1995 ANNUAL REPORT
Company Profile
Fred's, Inc., founded in 1947, operates 201 discount general
merchandise stores in 10 Southeastern states. The Company also
markets goods and services to 34 franchised stores. Fred's
stores stock more than 12,000 frequently purchased items that
address the everyday needs of its customers, including nationally
recognized brand name products, proprietary "Fred's" label
products, and lower-priced, off-brand products. The Company is
headquartered in Memphis, Tennessee.
FINANCIAL HIGHLIGHTS
(in thousands, except per share amounts)
53 Weeks 52 Weeks
Ended Ended
February 3, January 28,
1996 1995 Change
- ------------------------------------------------------------
Operating Data
Net sales $410,086 $380,702 7.7%
Operating income 4,771 13,563 (64.8%)
Net income 2,733 8,373 (67.4%)
Net income per share .29 .90 (67.8%)
Weighted average shares
outstanding 9,322 9,307 .2%
Balance Sheet Data
Working capital $ 59,349 $ 62,053 (4.4%)
Total assets 158,023 151,585 4.2%
Long-term debt (including
capital leases) 1,779 3,740 (52.4%)
Shareholders' equity 115,570 114,457 1.0%
Long-term debt to
capitalization 1.5% 3.2%
TO OUR SHAREHOLDERS
During 1995, Fred's faced tough conditions as consumers
generally remained reluctant to increase discretionary spending.
This difficult environment, which seemed to cut across all
segments of our industry, led to sluggish sales results for the
year. In addition, our transition to a new competitive pricing
strategy during 1995 had an impact on both sales and earnings.
We remain convinced that this move will enhance our competitive
position in the coming years and support our long-term growth
strategies that are intended to ensure Fred's successful future.
Financial Results
Net sales for the year ended February 3, 1996, rose 8% to
$410,086,000 compared with $380,702,000 for the year ended
January 28, 1995. Net income for 1995 totaled $2,733,000 or $.29
per share compared with $8,373,000 or $.90 per share in 1994.
It should be noted that because Fred's fiscal year falls on
the Saturday closest to January 31, fiscal 1995 was a 53-week
reporting period. As a result, the sales results for 1995 are
not directly comparable with those of the prior 52-week fiscal
year ended January 28, 1995. However, by adding the week ended
February 4, 1995, to the prior-year results, and thereby
obtaining a similar 53-week period, a meaningful comparison can
be made. On this basis, total sales for 1995 increased 5% from
$388.9 million in the 53-week period ended February 4, 1995,
while comparable store sales rose 1.3% on the continued strength
of our pharmacy department.
As part of the new competitive pricing program we introduced
in December 1994, we reduced prices on hundreds of items
throughout our stores. Primarily because of this change, gross
margins fell one and one-half percentage points, or the
equivalent of about $6.3 million at the 27.0% gross margin rate
we achieved in 1994. Ordinarily, the margin impact of lower
selling prices would have been offset by increased unit sales
volume, however this did not occur because of slow apparel sales
throughout much of the year and a weak Christmas selling season,
both of which affected most retailers in 1995.
Fred's selling, general and administrative expenses
increased as a percentage of sales during 1995 which, when
combined with the lower gross margin, caused our operating margin
to decline to 1.2% from 3.6% in the preceding year. To some
extent the higher expense percentage was due to normal inflation
in expenses which outpaced the lower-than-expected comparable
store sales increase for the year. The increase in expenses also
reflected costs associated with our October 1995 acquisition of
the inventory, fixtures and equipment, and leases for 18 Super D
stores. During the balance of 1995, we implemented a number of
changes in these stores' physical structure, layout and systems
to conform them to the Fred's format and consolidate their
operations with our other stores. Additionally, our higher
expense levels in 1995 included costs associated with a number of
operational improvements we implemented during the year. These
included changes to our distribution center operations to
implement a more competitive wage program and convert from a
four-day to a five-day work week. Also, we incurred additional
expenses in 1995 as we converted to a new management system for
our pharmacy department that provides the centralized controls
necessary to maximize the performance of our growing operations.
The implementation of this new system, used by some of the
largest pharmacy chains in the country, was completed in early
1996. Lastly, expenses relative to sales increased because the
proportion of retail sales, which carry a higher expense
percentage than wholesale sales, increased in 1995.
