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EX-32 - EXHIBIT 32 - FREDS INCv346664_ex32.htm
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EX-31.2 - EXHIBIT 31.2 - FREDS INCv346664_ex31-2.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended May 4, 2013.

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 x 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 36,692,361 shares of Class A voting, no par value common stock outstanding as of June 7, 2013.

 

 
 

 

FRED'S, INC.

 

INDEX

 

    Page No.
     
Part I - Financial Information    
     
Item 1 - Financial Statements:    
     
Condensed Consolidated Balance Sheets as of May 4, 2013 (unaudited) and February 2, 2013   3
     
Condensed Consolidated Statements of Income for the Thirteen Weeks Ended May 4, 2013 (unaudited) and April 28, 2012 (unaudited)   4
     
Condensed Consolidated Statements of Comprehensive Income for the Thirteen Weeks Ended May 4, 2013 (unaudited) and April 28, 2012 (unaudited)   4
     
Condensed Consolidated Statements of Cash Flows for the Thirteen Weeks Ended May 4, 2013 (unaudited) and April 28, 2012 (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 Disclosures about Market Risk   16
     
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)

 

   May 4, 2013   February 2, 
   (unaudited)   2013 
ASSETS          
Current assets:          
Cash and cash equivalents  $7,795   $8,129 
Receivables, less allowance for doubtful accounts of $1,244 and $1,489, respectively   34,875    35,943 
Inventories   369,883    353,266 
Other non-trade receivables   30,667    33,273 
Prepaid expenses and other current assets   13,058    13,134 
Total current assets   456,278    443,745 
Property and equipment, at depreciated cost   156,976    158,394 
Equipment under capital leases, less accumulated amortization of $5,085 and $5,077,
respectively
 
 
 
 
 
55
 
 
 
 
 
 
 
63
 
 
Intangibles   41,162    41,873 
Other noncurrent assets, net   3,258    3,078 
Total assets  $657,729   $647,153 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Current liabilities:          
Accounts payable  $112,906   $115,830 
Current portion of indebtedness   594    1,263 
Accrued expenses and other   50,910    44,000 
Income taxes payable   1,418    - 
Deferred income taxes   23,876    24,234 
Total current liabilities   189,704    185,327 
Long-term portion of indebtedness   5,190    12,241 
Deferred income taxes   3,745    4,732 
Other noncurrent liabilities   17,522    13,581 
Total liabilities   216,161    215,881 
           
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,  36,684,247 and 36,680,060 shares issued and outstanding, respectively   100,432    99,342 
Common stock, Class B nonvoting, no par value, 11,500,000 shares authorized,   none outstanding   -    - 
Retained earnings   340,342    331,136 
Accumulated other comprehensive income   794    794 
Total shareholders’ equity   441,568    431,272 
Total liabilities and shareholders’ equity  $657,729   $647,153 

 

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 
   May 4,   April 28, 
   2013   2012 
Net sales  $501,495   $500,505 
Cost of goods sold   350,476    352,663 
Gross profit   151,019    147,842 
           
Depreciation and amortization   10,301    9,364 
Selling, general and administrative expenses   122,934    121,377 
Operating income   17,784    17,101 
           
Interest income   -    - 
Interest expense   135    137 
Income before income taxes   17,649    16,964 
           
Provision for income taxes   6,238    6,506 
Net income  $11,411   $10,458 
           
Net income per share          
Basic  $0.31   $0.28 
           
Diluted  $0.31   $0.28 
           
Weighted average shares outstanding          
Basic   36,507    36,977 
Effect of dilutive stock options   114    133 
Diluted   36,621    37,110 
           
Dividends per common share  $0.06   $0.06 

 

FRED’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(in thousands)

 

   Thirteen Weeks Ended 
   May 4,   April 28, 
   2013   2012 
Net income  $11,411   $10,458 
Other comprehensive income (expense), net of tax          
Postretirement plan adjustment   -    - 
           
Comprehensive income  $11,411   $10,458 

 

See accompanying notes to condensed consolidated financial statements.

