FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended April 29, 2000. 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 000-19288 FRED'S, INC. (Exact name of registrant as specified in its charter) Tennessee 62-0634010 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4300 New Getwell Rd., Memphis, Tennessee 38118 (Address of principal executive offices) (zip code) (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 . ----------- ----------- The registrant had 12,025,096 shares of Class A voting, no par value common stock outstanding as of June 9, 2000. FRED'S, INC. INDEX Page No. - -------------------------------------------------------------------------------- Part I - Financial Information Item 1 - Financial Statements (unaudited): Consolidated Balance Sheets as of April 29, 2000 and January 29, 2000 3 Consolidated Statements of Income for the Thirteen Weeks Ended April 29, 2000 and May 1, 1999 4 Consolidated Statements of Cash Flows for the Thirteen Weeks Ended April 29, 2000 and May 1, 1999 5 Notes to Consolidated Financial Statements 6 - 8 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 9 - 11 Item 3 - Quantitative and Qualitative Disclosure about Market Risk 11 Part II - Other Information 12 - --------------------------- Signatures 13 - ---------- FRED'S, INC. CONSOLIDATED BALANCE SHEETS (unaudited) (in thousands, except for number of shares) April 29, January 29, 2000 2000 ---- ---- ASSETS: Current assets: Cash and cash equivalents $ 4,486 $ 3,036 Receivables, less allowance for doubtful Accounts of $452 ($452 at January 29, 2000) 11,118 10,911 Inventories 145,143 141,612 Deferred income taxes 2,162 3,002 Other current assets 649 1,865 --- ----- Total current assets 163,558 160,426 Property and equipment, at depreciated cost 74,952 73,459 Equipment under capital leases, less accumulated amortization of $968 ($856 at January 29,2000) 1,723 1,835 Deferred income taxes 1,441 866 Other noncurrent assets 4,116 3,636 ----- ----- Total assets $ 245,790 $ 240,222 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 37,608 $ 39,653 Current portion of indebtedness 2,045 30,306 Current portion of capital lease obligations 447 430 Accrued liabilities 9,075 9,680 Income taxes payable 2,270 650 ----- --- Total current liabilities 51,445 80,719 ------ ------ Long term portion of indebtedness 42,184 10,027 Capital lease obligations 1,615 1,734 Other noncurrent liabilities 1,873 1,829 ----- ----- Total liabilities 97,117 94,309 ------ ------ Shareholders' equity: Common stock, Class A voting, no par value, 11,976,728 shares issued and outstanding (11,988,276 shares at January 29, 2000) 67,209 67,326 Retained earnings 81,734 78,902 Deferred compensation on restricted Stock incentive plan (270) (315) ---- ---- Total shareholders' equity 148,673 145,913 ------- ------- Total liabilities and shareholders equity $ 245,790 $ 240,222 ========= ========= See accompanying notes to consolidated financial statements FRED'S, INC. CONSOLIDATED STATEMENTS OF INCOME (unaudited) (in thousands, except per share amounts) Thirteen Weeks Ended -------------------- April 29, May 1, 2000 1999 ---- ---- Net Sales $176,660 $154,934 Cost of goods sold 127,538 110,615 ------- ------- Gross Profit 49,122 44,319 Selling, general and administrative Expenses 43,162 39,421 ------ ------ Operating income 5,960 4,898 Interest expense 673 452 --- --- Income before income taxes 5,287 4,446 Provision for income taxes 1,855 1,560 ----- ----- Net income $ 3,432 $ 2,886 ======== ======== Net income per share: Basic $ .29 $ .24 ======== ======== Diluted $ .28 $ .24 ======== ======== Weighed average shares outstanding: Basic 11,890 11,813 ====== ====== Diluted 12,080 12,036 ====== ====== See accompanying notes to consolidated financial statements FRED'S, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands) Thirteen Weeks Ended -------------------- April 29, May 1, 2000 1999 ---- ---- Cash flows from operating activities: Net income $ 3,432 $ 2,886 Adjustments to reconcile net income To net cash flows from operating activities: Depreciation and amortization 3,335 2,776 Lifo reserve 200 200 Deferred income taxes 265 624 Amortization of deferred compensation on restricted stock incentive plan 38 69 Cancellation of restricted stock (202) -- (Increase)decrease in assets: Receivables (207) (679) Inventories (3,731) (5,684) Other assets 408 (273) Increase (decrease) in liabilities: Accounts payable and accrued liabilities (2,650) (6,774) Income taxes payable 1,620 940 Other noncurrent liabilities 44 40 ----- ------ Net cash provided by (used in)operating activities 2,552 (5,875) ----- ------ Cash flows from investing activities: Capital expenditures (4,388) (3,985) ------ ------ Net cash used in investing activities (4,388) (3,985) ------ ------ Cash flows from financing activities: Reduction of indebtedness and capital lease obligations (102) (420) Proceeds from revolving line of credit, net of payments 3,896 6,300 Proceeds from term loan ---- 2,250 Proceeds from exercise of options 92 107 Cash dividends paid (600) (599) ----- ------ Net cash provided by financing activities 3,286 7,638 ----- ----- Increase (decrease) in cash and cash Equivalents 1,450 (2,222) Beginning of period cash and cash Equivalents 3,036 2,406 ----- ----- End of period cash and cash equivalents $ 4,486 $ 184 ======= ======= Supplemental disclosures of cash flow information: Interest paid $ 361 $ 453 ======= ======= Income taxed paid -- -- ======= ======= See accompanying notes to consolidated financial statements FRED'S, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1: BASIS OF PRESENTATION Fred's, Inc. ("Fred's" or the "Company") operates 322 discount general merchandise stores, including 26 franchised Fred's stores, in ten states in the southeastern United States. One hundred and eighty-five of the stores have full service pharmacies. The accompanying unaudited consolidated financial statements of Fred's have been prepared in accordance with the instructions to 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 generally accepted accounting principles. The statements do reflect all adjustments (consisting of only normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of financial position in conformity with generally accepted accounting principles. The statements should be read in conjunction with the Notes to the Consolidated Financial Statements for the fiscal year ended January 29, 2000 incorporated into the Company's Annual Report on Form 10-K. The results of operations for the thirteen-week period ended April 29, 2000 are not necessarily indicative of the results to be expected for the full fiscal year. Certain prior quarter amounts have been reclassified to conform to the 2000 presentation. NOTE 2: INVENTORIES Wholesale inventories are stated at the lower of cost or market using the FIFO (first-in, first-out) method. Retail inventories are stated at the lower of cost or market as determined by the retail inventory method. For pharmacy inventories, which comprise approximately 16% of the retail inventories at April 29, 2000, cost was determined using the LIFO (last-in, first-out) method. For the remainder of the retail inventories, the FIFO method was applied. The current cost of inventories exceeded the LIFO cost by approximately $3,408,000 and $3,208,000 at April 29, 2000 and January 29, 2000, respectively. LIFO inventory costs can only be determined annually when inflation rates and inventory levels are finalized; therefore, LIFO inventory costs for interim financial statements are estimated. NOTE 3: NET INCOME PER SHARE Basic income per share is based on the weighted average number of common shares outstanding, and diluted net income per share is based on the weighted average number of common shares and common equivalent shares outstanding. COMPUTATION OF NET INCOME PER SHARE (unaudited) (in thousands, except per share amounts) Thirteen Weeks Ended -------------------- April 29, May 1, 2000 1999 ---- ---- Basic net income per share Net income $ 3,432 $ 2,886 ======= ======= Weighted average number of common shares Outstanding during the period 11,890 11,813 ====== ====== Net income per share $ .29 $ .24 ======= ======= Diluted net income per share Net income $ 3,432 $ 2,886 ======= ======= Weighted average number of common shares Outstanding during the period 11,890 11,813 Additional shares attributable to common Stock equivalents 190 223 --- --- 12,080 12,036 ====== ====== Net income per share $ .28 $ .24 ======= ======= NOTE 4: LOAN AND LOAN MODIFICATION AGREEMENT On April 3, 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement (the "Agreement") to replace the May 15, 1992 Revolving Loan and Credit Agreement, as amended. The Agreement provides the Company with an unsecured revolving line of credit commitment of up to $40 million and bears interest at the lesser of 1.5% below prime rate or a LIBOR-based