As to our financial position, we were able to identify the
sluggish sales trends early enough to control our inventory
levels throughout the year and maintain a strong balance sheet.
Total inventories increased less than 4% over year-earlier levels
despite a 7% increase in retail selling space during the year,
and shareholders' equity rose to $115.6 million versus $114.5
million in 1994. Again in 1995, we ended the year with virtually
no long-term debt, which provides us with the financial strength
necessary to pursue new opportunities for growth.
During 1995, Fred's paid regular cash dividends to
shareholders totaling $.20 per share. This was the third
consecutive year in which cash dividends have been paid.
New Pricing Strategy
Our decision to implement a new pricing strategy for 1995
was the initial phase of a plan to improve the long-term
performance of the Company. Historically, Fred's has relied
heavily on sales events timed throughout the year to boost sales,
particularly around holidays and other seasonal shopping
occasions. While this kind of pricing strategy produces
temporary gains, unfortunately it also trains consumers to delay
all but the most necessary of purchases until those sales events
occur, reinforcing the idea that real bargains are not possible
at other times. Operationally, this type of program also entails
additional costs associated with preparing our stores for the
sales events, as well as the significant advertising expenditures
related to each sale.
Clearly, the use of sales events will always be a part of
our business, and when we can source merchandise at particularly
attractive costs, we will use those opportunities to our
advantage. Aside from a more limited use of sales events,
though, we recognize the long-term importance of building a
strong image among our customers as a price leader. By changing
our strategy to embrace competitive prices on hundreds of
products that people need and purchase every day, our customers
know that they need not wait for a sale to get our lowest price
or our best value. As we continue to reinforce that image, we
believe customers will shop our stores more regularly, sales
patterns will become more predictable and, over time, we will
build volume beyond what we could have achieved under our old
pricing approach.
Super Dollar Concept
In July, we began the next phase of our re-imaging program
with the introduction of the Fred's Super Dollar Store concept.
This new concept better aligns Fred's with the strong
price-to-value image of the dollar store customer. The "Super"
aspect of the concept is supported by the fact that, along with
everyday dollar store pricing, our stores are twice as large as a
typical dollar store and we have twice as many items in our
stores.
Opportunities for Growth
Throughout 1995, we looked for opportunities to strengthen
our network of retail stores throughout the Southeast, including
ways to enhance our existing presence and expand on that store
base. We are pleased to note that we have made progress on
several fronts in developing new opportunities for both internal
and external growth.
Perhaps the single most significant proposal in this regard
occurred in March 1996 when we signed a letter of intent to merge
with Rose's Stores, Inc., an 80-year old chain with 105 stores
based in Henderson, North Carolina. Under the terms of the
letter of intent, Rose's shareholders will receive approximately
three-tenths of a share of Fred's Class A common stock for each
share of Rose's stock. The merger with Rose's is subject to the
execution of a definitive merger agreement, approval by the
shareholders of Fred's and Rose's, and certain other conditions.
This proposed merger, along with our acquisition of the
former Super D stores in October, presents exciting possibilities
for us to increase our penetration of our existing 10-state
market region and to expand into new areas. With these
additions, we gain entry to Delaware, Maryland, North Carolina,
South Carolina, Virginia, and West Virginia, and we strengthen
our presence in Georgia, Kentucky, Mississippi, and Tennessee.
Equally important, however, with these new stores we further
leverage our existing support capabilities and expect to realize
additional benefits through the enhanced purchasing power of a $1
billion chain.
In addition, because of the continuing success of our
pharmacy department and the strong correlation between the
presence of a pharmacy department in our stores and their overall
success, we continued an aggressive expansion program in this
area during 1995. During the year, we acquired 19 pharmacies,
five of which were converted into Fred's Xpress units, a new
concept involving a small, free-standing location focused
primarily on pharmaceuticals and other health care needs. In the
coming year, we intend to continue testing in this area and,
depending on acquisition opportunities, we expect to expand the
Fred's Xpress program to other markets.
Conclusion
Although we are disappointed by the temporary setbacks
encountered during 1995, we remain convinced that Fred's is
moving in the right direction with its new pricing strategy and
its efforts to build its competitive position in the dollar store
segment. We are convinced that the investments we have made in
new technologies and in the promising areas of our business will
lead to improved performance in the future.