 

4
 

 

FRED’S, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

   Thirteen Weeks Ended 
   May 4, 2013   April 28, 2012 
Cash flows from operating activities:          
Net income  $11,411   $10,458 
Adjustments to reconcile net income to net cash flows from operating activities:          
Depreciation and amortization   10,301    9,364 
Net loss on asset disposition   382    13 
Provision for store closures and asset impairment   893    24 
Stock-based compensation   576    509 
Provision (recovery) for uncollectible receivables   (245)   212 
LIFO reserve increase   1,699    1,780 
Deferred income tax expense (benefit)   (800)   581 
Income tax benefit upon exercise of stock options   35    26 
(Increase) decrease in operating assets:          
Trade and non-trade receivables   1,912    (2,127)
Insurance receivables   -    (2)
Inventories   (18,622)   (30,220)
Other assets   76    101 
Increase in operating liabilities:          
Accounts payable and accrued expenses   3,986    4,034 
Income taxes payable   3,484    5,319 
Other noncurrent liabilities   3,119    1,009 
Net cash provided by operating activities   18,207    1,081 
           
Cash flows from investing activities:          
Capital expenditures   (6,854)   (6,049)
Proceeds from asset dispositions   120    14 
Asset acquisition, net  (primarily intangibles)   (2,397)   (5,312)
Net cash used in investing activities   (9,131)   (11,347)
           
Cash flows from financing activities:          
Payments of indebtedness and capital lease obligations   (744)   (88)
Proceeds from revolving line of credit   85,918    - 
Payments on revolving line of credit   (92,893)   - 
Excess tax charges from stock-based compensation   (35)   (26)
Proceeds from exercise of stock options and employee stock purchase plan   548    410 
Repurchase of shares   -    (7,056)
Cash dividends paid   (2,204)   (2,285)
Net cash used in financing activities   (9,410)   (9,045)
           
Decrease in cash and cash equivalents   (334)   (19,311)
Cash and cash equivalents:          
Beginning of year   8,129    27,130 
End of period  $7,795   $7,819 
           
Supplemental disclosures of cash flow information:          
Interest paid  $135   $137 
Income taxes paid  $3,144   $810 

 

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 its subsidiaries ("Fred's", “We”, “Our”, “Us” or “Company”) operates, as of May 4, 2013, 715 discount general merchandise stores, including 21 franchised Fred's stores, in 15 states in the southeastern United States. There are 349 full service pharmacy departments located within our discount general merchandise stores.

 

The accompanying unaudited condensed 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 February 2, 2013 incorporated into Our Annual Report on Form 10-K.

 

The results of operations for the thirteen week period ended May 4, 2013 are not necessarily indicative of the results to be expected for the full fiscal year.

 

NOTE 2: 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 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. 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.

 

6
 

 

For pharmacy inventory, which was approximately $32.6 million and $33.8 million at May 4, 2013 and February 2, 2013, 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 $32.4 million at May 4, 2013 and $30.7 million at February 2, 2013.

 

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 May 4, 2013 is $22.4 million, with the corresponding amount of $21.6 million at February 2, 2013.

 

NOTE 3: STOCK-BASED COMPENSATION

 

The Company accounts for its stock-based compensation plans in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) ("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 
   May 4, 2013   April 28, 2012 
         
Stock option expense  $163   $91 
Restricted stock expense   361    373 
ESPP expense   52    45 
Total stock-based compensation  $576   $509 
           
Income tax benefit on stock-based compensation  $159   $142 

 

7
 

 

The fair value of each option granted during the thirteen week periods ended May 4, 2013 and April 28, 2012, respectively, are estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

   Thirteen Weeks Ended 
   May 4, 2013   April 28, 2012 
Stock Options          
Expected volatility   39.2%   40.0%
Risk-free interest rate   1.0%   1.0%
Expected option life (in years)   5.84    5.84 
Expected dividend yield   1.24%   0.98%
           
Weighted average fair value at grant date  $4.68   $5.19 
           
Employee Stock Purchase Plan          
Expected volatility   27.4%   28.8%
Risk-free interest rate   0.2%   0.1%
Expected option life (in years)   0.25    0.25 
Expected dividend yield   0.45%   0.39%
           
Weighted average fair value at grant date  $2.80   $2.99 

 

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.

 

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 16,103 shares issued during the thirteen weeks ended May 4, 2013. There are 1,410,928 shares approved to be issued under the 2004 Plan and as of May 4, 2013, there were 903,374 shares available.