rate. Under the most restrictive covenants of the Agreement, the Company is required to maintain specified shareholder's equity and net income levels. The Company is required to pay a commitment fee to the bank at a rate per annum equal to .18% on the unutilized portion of the revolving line commitment over the term of the agreement. The term of the Agreement extends to April 3, 2003. On May 26, 2000, subsequent to the press release dated May 16, 2000, the Company negotiated a modification to its revolving loan and credit agreement (the "agreement") entered into on April 3, 2000. The agreement modified the terms "Due on Demand" and accordingly the Company has reclassified the debt as long term. Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL Fred's business is subject to seasonal influences, but the Company has tended to experience less seasonal fluctuation than many other retailers due to the Company's mix of everyday basic merchandise and pharmacy business. The fourth quarter is typically the most profitable quarter because it includes the Christmas selling season. The overall strength of the fourth quarter is partially mitigated, however, by the inclusion of the month of January, which is generally the least profitable month of the year. The impact of inflation on labor and occupancy costs can significantly affect Fred's operations. Many of Fred's employees are paid hourly rates related to the federal minimum wage and, accordingly, any increase affects Fred's. In addition, payroll taxes, employee benefits and other employee-related costs continue to increase. Occupancy costs, including rent, maintenance, taxes and insurance, also continue to rise. Fred's believes that maintaining adequate operating margins through a combination of price adjustments and cost controls, careful evaluation of occupancy needs, and efficient purchasing practices is the most effective tool for coping with increasing costs and expenses. RESULTS OF OPERATIONS Thirteen Weeks Ended April 29, 2000 and May 1, 1999 Net sales increased to $176.7 million in 2000 from $154.9 million in 1999, an increase of $21.8 million or 14.1%. The increase was attributable to comparable store sales increases of 9.4% ($13.5 million) and sales by stores not yet included as comparable stores ($8.4 million). Sales to franchisees decreased $.1 million in 2000. The sales mix for the period was 47.6% Hardlines, 32.8% Pharmacy, 14.6% Softlines, and 5.0% Franchise. This compares with 47.9% Hardlines, 32.7% Pharmacy, 13.7% Softlines, and 5.7% Franchise for the same period last year. Gross profit decreased to 27.8% of sales in 2000 compared with 28.6% of sales in the prior-year period. Gross profit margins decreased as a result of the increased mix of certain categories in hardline sales and strong quarterly sales in pharmacy which typically carry lower margins. Selling, general and administrative expenses increased to $43.2 million in 2000 from $39.4 million in 1999. As a percentage of sales, expenses decreased to 24.4% of sales compared to 25.4% of sales last year. Selling, general and administrative expenses were improved primarily due to controlling costs and improving efficiencies in the store and pharmacy operations. Improved performance in the distribution operations and better merchandising practices have resulted in stronger control of labor and related costs at the store. Interest expense increased to $.7 million in 2000 from $.5 million in 1999, reflecting higher average revolver borrowings than last year for inventory purchases to improve store in-stock positions. LIQUIDITY AND CAPITAL RESOURCES Due to the seasonality of Fred's 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 flow provided by operating activities totaled $2.6 million during the thirteen-week period ended April 29, 2000. Cash was primarily used to increase inventories and reduce accounts payable. Total inventories increased approximately $3.7 million in the first quarter of 2000. This increase was primarily attributable to 4 new stores and 3 new pharmacies in the first quarter of 2000, coupled with the additional inventory necessary to improve store in-stock positions over 1999. Accounts payable decreased approximately $2.6 million in the first quarter of 2000. Cash flows used by investing activities totaled $4.4 million, and consisted primarily for capital expenditures associated with the Company's store and pharmacy expansion program. During the first quarter, the