| DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES | NOTE
1 — DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Description
of business. Consolidated
Financial Statements. Subsequent
Events. Fiscal
year. Use
of estimates. Cash
and cash equivalents. Allowance
for doubtful accounts Inventories.
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. 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 storeÂ’s shrink rate, which
is based on the previously mentioned factors, by the interim periodÂ’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 CompanyÂ’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 methodology that we have applied in
estimating shrink has resulted in variability that is not material to our financial statements. Management
believes that the CompanyÂ’s retail inventory method provides an inventory valuation which reasonably approximates cost and
results in valuing inventory at the lower of cost or market. For pharmacy department inventories, which were approximately $49.9
million, and $43.5 million at January 30, 2016 and January 31, 2015, 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
highly inflationary 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 $47.5 million at January 30, 2016 and $39.9 million at January
31, 2015. The LIFO reserve increased by approximately $7.6 million and $4.7 million during 2015 and 2014, respectively. The
Company has historically included an estimate of inbound freight and certain general and administrative costs in merchandise inventory
as prescribed by U.S. 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 January 30, 2016 is
$21.2 million compared to $19.4 million at January 31, 2015. In
the second quarter of 2014, the Company recorded markdowns on product that management identified as low-productive and does not
fit our go-forward convenient and pharmacy healthcare services model. The Company recorded a below-cost inventory adjustment in
accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”)
330, "Inventory," of approximately $12.5 million (including $1.6 million, for the accelerated recognition of freight capitalization
expense) in cost of goods sold to value inventory at the lower of cost or market on inventory identified as low-productive, which
the Company began liquidating in accordance with our strategic plan. The
Company recorded $0.7 million and $3.3 million of below-cost inventory adjustments during the years ended January 30, 2016 January
31, 2015, respectively, in connections with planned store closures. No below cost inventory adjustment was recorded during the
year ended February 1, 2014 in connection with planned store closures (see Note 12 - Exit and Disposal Activity). Property
and equipment. The
following average estimated useful lives are generally applied:
Estimated
Useful Lives
Building and building
improvements 8 - 31.5 years
Furniture, fixtures
and equipment 3 - 10 years
Leasehold improvements 3 - 10 years
or term of lease, if shorter
Automobiles and vehicles 3 - 10 years
Airplane 9 years Assets
under capital lease are amortized in accordance with the CompanyÂ’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. There was no amortization expense on assets under capital lease for 2015. Leases.
The
Company recognizes contingent rental expense when the achievement of specified sales targets are considered probable in accordance
with FASB ASC 840 “Leases”. The amount expensed but not paid was $0.7 million and $0.9 million at January 30, 2016 and
January 31, 2015, respectively, and is included in “Accrued expenses and other” in the consolidated balance sheet (See
Note 2 - Detail of Certain Balance Sheet Accounts). The
Company occasionally receives reimbursements from landlords to be used towards construction of the store the Company intends to
lease. The reimbursement is primarily for the purpose of performing work required to divide a much larger location into smaller
segments, one of which the Company will use for its store. This work could include the addition or demolition of walls, separation
of plumbing, utilities, electrical work, entrances (front and back) and other work as required. Leasehold improvements are recorded
at their gross costs including items reimbursed by landlords. The reimbursements are initially recorded as a deferred credit and
then amortized as a reduction of rent expense over the initial lease term. Based
upon an overall analysis of store performance and expected trends, we periodically evaluate the need to close underperforming
stores. When we determine that an underperforming store should be closed and a lease obligation still exists, we record the estimated
future liability associated with the rental obligation on the date the store is closed in accordance with FASB ASC 420, “Exit
or Disposal Cost Obligations.” Liabilities are computed based at the point of closure 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. The assumptions in calculating the liability include the timeframe expected to terminate the lease
agreement, estimates related to the sublease of potential closed locations, and estimation of other related exit costs. If the
actual timing and the potential termination costs or realization of sublease income differ from our estimates, the resulting liabilities
could vary from recorded amounts. We periodically review the liability for closed stores and make adjustments when necessary. Impairment
of long-lived assets. During
2014, in association with the planned closure of stores not meeting the Company's operational performance targets, we recorded
a charge of $2.9 million in selling, general and administrative expense for the impairment of fixed assets and leasehold improvements.
The Company recorded an additional charge of $0.3 million in 2015 related to the 2014 store closures. In the fourth quarter of
2015, the Company recorded an additional charge of $0.5 million related to five stores that are scheduled to close in early fiscal
2016. No impairment charge was recorded in 2013. Impairment
of goodwill and other intangibles. Additionally,
we make judgments about the recoverability of purchased finite-lived intangible assets whenever events or changes in circumstances
indicate that impairment may exist. Recoverability of finite-lived intangible assets is measured by comparing the carrying amount
of the asset to the future undiscounted cash flows that the asset is expected to generate. We perform an annual impairment assessment
in the fourth quarter of each year for finite-lived intangible assets, or more frequently if indicators of potential impairment
exist, to determine whether it is more likely than not that the carrying value of the assets may not be recoverable. Recoverability
of indefinite-lived intangible assets is measured by comparing the carrying amount of the asset to the future discounted cash
flows that the asset is expected to generate. If we determine that an individual asset is impaired, the amount of any impairment
is measured as the difference between the carrying value and the fair value of the impaired asset. The assumptions and estimates
used to determine future values and remaining useful lives of our intangible assets are complex and subjective. They can be affected
by various factors, including external factors such as industry and economic trends, and internal factors such as changes in our
business strategy and our forecasts for specific product lines. As
of November 1, 2015, we concluded that there are no indicators of impairment that would cause us to believe that it is more likely
than not that the fair value of our reporting units is less than the carrying value or that the fair value of our indefinite-lived
intangibles is less than the carrying value. Accordingly, we did not perform the two-step impairment test for goodwill or indefinite-lived
intangibles. Revenue
recognition. Revenue
from sales of pharmaceutical products is recognized at the time the prescription is filled. This approximates when a customer
picks up the prescription or when the prescription has been delivered and is recorded net of an allowance for prescriptions that
were filled but not picked up by the customer. For all periods presented, there is no material difference between the revenue
recognized at the time the prescription is filled and that which would be recognized when the customer picks up the prescription.