 

8
 

 

Stock Options

 

The following table summarizes stock option activity during the thirteen weeks ended May 4, 2013:

 

   Options   Weighted
Average
Exercise Price
   Weighted Average
Remaining
Contractual Life
(Years)
   Aggregate
Intrinsic
Value
(Thousands)
 
                 
Outstanding at February 2, 2013   1,145,655   $12.18   3.2   $1,467 
Granted   42,574   $13.99           
Forfeited / Cancelled   (96,208)  $13.30           
Exercised   (36,657)  $11.78           
Outstanding at May 4, 2013   1,055,364   $12.17   3.4   $2,423 
                     
Exercisable at May 4, 2013   474,764   $10.79   2.1   $1,737 

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between Fred’s closing stock price on the last trading day of the period ended May 4, 2013 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 May 4, 2013, total unrecognized stock-based compensation expense net of estimated forfeitures related to non-vested stock options was approximately $1.5 million, which is expected to be recognized over a weighted average period of approximately 3.4 years. The total fair value of options vested during the thirteen weeks ended May 4, 2013 was $216.8 thousand.

 

Restricted Stock

 

The following table summarizes restricted stock activity during the thirteen weeks ended May 4, 2013:

 

   Number of Shares   Weighted Average
Grant Date Fair
Value
 
         
Non-vested Restricted Stock  at February 2, 2013   621,009   $13.09 
Granted   28,106   $13.81 
Forfeited / Cancelled   (77,520)  $13.30 
Vested   (6,475)  $12.90 
Non-vested Restricted Stock at May 4, 2013   565,120   $13.10 

 

The aggregate pre-tax intrinsic value of restricted stock outstanding as of May 4, 2013 is $8.2 million with a weighted average remaining contractual life of 5.3 years. The unrecognized compensation expense net of estimated forfeitures, related to the outstanding stock is approximately $3.8 million, which is expected to be recognized over a weighted average period of approximately 5.8 years. The total fair value of restricted stock awards that vested during the thirteen weeks ended May 4, 2013 was $97.0 thousand.

 

NOTE 4 — FAIR VALUE MEASUREMENTS

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy, as defined below, gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

 

Level 1, defined as quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
Level 2, defined as Inputs other than quoted prices included within Level 1, that are observable for the asset or liability, either directly or indirectly.
Level 3, defined as unobservable inputs for the asset or liability.

 

9
 

 

Due to their short-term nature, the Company’s financial instruments, which include cash and cash equivalents, receivables and accounts payable, are a reasonable estimate of their fair value as of May 4, 2013 and April 28, 2012. No borrowings on the revolving line of credit existed at the balance sheet date. The fair value of our mortgage loans are estimated using Level 2 inputs based on the Company's current incremental borrowing rate for comparable borrowing arrangements.

 

The table below details the fair value and carrying values for the mortgage loans as of the following dates:

 

   May 4, 2013   April 28, 2012 
(in thousands)  Carrying Value   Fair Value   Carrying Value   Fair Value 
Mortgage loans on land & buildings   5,884    6,096    7,222    7,449 

 

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 (in thousands):

 

   May 4, 2013   February 2, 2013 
Property and equipment, at cost:          
           
Buildings and building improvements  $113,394   $113,164 
Leasehold improvements   75,801    74,552 
Automobiles and vehicles   5,550    5,601 
Airplane   4,697    4,697 
Furniture, fixtures and equipment   270,746    266,949 
    470,188    464,963 
Less: Accumulated depreciation and amortization   (321,816)   (315,175)
    148,372    149,788 
Construction in progress   -    2 
Land   8,604    8,604 
Total Property and equipment, at depreciated cost  $156,976   $158,394 

 

NOTE 6: EXIT AND DISPOSAL ACTIVITIES

 

Lease Termination

 

A lease obligation still exists for some store closures that occurred in 2008. We record the estimated future liability associated with the rental obligation on the cease use date (when the stores were closed). The lease obligations 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 estimates 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 quarter of fiscal 2013, we utilized $0.1 million of the remaining lease liability for the fiscal 2008 store closures, leaving $0.1 million in the reserve at May 4, 2013.