Company opened 4 stores and closed 1 store. The Company expects to open 12 to 15 stores in the second quarter, and approximately 20 to 30 stores for the year. The Company's capital expenditure plan for the year 2000 is in the $12 million dollar range and will approximate depreciation expense for the year. Cash flows provided by financing activities totaled $3.3 million and included $3.9 million of borrowings under the Company's revolver for inventory and accounts payable needs. On April 3, 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement (the "Agreement") to replace the May 15, 1992 Revolving Loan and Credit Agreement, as amended. The Agreement provides the Company with an unsecured revolving line of credit commitment of up to $40 million and bears interest at the lesser of 1.5% below prime rate or a LIBOR-based rate. Under the most restrictive covenants of the Agreement, the Company is required to maintain specified shareholder's equity and net income levels. The Company is required to pay a commitment fee to the bank at a rate per annum equal to .18% on the unutilized portion of the revolving line commitment over the term of the agreement. The term of the Agreement extends to April 3, 2003. The borrowings outstanding under this agreement at April 29, 2000 were $32.5 million. The borrowings outstanding under the previous Agreement at May 1, 1999 were $16.5 million. On May 5, 1998, the Company and a bank entered into a Loan Agreement (the "Loan Agreement"). The Loan Agreement provided the Company with an unsecured term loan of $12 million to finance the modernization and automation of the Company's distribution center and corporate facilities. The Loan Agreement bears interest of 6.82% per annum and matures on November 1, 2005. Borrowings outstanding under this Loan Agreement totaled $9,954,000 at April 29, 2000 and $11,322,000 at May 1, 1999. On April 23, 1999, the Company and a bank entered into a Loan Agreement (the "Loan Agreement"). The Loan Agreement provided the Company with a four-year unsecured term loan of $2,250,000 to finance the replacement of the Company's mainframe computer system. The Loan Agreement bears interest of 6.15% per annum and matures on April 15, 2003. Borrowings outstanding under this agreement totaled $1,734,000 at April 29, 2000 and $2,250,000 at May 1, 1999. The Company believes 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. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION Statements, other than those based on historical facts, are forward-looking statements which are based upon a number of assumptions concerning future conditions that may ultimately prove to be inaccurate. Actual events and results may materially differ from anticipated results described in such statements. The Company's ability to achieve such results is subject to certain risks and uncertainties, including, but not limited to, economic and weather conditions which affect buying patterns of the Company's customers, changes in consumer spending and the Company's ability to anticipate buying patterns and implement appropriate inventory strategies, continued availability of capital and financing, competitive factors, and other factors affecting business beyond the Company's control. Consequently, all of the forward-looking statements are qualified by these cautionary statements and there can be no assurance that the results or developments anticipated by the Company will be realized or that they will have the expected effects on the Company or its business or operations. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK The Company has no holdings of derivative financial or commodity instruments as of April 29, 2000. The Company is exposed to financial market risks, including changes in interest rates. All borrowings under the Company's Revolving Credit Agreement bear interest at 1.5% below prime rate or a LIBOR-based rate. An increase in interest rates of 100 basis points would not significantly affect the Company's income. All of the Company's business is transacted in U.S. dollars and, accordingly, foreign exchange rate fluctuations have never had a significant impact on the Company, and they are not expected to in the foreseeable future. RECENT ACCOUNTING PRONOUNCEMENTS In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 deals with various revenue recognition issues, several which are common within the retail industry including treatment of revenue recognition