As we look ahead to the coming year, we are dedicated to
enhancing shareholder value. Additionally, as demonstrated by
our proposed merger with Rose's and our 1995 acquisition of the
Super D stores, we also intend to be alert for other
opportunities to expand our chain.
/s/ Michael J. Hayes
- -------------------------------------
Michael J. Hayes
Chief Executive Officer and President
SELECTED FINANCIAL DATA
(dollars in thousands, except per share amounts)
1995(1) 1994 1993 1992 1991
-------------------------------------------------
Statement of Operations Data:
Net sales $410,086 $380,702 $347,903 $316,494 $291,634
Operating income 4,771 13,563 15,244 14,290 11,230
Income before taxes and
cumulative effect of
changes in accounting
methods 4,337 13,103 14,937 13,101 3,886
Provision for income taxes 1,604 4,730 5,195 4,909 47
Income before cumulative
effect of changes in
accounting methods 2,733 8,373 9,742 8,192 3,839
Net income $ 2,733 $ 8,373 $ 9,742 $ 25,127 $ 3,839
Net income per share:
Before cumulative effect
of changes in
accounting methods $ .29 $ .90 $ 1.05 $ .92 $ .61
Net income $ .29 $ .90 $ 1.05 $ 2.83 $ .61
Selected Operating Data:
Operating income as a
percentage of sales 1.2% 3.6% 4.4% 4.5% 3.9%
Increase in comparable
stores sales(2) 1.3% 3.6% 3.6% 5.6% 3.3%
Stores open at end of
period 201 184 170 156 144
Balance Sheet Data (at period end):
Total assets $158,023 $151,585 $139,064 $127,009 $104,382
Short-term debt
(including capital
leases) 1,961 2,037 436 410 1,664
Long-term debt
(including capital
leases) 1,779 3,740 1,496 1,918 48,799
Shareholders' equity 115,570 114,457 107,803 99,381 28,433
(1) Results of 1995 include 53 weeks.
(2) A store is first included in the comparable store sales calculation after
the end of the twelth month following the store's grand opening month.
MANAGEMENT'S DISCUSSION AND ANALYSIS
Results of Operations
The following table provides a comparison of Fred's
financial results for the past three years. In this table,
categories of income and expense are expressed as a percentage of
net sales, and the year-over-year percentage changes for the past
two years are shown.
Change from
Prior Year
---------------
1995 1994
Versus Versus
1995 1994 1993 1994 1993
- ---------------------------------------------------------------
Net sales 100.0% 100.0% 100.0% 7.7% 9.4%
Cost of goods sold 74.5 73.0 73.6 10.0 8.6
----- ----- ----- ----- -----
Gross profit 25.5 27.0 26.4 1.7 11.7
Selling, general
and administrative
expenses 24.3 23.4 22.0 11.8 16.2
Operating income 1.2 3.6 4.4 (64.8) (11.0)
Interest expense, net .1 .1 .1 20.6 66.7
----- ----- ----- ----- -----
Income before taxes 1.1 3.5 4.3 (66.9) (12.3)
Income taxes .4 1.3 1.5 (66.1) (9.0)
----- ----- ----- ----- -----
Net income .7% 2.2% 2.8% (67.4)% (14.1)%
===== ===== ===== ===== =====
Net sales increased 7.7% ($29 million) in 1995.
Approximately $18 million of the increase was attributable to the
net addition of 17 stores and the acquisition of 19 pharmacies in
1995, together with the sales of 14 stores and 11 pharmacies that
were opened in 1994 and not included in the comparable store
sales calculation until various points in 1995. In addition,
1995 included 53 weeks versus 52 in 1994, resulting in a $7
million increase in sales, and comparable store sales increased
1.3% ($4 million). Comparable store sales increases were
comprised of the following components:
* Sales in comparable pharmacies increased 12.5%.
* Comparable store sales in non-pharmaceutical
departments experienced a decrease of 1.4% due to lower
retail prices resulting from the Company's
implementation of an everyday competitive pricing
strategy. Also, apparel sales were lower in 1995 as a
result of sluggish overall consumer spending in this
area beginning in June.
Net sales increased 9.4% ($33 million) in 1994.