 

10
 

 

The following table illustrates the exit and disposal activity related to the store closures discussed in the previous paragraph (in millions):

 

   Balance at
February 2, 2013
   Additions   Utilization   Ending Balance
May 4, 2013
 
                     
Lease contract termination liability  $0.2   $-   $(0.1)  $0.1 

 

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:

 

   Thirteen Weeks Ended   Year Ended 
(in thousands)  May 4, 2013   April 28, 2012   February 2, 2013 
                
Accumulated other comprehensive income  $794   $864   $864 
Amortization of postretirement benefit   -    -    (70)
Ending balance  $794   $864   $794 

 

NOTE 8: RELATED PARTY TRANSACTIONS

 

Atlantic Retail Investors, LLC, which is partially owned by Michael J. Hayes, a director of the Company and Chairman of the Board, owns the land and buildings occupied by three Fred’s stores. The terms and conditions regarding the leases on these locations were consistent in all material respects with other stores' leases of the Company with unrelated landlords. The total rental payments related to related party leases were $75.2 thousand and $75.2 thousand for the thirteen weeks ended May 4, 2013 and April 28, 2012, respectively.

 

NOTE 9: LEGAL CONTINGENCIES

 

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.  On or about March 15, 2013, the Magistrate Judge issued a Report and Recommendation that the case be conditionally certified as a collective action, which the District Court Judge affirmed. As a result, notice of a collective action is being sent to the appropriate class as required by the Court. The Company believes that all of its assistant managers have been properly paid and that the matter is not appropriate for collective action treatment.  The Company is and will continue to vigorously defend this matter, however, it is not possible to predict whether Chapman will ultimately be able to proceed collectively and no assurances can be given that the Company will be successful in the defense of the action on the merits or otherwise.  In accordance with FASB ASC 450, “Contingencies”, the Company does not believe that a loss in this matter is probable at this time.  For these reasons, the Company is unable to estimate any potential loss or range of loss in the matter.  The Company has tendered the matter to its Employment Practices Liability Insurance (“EPLI”) carrier for coverage under its EPLI policy.  At this time, the Company expects that the EPLI carrier will participate in the defense or resolution of a part or all of the potential claims.

 

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 these proceedings and claims should not have a material adverse effect on the financial statements as a whole.  However, litigation involves an element of uncertainty.  Future developments could cause these actions or claims, individually or in aggregate, to have a material adverse effect on the financial statements as a whole.

 

11
 

 

Item 2.

Management's Discussion and Analysis of Financial

Condition and Results of Operations

 

GENERAL

 

Executive Overview

 

Fred's, Inc. and its subsidiaries ("Fred's", “We”, “Our”, “Us” or “Company”) operates, as of May 4, 2013, 715 discount general merchandise stores, including 21 franchised Fred's stores, in 15 states in the southeastern United States. There are currently 349 full service pharmacies in our stores.

 

As announced in our press release filed May 30, 2013, earnings per diluted share for the first quarter of 2013 ended May 4, 2013 increased 11% to $0.31 from $0.28 in the prior year, which followed a 17% increase in earnings per diluted share in the first quarter of fiscal 2012. Net income for the first quarter of 2013 increased 9% to $11.4 million from $10.5 million in the prior year.

 

Sales for the first quarter of 2013 were $501.5 million as compared to $500.5 million in 2012, a 0.2% increase. On a comparable store basis, sales for the first quarter declined 1.3% as compared to a decrease of 0.4% in the prior year. During the quarter, unseasonably cool weather impacted sales in our general merchandise weather sensitive product lines. In addition, the popularity of our Spring layaway program reduced sales and increased deferred layaway sales by $2.4 million over the first quarter of last year.

 

Our favorable earnings in the first quarter, when compared to the prior year, were primarily driven by gross profit improvement of 60 basis points over the same period last year. Pharmacy department gross margins were higher in the first quarter as a result of the shift from lower gross margin brand drugs to higher margin generics, as well as lower shrinkage. The gross margin improvement was partially offset by higher selling, general, and administrative expense related to new store and pharmacy growth. Although operating expenses increased $2.5 million and deleveraged by 50 basis points in the quarter, the increase is totally attributed to investments in future growth. Operating margin for the first quarter improved 10 basis points to 3.5% from 3.4% in the prior year.