Prescriptions are generally not returnable. The
Company also sells gift cards for which revenue is recognized at the time of redemption. The Company records a gift card liability
on the date the gift card is issued to the customer. Revenue is recognized and the gift card liability is reduced as the customer
redeems the gift card. The Company will recognize aged liabilities as revenue when the likelihood of the gift card being redeemed
is remote. During 2015, we recognized $0.1 million of gift card revenue, or less than $0.01 per share, while during 2014 we recognized
$1.0 million of gift revenue, or $0.02 per share. No gift card revenue was recognized in 2013. In
addition, the Company charges its franchised stores a fee based on a percentage of their purchases from the Company. These fees
represent a reimbursement for use of the Fred's name and other administrative costs incurred on behalf of the franchised stores.
Total franchise income for 2015, 2014 and 2013 was $1.5 million, $1.5 million and $1.6 million, respectively. Cost
of goods sold. Vendor
rebates and allowances. Selling,
general and administrative expenses. Advertising.
Pre-opening
costs. Intangible
assets. Other
identifiable intangible assets, net of accumulated amortization, totaled $97.2 million at January 30, 2016, and $79.5 million
at January 31, 2015. Accumulated amortization at January 30, 2016 and January 31, 2015 totaled $85.1 million and $66.4 million,
respectively.
(in
millions) January
30, 2016 January
31, 2015 Estimated
Useful Lives (years)
Customer
prescription files $ 76,811 $ 69,601 4 - 7
Non-compete agreements 10,417 9,941 3 - 15
Trade names 7,300 - -
Software 1,765 - 3
Referral and relationships 817 - 2
Business
licenses 43 - 1
$ 97,153 $ 79,542 Amortization
expense for 2015, 2014 and 2013, was $18.7 million, $12.1 million and $12.1 million, respectively. Estimated
amortization expense for the assets recognized as of January 30, 2016, in millions for each of the next 7 years is as follows:
(in
millions) 2016 2017 2018 2019 2020 2021 2022
Estimated
amortization expense $ 19.9 $ 19.1 $ 17.9 $ 13.7 $ 10.3 $ 5.9 $ 2.1 Goodwill.
Fair
value of financial instruments.
· 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, which are based on an entityÂ’s own assumptions as there is little,
if any, observable activity in identical assets or liabilities. At
January 31, 2016, the Company did not have any outstanding derivative instruments. The recorded value of the CompanyÂ’s financial
instruments, which include cash and cash equivalents, receivables, accounts payable and indebtedness, approximates fair value.
The following methods and assumptions were used to estimate fair value of each class of financial instrument: (1) the carrying
amounts of current assets and liabilities approximate fair value because of the short maturity of those instruments and (2) the
fair value of the CompanyÂ’s indebtedness is estimated based on the current borrowing rates available to the Company for bank
loans with similar terms and average maturities. Most of our indebtedness is under variable interest rates. Insurance
reserves Stock-based
compensation. Effective
January 29, 2006, the Company elected to adopt the alternative transition method provided in FASB ASC 718 for calculating
the income tax effects of stock-based compensation. The alternative transition method includes simplified methods to establish
the beginning balance of the additional paid-in-capital pool (“APIC Pool”) related to the income tax effects of stock
based compensation, and for determining the subsequent impact on the APIC pool and consolidated statements of cash flows of the
income tax effects of stock-based compensation awards that are outstanding upon adoption of FASB ASC 718. 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. The impact of adopting FASB ASC 718 on future results will depend on, among
other things, levels of share-based payments granted in the future, actual forfeiture rates and the timing of option exercises. Stock-based
compensation expense, post adoption of FASB ASC 718, 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 CompanyÂ’s historical forfeiture experience
and will be revised in subsequent periods if actual forfeitures differ from those estimates. Income
taxes. The
Company also applies the guidance of FASB ASC 740-10-25, Income Taxes, Uncertain Tax Positions, Valuation
allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.
Significant judgment is required in evaluating the need for and magnitude of appropriate valuation allowances against deferred
tax assets. The realization of these assets is dependent on generating future taxable income, as well as successful implementation
of various tax planning strategies. While
FredÂ’s believes that these judgments and estimates are appropriate and reasonable under the circumstances, actual resolution
of these matters may differ from recorded estimated amounts. Business
segments. Comprehensive
income. Reclassifications.
Recent
Accounting Pronouncements. Revenue from Contracts
with Customers (Topic 606). Revenue Recognition Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date In
April 2015, the Financial Accounting Standards Board issued ASU 2015-16, Intangibles-Goodwill and Other-Internal-Use Software
(Subtopic 350-40): CustomerÂ’s Accounting for Fees Paid in a Cloud Computing Arrangement In
September 2015, the Financial Accounting Standards Board issued ASU 2015-16, Business Combinations (Topic 805): Simplifying
the Accounting for Measurement-Period Adjustments. In
November 2015, the Financial Accounting Standards Board issued ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification
of Deferred Taxes In
February 2016, the Financial Accounting Standards Board issued ASU 2016-02, Leases (Topic 842) In
March 2016, the Financial Accounting Standards Board issued ASU 2016-04, Liabilities – Extinguishments of Liabilities
(Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products |