on layaway sales. The company is currently developing a system to report the effects of SAB 101. However, the effect of layaway sales in this quarter is not material in relation to the overall financial statements. PART II. OTHER INFORMATION Item 1. Legal Proceedings Not Applicable. Item 2. Changes in Securities Not Applicable. Item 3. Defaults Upon Senior Securities Not Applicable. Item 4. Submission of Matters to a Vote of Securities Holders Not Applicable. Item 5. Other Information Not Applicable. Item 6. Exhibits and Reports on Form 8-K Exhibits: Exhibit 10.24-Loan modification agreement dated May 26, 2000 (modifies the Revolving Loan agreement included as Exhibit 10.23) [incorporated herein by reference to the Company's report on Form 10-K for the year ended January 29, 2000.] Exhibit 27 - Financial Data Schedule (Edgar Filing only) Reports on Form 8-K: Not Applicable. 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 9, 2000 /s/ Michael J. Hayes - ------------------- -------------------- Michael J. Hayes Chief Executive Officer Date: June 9, 2000 /s/ Jerry A. Shore - ------------------- ------------------ Jerry A. Shore Chief Financial Officer EXHIBIT 10.24 MODIFICATION AGREEMENT THIS MODIFICATION AGREEMENT, made and entered into on this 26th day of May, 2000, by and between UNION PLANTERS BANK, N.A. ("Bank"), SunTrust Bank ("Documentation Agent"), and FRED'S, INC., a Tennessee corporation ("Borrower"). WITNESSETH: WHEREAS, Borrower executed a promissory note (the "Note") dated April 3, 2000, in the original principal sum of Forty Million Dollars ($40,000,000.00) held by and payable to the Bank, which Note was executed in connection with the Credit Agreement (Restated), dated March 27, 2000, effective as of April 3, 2000 (the "Agreement"), by and among Borrower, Documentation Agent and Bank; and WHEREAS, Borrower desires to obtain from Bank and Documentation Agent a modification of the terms of payment of the Note, and Bank and Documentation Agent are willing to grant said modification upon the agreement of Borrower to make, keep and perform all of the terms, conditions and covenants hereinafter set forth. NOW, THEREFORE, in consideration of the premises, the sum of Ten Dollars ($10.00) cash in hand paid and other valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties do hereby agree as follows: 1. The terms of the Note are hereby modified, effective as of April 3, 2000, to provide that the Note shall not be payable on demand absent the occurrence of an event of default or other condition which would allow Bank to accelerate the maturity pursuant to the terms of the Agreement. The outstanding principal balance of the Note and accrued but unpaid interest shall be due and payable on April 3, 2003. Interest on the outstanding principal balance shall accrue and be payable as provided in the Agreement. 2. Bank agrees to make a notation upon its records showing that the Note has been modified as set forth herein. 3. In consideration of the modification granted herein, Borrower promises to pay the indebtedness evidenced by the Note as set forth hereinabove, to keep and perform all the covenants, terms and conditions contained in any agreement or document governing the terms and conditions of the borrowing affected hereby, in default of which the holder of said indebtedness, at its option, may declare said indebtedness accelerated and matured for all purposes, and may proceed to exercise, at its option, any right or privilege granted in any documents or by law. It is expressly understood and agreed that the terms, covenants and conditions of all instruments evidencing the aforesaid indebtedness shall remain in full force and effect, and shall in no manner be affected by the execution of this Modification Agreement except as the same are expressly modified herein. 4. This Modification Agreement shall be binding upon and inure to the benefit of the parties hereto, successors, assigns, transferees and grantees, and shall be governed and construed in accordance with the laws of the State of Tennessee. 5. IN WITNESS WHEREOF, the parties hereunto have executed this Agreement on the date first above written. BANK: BORROWER: UNION PLANTERS BANK, N.A. FRED'S, INC. By:/s/ Elizabeth Rouse By:/s/ Jerry A. Shore ------------------- ------------------ Title: Senior Vice President Title: Chief Financial Officer DOCUMENTATION AGENT: SUNTRUST BANK By: /s/ B.W. Ford ------------- Title: Vice President