 

Our pharmacy department is a key differentiating factor from other small-box discount retailers. Overall, the pharmacy department produced strong results in the quarter, with higher comparable prescription counts and increased gross margins despite continued sales pressure from the large brand-to-generic drug conversions that occurred throughout 2012, as well as on-going challenges in third-party reimbursements. Although the sales impact of the brand-to-generic drug conversion is negative, the gross margin on generic drugs is typically higher than brand drugs. Comparable script growth increased 2.6% and overall scripts increased 6.8% over last year. During the first quarter of 2013, four new pharmacies were opened and one pharmacy department was closed, totaling 349 pharmacy departments at quarter end.

 

During the first quarter, we announced the launch of our three-year reconfiguration plan designed to regain the momentum we experienced in the prior three years in driving toward our 4% operating margin goal. The main focus of our reconfiguration plan is to improve our overall store productivity and space efficiency while enhancing the product selection in stores with pharmacies. The plan has two fundamental principles: to aggressively accelerate our pharmacy department presence and to improve our general merchandise space efficiency and productivity.

 

Continuing to accelerate pharmacy department growth is a key component of our reconfiguration plan. Under the reconfiguration plan, we will focus on increasing our pharmacy department penetration to 65% to 70% of our store base from the current 50% over the next three years. To achieve this goal, we will concentrate on adding pharmacies to existing stores without pharmacy departments, open all new stores with a pharmacy department and make opportunistic acquisitions that will operate as Xpress pharmacy locations until they become a future full-service location. This growth in pharmacy department locations will position us to expand our specialty pharmacy program in 2013, the fastest-growing segment of the pharmacy industry. During 2012, we entered into an agreement with Diplomat Specialty Pharmacy to provide clinical and patient administration services necessary to manage our patients who are receiving specialty medications. Specialty medications are high cost drugs that are used to treat chronic or rare conditions such as cancer, multiple sclerosis, rheumatoid arthritis and other complex diseases.

 

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The reconfiguration plan in our general merchandise business is centered on expanding space in discretionary product lines. The three main areas of focus of our reconfiguration plan are the (1) expansion of our Hometown Auto and Hardware program, (2) expansion of seasonal space and (3) expansion of health and beauty aids in stores with pharmacy departments. In the third quarter of 2012, we began testing our reconfiguration plan by reallocating space in 78 stores to deploy our expanded Hometown Auto and Hardware program. During the first quarter of 2013, an additional 97 stores have been reset with the expanded Hometown Auto and Hardware program bringing the total stores expanded to 175. These test stores returned results that exceeded our plan by delivering comparable store sales increases in these departments of 15% to 43% and outperforming on total comparable store sales above the remainder of the chain. We expect to have approximately 50% of our total stores reset with the Hometown Auto and Hardware program by the end of the fiscal year. In stores with pharmacies, our general merchandise product offerings will be tailored to appeal to the pharmacy customer and will include the expansion of health and beauty aids, cosmetics, eye care, vitamins, pain relief and durable medical equipment. Over the next three years, we will reconfigure 12% to 15% of our selling square feet from less productive categories on a sales-per-square foot and gross margin-per-square foot basis to more productive categories. The goal of these changes is to shift our general merchandise business to a healthier balance between higher gross margin discretionary product lines and lower margin consumable products lines while expanding our pharmacy department and healthcare services offerings.

 

Our Core 5 program was launched in 2010 and continues to be a long-term strategy designed to highlight key categories within our stores that differentiate us from our competition. The Core 5 categories are Pet, Household Supplies, Celebration, Home and Pharmacy and are strong trip driving departments in which Fred’s has a clear and marketable advantage versus small box competitors. We continue to see improvement in stores that have been reformatted with the Core 5 layout, especially in the Pet, Household Supplies and Pharmacy Departments.

 

In addition to the launch of our three-year reconfiguration plan and the Core 5 program, other key initiatives in 2013 include our Discount Tobacco Shop, introduced in 2012, which continues to provide increased sales and customer traffic, and we expect the positive performance to continue throughout the year. In the first quarter, we continued our efforts to broaden our food and beverage assortment by adding new and expanded coolers in our top 100 food and beverage stores in order to add additional branded frozen and refrigerated products. We also plan to expand brands across a number of categories including softlines, toys, automotive and hardware and lawn and garden. In the first quarter, we introduced recognizable brands such as Dickies, Wrangler, Fruit of the Loom, Huggies, Dixie, Brawny, Igloo and Barbie to our product offerings. In the second and third quarters of 2013, we will provide additional advertising focusing around our discretionary product lines. We will continue to focus on improving store productivity through the Core 5 Program and on initiatives aimed at driving operating margin improvement. Our Fred’s team is committed to finding ways to help our financially challenged customer and building customer loyalty.

