year-over-year increase of $13.2 million or 5.3%. Gross
margin, measured as a percentage of sales, increased to 28.5% in 2010 from 28.0%
in 2009. The improvement in gross margin was primarily due to higher
initial markup from the improving product mix and the improvement in store
shrink.
Selling, General and Administrative
Expenses
Selling,
general and administrative expenses, including depreciation and amortization,
increased to $241.5 million in 2010 (26.2% of sales) from $227.9 million in 2009
(25.5% of sales). This 70 basis point expense deleveraging was
primarily the result of an increase in pharmacy labor expense ($5.6 million) and
amortization expense ($.8 million) primarily related to new pharmacy openings
during the last twelve months, additional advertising expense ($1.9 million),
increased legal and professional fees ($1.7 million) and higher supplies expense
($1.4 million).
Operating Income
Operating
income decreased to $21.4 million in 2010 (2.3% of sales) from $21.8 million in
2009 (2.4% of sales), a year-over-year decrease of $.4 million. The
$13.6 million increase in selling, general and administrative expenses as
detailed in the Selling, General and Administrative Expenses section above,
offset all of the gross profit increase of $13.2 million that is detailed in the
Gross Profit section above.
Interest Expense,
Net
Net
interest expense for 2010 totaled $.1 million or less than .1% of sales
compared to $.2 million in 2009, which was also less than .1% of
sales.
Income
Taxes
The
effective income tax rate was 38.3% in 2010 compared to 40.9% in 2009. The
decrease in the effective tax rate was primarily due to the final assessment and
settlement of the Internal Revenue Service exam for tax years 2004 - 2007 during
the second quarter of 2009. The effective income tax rate for the
quarter was higher than expected due primarily to tax credits not yet approved
by Congress. We anticipate the tax rate for the remaining two
quarters to be in the range of 34% to 36%.
Net Income
Net
income increased to $13.1 million ($.34 per diluted share) in 2010 from $12.8
million ($.32 per diluted share) in 2009. The increase in net income
is primarily attributable the higher tax expense ($.7 million) incurred in the
second quarter of 2009 for the final assessment and settlement of the Internal
Revenue Service exam as detailed in the Income Taxes section
above.
15
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 $16.1 million during the twenty-six
week period ended July 31, 2010 compared to $33.6 million in the same period of
the prior year. We generated operating cash flow through quarterly
income and from our ongoing initiative to better manage our Accounts Payable
processes while we used $13.8 million more to purchase inventory in the first
half of 2010 versus the same time last year and had $4.0 million more trade and
non-trade receivables.
Cash used
in investing activities totaled $17.5 million, and consisted primarily of
expenditures related to existing stores ($9.6 million), pharmacy acquisitions
and new store openings ($1.9 million) and technology and other corporate
expenditures ($1.7 million). During the first half of 2010, we opened
1 new store, upgraded 3 express pharmacies to full stores and opened 5 express
pharmacies and 7 additional new pharmacies within stores. In
addition, the Company also closed 6 pharmacies. In 2010, the Company is planning
capital expenditures totaling approximately $26.6 million. Expenditures are
planned totaling $19.3 million for new and existing stores and pharmacies.
Planned expenditures also include approximately $4.3 million for technology
upgrades and approximately $2.4 million for distribution center equipment
and other capital maintenance. Technology upgrades in 2010 will be made in the
areas of Human Resource and Payroll systems, in-store systems and pharmacy
systems. In addition, the Company plans expenditures of approximately
$10.0 million in 2010 for the acquisition of prescription lists and other
pharmacy related items.
Cash used
by financing activities totaled $6.5 million and included $3.1 million for the
payment of cash dividends and $3.0 million for the repurchase of shares and $.6
million for the repayment of debt. There were $4.3 million in
borrowings outstanding at July 31, 2010 related to real estate mortgages
compared to $4.9 million at January 30, 2010.
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 litigation described under Legal Proceedings on
page 17.
|
|
·
|
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 30,
2010.
|
16
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.
Item
3.
QUANTITATIVE
AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We have
no holdings of derivative financial or commodity instruments as of July 31,
2010. 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 July 31, 2010 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, but
the court has not 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 can be reasonably
estimated. Therefore, we have not recorded a liability for this
case.
In August
2007, a lawsuit entitled Julia Atchinson, et al. v. FRED’S Stores of Tennessee,
Inc., et al, 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 current and former FRED’S Discount assistant store managers were
improperly classified as exempt executive employees under the Fair Labor
Standards Act (FLSA) and seeks to recover overtime pay, liquidated damages,
attorney’s fees and court costs. The plaintiffs filed a motion
seeking a collective action which the Judge has not ruled
on. Although the Company continues to believe that its assistant
store managers are and have been properly classified as exempt employees under
FLSA and that the matter is not appropriate for collective action treatment, the
parties agreed to mediate this case in January 2009 and did so successfully,
reaching a settlement of $1.5 million (including attorneys’ fees and costs),
which was accrued at July 31, 2010. The court approved the settlement
and the Company subsequently paid it in August 2010. Based on the
substantial costs of continuing litigation, unfavorably high jury verdicts
against other retailers and the constant distraction to management of a possible
protracted jury trial, we believe that this is a favorable settlement for
FRED’S. FRED’S has admitted no liability or wrongdoing, and no
liability or wrongdoing has been found against the Company.
17
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 30, 2010, should be considered with the
information provided elsewhere in this Quarterly Report on Form 10-Q, which
could materially adversely affect the business, financial condition or results
of operations. There have been no material changes to the risk factors as
previously disclosed in such Annual Report on Form 10-K.
Item
2. Unregistered Sales of Equity Securities and Use of Proceeds
On
August 27, 2007, the Board of Directors approved a plan that authorized
stock repurchases of up to 4.0 million shares of the Company’s common
stock. Under the plan, the Company may repurchase its common stock in open
market or privately negotiated transactions at such times and at such prices as
determined to be in the Company’s best interest. These purchases may be
commenced or suspended without prior notice depending on then-existing business
or market conditions and other factors. The following table sets forth the
amounts of our common stock purchased by the Company through July 31, 2010
(amounts in thousands, except price data). The repurchased shares have been
cancelled and returned to authorized but unissued shares.
Total Number of
Shares Purchased
|
Average Price Paid
Per Share
|
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Program
|
Maximum Number of
Shares That May Yet Be
Purchased Under the
Plans or Program
|
|||||||||||||
Balance at January 30, 2010
|
2,830.8 | |||||||||||||||
January
31 - February 27, 2010
|
69.3 | $ | 9.41 | 69.3 | 2,761.5 | |||||||||||
February
28 - April 3, 2010
|
- | $ | - | - | 2,761.5 | |||||||||||
April
4, - May 1, 2010
|
- | $ | - | - | 2,761.5 | |||||||||||
May
2, - May 29, 2010
|
- | $ | - | - | 2,761.5 | |||||||||||
May
30, - July 3, 2010
|
- | $ | - | - | 2,761.5 | |||||||||||
July
4, - July 31, 2010
|
222.6 | $ | 10.43 | 222.6 | 2,538.9 |
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.
|
18
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: September 9, 2010
|
/s/ Bruce A. Efird
|
Bruce
A. Efird
|
|
Chief
Executive Officer and President
|
|
Date: September 9, 2010
|
/s/ Jerry A. Shore
|
Jerry
A. Shore
|
|
Executive
Vice President and
|
|
Chief
Financial
Officer
|
19