 

Our fred’s® brand initiative continues to be a key strategy for the Company in terms of building customer loyalty and increasing gross margin. As of May 4, 2013, our fred’s® brand penetration rate was 18.8% of consumable product sales, which deleveraged 40 basis points over last year as total consumable sales outpaced the growth of our fred’s® brand. Our commitment to quality in our fred’s® 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 and have seen significant penetration in our fred’s® branded paper, pet, health aids and automotive categories.

 

The launch of the Fred’s loyalty card in April 2012, called smartcard ™, rewards customers for qualifying purchases, primarily purchases of fred’s® brand products and higher margin categories such as home furnishings, auto and hardware. Since the launch of the smartcard ™, we’ve had approximately 1.6 million cards distributed with approximately 25% of those customers with enrolled accounts. The information gained from the usage of the smartcard ™ will be used to grow our loyal customer base and to direct the use of promotional funds towards those customers.

 

As previously published in our first quarter press release filed May 30, 2013, the Company expects total sales in 2013 to increase in the range of 2% to 4%. Comparable store sales are expected to be approximately flat. We anticipate general merchandise comparable store sales to continue their positive trend in the second quarter. The pharmacy department comparable store sales are expected to remain negative through the second quarter of 2013 due to the brand-to-generic shift, and we expect pharmacy department comparable store sales to turn positive by the end of the year as we anniversary the large generic drug shift which occurred in 2012. We plan to open in the range of 20 to 25 new stores and 25 to 30 new pharmacies in 2013 and close 20 to 25 stores and 3 pharmacies. In 2013, the Company is planning capital expenditures excluding the acquisition of prescription lists of approximately $27.2 million. Based on this outlook, the Company continues to expect total earnings per diluted share to be in the range of $0.77 to $0.88.

 

Key factors that will be critical to the Company’s future success include the successful performance of our reconfiguration plan, as well as managing the strategy for opening new stores and pharmacies. The successful opening of new stores and pharmacies includes 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.

 

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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 February 2, 2013. 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 May 4, 2013 and April 28, 2012

 

Sales

Net sales for the first quarter of 2013 were $501.5 million compared to $500.5 million in 2012, a year-over-year increase of $1.0 million or 0.2%. On a comparable store basis, sales decreased 1.3% compared with a decrease of 0.4% in the same period last year. Deferred layaway sales during the quarter totaled $3.6 million in 2013 as compared to $1.2 million in 2012, an increase of $2.4 million.

 

The Company's 2013 general merchandise (non-pharmacy) sales increased 0.6% over 2012. We experienced sales increases primarily in the tobacco, beverage, auto and hardware categories which were partially offset by decreases in seasonal categories such as lawn and garden, apparel and small appliances.

 

The Company’s pharmacy department sales were 36.1% of total sales ($180.3 million) in 2013 compared to 35.8% of total sales ($179.5 million) in the prior year and continue to rank as the largest department within the Company. The total sales in this department increased 0.7% over 2012 with third party prescription sales representing approximately 91% of total pharmacy sales, the same as in the prior year. Despite the continued pressure of the brand-to-generic shift on top-line sales, 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.

 

During the quarter, there were no changes to the franchised locations, with 21 franchised locations at May 4, 2013 and 21 franchised locations as of April 28, 2012. Sales to these locations during the quarter decreased to $8.4 million (1.7% of sales) from $8.9 million (1.8% of sales) in 2012. The Company does not intend to expand its franchise network.

 

The following table illustrates the sales mix unadjusted for deferred layaway sales:

 

   Thirteen Weeks Ended 
   May 4, 2013   April 28, 2012 
Pharmaceuticals   35.7%   35.8%
Household Goods   22.7%   23.4%
Food and Tobacco   17.6%   16.3%
Paper and Cleaning Supplies   8.4%   8.6%
Health and Beauty Aids   7.4%   7.4%
Apparel and Linens   6.5%   6.7%
Franchise   1.7%   1.8%
    100.0%   100.0%

 

For the quarter, comparable store customer traffic decreased 1.3% over last year while the average customer ticket remained flat at $21.22.

 

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Gross Profit

Gross profit for the quarter was $151.0 million in 2013 compared to $147.8 million in 2012, a year-over-year increase of $3.2 million or 2.1%. Gross margin, measured as a percentage of sales was 30.1% in 2013, compared with 29.5% in the same quarter last year. The 60 basis point improvement was driven by increased vendor rebates and allowances and pharmacy department shrink improvement. These improvements were offset by unfavorable markdowns in our general merchandise and pharmacy departments and unfavorable LIFO charges on pharmacy inventory.

 

Selling, General and Administrative Expenses

Selling, general and administrative expenses, including depreciation and amortization, were $133.2 million in 2013 (26.6% of sales) compared to $130.7 million in 2012 (26.1% of sales), an increase of $2.5 million. Selling, general and administrative expenses deleveraged 50 basis points as a percent of sales due to an increase in labor expense of $1.5 million (28 basis points), $0.9 million in higher depreciation and amortization (18 basis points) and $0.8 million of additional property rental (15 basis points), which are associated with new store and pharmacy growth. In addition to the deleveraging we experienced from investments in store and pharmacy growth, we also incurred a loss on the disposal of fixed assets of $1.0 million (19 basis points) primarily related to the closure of twenty locations, which began going-out-of business sales in the first quarter. The deleveraging was partially offset by a reduction in advertising expense of $1.0 million (21 basis points) and $0.7 million in higher proceeds from pharmacy script file sales over last year (13 basis points).

 

Operating Income

Operating income was $17.8 million in 2013 (3.5% of sales) compared to $17.1 million in 2012 (3.4% of sales). The year-over-year favorable variance is attributable to the $3.2 million increase in gross profit driven by increased vendor rebates and allowances and pharmacy department shrink improvement offset by the $2.5 million increase in selling, general and administrative expenses as detailed in the Selling, General and Administrative Expenses section above.

 

Interest Expense, Net

Net interest expense for the first quarter of 2013 totaled $0.1 million or less than 0.1% of sales compared to $0.1 million in the same period last year, which was also less than 0.1% of sales in 2012.

 

Income Taxes 

The effective income tax rate was 35.3% in 2013 compared to 38.4% in 2012. The decrease in the effective income tax rate is primarily the result of the reinstatement of the federal Work Opportunity Tax Credits (WOTC) at the end of 2012.

 

Net Income

Net income increased to $11.4 million ($0.31 per diluted share) in 2013 from $10.5 million ($0.28 per diluted share) in 2012. The increase in net income was due to the $3.2 million increase in gross profit as a result of increased vendor rebates and allowances and pharmacy department shrink improvement and $0.3 million in reduced tax expense resulting from the reinstatement of the federal Work Opportunity Tax Credits (WOTC) at the end of 2012. This favorability was offset by a $2.5 million increase in selling, general and administrative expenses as described in the Selling, General and Administrative Expenses section above.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Due to the seasonality of our business, inventories are generally lower at year-end than at each quarter-end of the following year.

 

Cash provided by operating activities totaled $18.2 million during the thirteen week period ended May 4, 2013 compared to $1.1 million in the same period of the prior year. We generated operating cash flow primarily through $11.4 million in year-to-date net income, an increase in operating liabilities of $10.6 million, a $10.3 million increase in depreciation and amortization and a $1.7 increase to the LIFO reserve, all of which resulted from our investment in new store and pharmacy growth. Also contributing to operating cash flow were a $1.9 million decrease in receivables and a $0.9 million increase to the provision for store closures. Operating cash flows were offset by an inventory increase of $18.6 million which is due to new store and pharmacy growth, inflation and seasonal merchandise purchases.

 

Cash used in investing activities totaled $9.1 million during the thirteen week period ended May 4, 2013 and consisted primarily of capital expenditures of $6.9 million related to existing store and pharmacy expenditures ($5.8 million), technology and other corporate expenditures ($0.6 million) and new store and pharmacy expenditures ($0.5 million). In addition, the Company planned expenditures of approximately $18.8 million in 2013 for the acquisition of prescription lists and other pharmacy related items of which $2.4 million has been spent to date. During the first quarter of 2013, we opened 4 new locations, comprising of 1 new store and 3 new Xpress pharmacies. Fred's also closed 1 store during the quarter. In 2013, the Company is planning capital expenditures excluding the acquisition of prescription lists of approximately $27.2 million. Expenditures are planned totaling $18.0 million for new and existing stores and pharmacies. Planned expenditures also include approximately $5.2 million for technology upgrades and approximately $4.0 million for distribution center equipment and other capital maintenance. Technology upgrades in 2013 will be made in the areas of IT software and hardware and store and pharmacy server upgrades. To date, the Company has spent $0.5 million towards these improvements.

 

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Cash used in financing activities totaled $9.4 million during the thirteen week period ended May 4, 2013. During the quarter, we borrowed $85.9 million under the revolving line of credit and made payments of $92.9 million on the revolving line of credit. We also paid cash dividends of $2.2 million. There were $5.9 million in borrowings outstanding at May 4, 2013 related to real estate mortgages compared to $6.6 million at February 2, 2013. The decrease is attributable to $0.7 million of payments on mortgage debt. There were no borrowings under the revolving line of credit at May 4, 2013.

 

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, we have 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 insurance costs.
·Increases in fuel and utility rates.
·Potential adverse results in the litigation described under Legal Proceedings (see Note 9 - Legal Contingencies).
·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 February 2, 2013.

 

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 May 4, 2013. We are exposed to financial market risks, including changes in interest rates. We had no borrowings under our Revolving Loan and Credit Agreement, which bears interest at our option, on a sliding scale from 1.00% - 1.625% plus LIBOR, or an alternative base 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.

 

16
 

 

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 Exchange Act 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 May 4, 2013 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.  On or about March 15, 2013, the Magistrate Judge issued a Report and Recommendation that the case be conditionally certified as a collective action, which the District Court Judge affirmed. As a result, notice of a collective action is being sent to the appropriate class as required by the Court. The Company believes that all of its assistant managers have been properly paid and that the matter is not appropriate for collective action treatment.  The Company is and will continue to vigorously defend this matter, however, it is not possible to predict whether Chapman will ultimately be able to proceed collectively and no assurances can be given that the Company will be successful in the defense of the action on the merits or otherwise.  In accordance with FASB ASC 450, “Contingencies”, the Company does not believe that a loss in this matter is probable at this time.  For these reasons, the Company is unable to estimate any potential loss or range of loss in the matter.  The Company has tendered the matter to its Employment Practices Liability Insurance (“EPLI”) carrier for coverage under its EPLI policy.  At this time, the Company expects that the EPLI carrier will participate in the defense or resolution of a part or all of the potential claims.

 

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 these proceedings and claims should not have a material adverse effect on the financial statements as a whole.  However, litigation involves an element of uncertainty.  Future developments could cause these actions or claims, individually or in aggregate, to have a material adverse effect on the financial statements as a whole.

 

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 February 2, 2013, 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.

 

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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 the open market or through privately negotiated transactions at such times and at such prices as determined to be in the Company’s best interest. On February 16, 2012, Fred's Board authorized the expansion of the Company's existing stock repurchase program by increasing the authorization to repurchase an additional 3.6 million shares or approximately 10% of the current outstanding shares. These repurchases 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 May 4, 2013 (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
    Authorized
Share
Expansion
   Maximum Number of
Shares That May Yet
Be Purchased Under
the Plans or Program
 
                           
Balance at February 2, 2013                        3,040.8 
February 3 - March 2, 2013   -   $-    -          3,040.8 
March 4 - April 6, 2013   -   $-    -          3,040.8 
April 7, - May 4, 2013   -   $-    -          3,040.8 

 

Item 6. Exhibits

 

Exhibits

31.1Certification of Chief Executive Officer.
31.2Certification of Chief Financial Officer.
32Certification 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.

 

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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: June 13, 2013   /s/ Bruce A. Efird
    Bruce A. Efird
    Chief Executive Officer and President
     
Date: June 13, 2013   /s/ Jerry A. Shore
    Jerry A. Shore
    Executive Vice President and
    Chief Financial Officer

 

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