Approximately $22 million of the increase was attributable to the
net addition of 14 stores and the acquisition of 11 pharmacies in
1994, together with the sales of 14 stores and 15 pharmacies that
were opened in 1993 and not included in the comparable store
sales calculation until various points in 1994. In addition,
comparable store sales increased 3.6% ($11 million) due to the
following:
* Sales in comparable pharmacies increased 8.0%.
* Eight stores were upgraded either through expansion or
relocation to larger store sites in existing markets during 1994,
allowing Fred's to expand the merchandise mix in those stores.
* Lawn and garden sales increased due to an enhanced mix
and the addition of ten garden centers.
* Ladies' apparel had higher sales due to an improved
selection.
* The aforementioned sales increases were partially
offset by lower sales of tobacco products due to price deflation
and increased competition.
Fred's gross margin decreased in 1995 due primarily to the
implementation of its competitive pricing strategy, combined with
a reduction in apparel sales (which carry a higher margin than
the Company's average), and higher than normal markdowns
associated both with selling apparel and changes made to the
merchandise mix.
Fred's gross margin increased during 1994 primarily because
retail sales, which result in higher gross margin compared with
Fred's wholesale sales, increased as a percentage of total sales.
In addition, apparel sales increased as a percentage of total
sales because all new stores included a full line of apparel.
Selling, general and administrative expenses, relative to
sales, increased in 1995 due to the following:
* Normal inflation in expenses outpaced the weak
comparable store sales increases.
* A more competitive wage program for the Company's
distribution center operations was implemented.
* Retail sales, which carry higher expense percentages
than wholesale sales, increased as a percentage of total sales
during 1995.
* Higher expenses were incurred as the result of
converting to a new pharmacy management system that provides the
centralized controls necessary to maximize the performance of a
large chain of pharmacies.
* There were nonrecurring costs associated with the third
quarter acquisition of eighteen stores and the related steps
taken to conform these stores to the Fred's concept.
* Insurance costs associated with the Company's
self-insured employee medical plan were higher due to more
large-dollar claims (i.e. individual claims in excess of
$20,000).
* Depreciation expense increased due to capital
expenditures related to enhanced point-of-sale cash register
systems and the addition of new stores and pharmacies.
Selling, general and administrative expenses, relative to
sales, increased in 1994 due to the following:
* Fred's incurred higher store payroll and supplies
expense in connection with the implementation of a
plan-o-gramming system in its high turnover merchandise
departments. This system is designed to improve merchandise
presentation and in-stock inventory positions.
* The Company's plan for general merchandise
(non-pharmacy) sales proved to be too aggressive, and when sales
did not increase at the rate expected, the stores were
over-committed to variable labor.
* Retail sales, which carry higher expense percentages
than wholesale sales, increased as a percentage of total sales
during 1994.
* Insurance costs associated with the Company's
self-insured employee medical plan were higher due to an increase
in the number of claims.
Income tax expense decreased in 1995 due to a reduction in
pretax income. In 1994, income tax expense decreased because of
lower pretax income, partially offset by a benefit of $.2 million
in 1993 from recognizing the effect of the Omnibus Budget
Reconciliation Act of 1993 on the deferred tax accounts.
Liquidity and Capital Resources
Fred's has a $12 million revolving credit commitment with a
bank that has been used during each of the last three years to
build inventory levels for the Christmas selling season. These
borrowings were repaid prior to each year end.
Cash provided by operations in 1995, 1994 and 1993 totaled
$13.1 million, $4.6 million and $11.1 million, respectively.
During those years, cash from operations was used primarily for
capital expenditures associated with new and upgraded stores and
pharmacies, the enhancement of store point-of-sale cash register
systems, and capital maintenance; the 1995 acquisition of the
inventory and fixed assets of an eighteen-store chain; repayment
of debt; and the payment of cash dividends. In 1994, the Company
borrowed $4.5 million to finance the purchase of a portion of the
new point-of-sale systems and a new mainframe computer at the
corporate information systems center. Such borrowings are being
repaid over a 42-month term. The Company believes that
sufficient capital resources are available in both the short-term
and long-term through currently available cash, cash generated
from future operations and, if necessary, the ability to obtain
additional financing.
Tax Loss Carryforwards
At February 3, 1996, the Company had certain net operating
loss carryforwards which were acquired in reorganizations and
certain purchase transactions and are available to reduce income
taxes, subject to usage limitations. These carryforwards total
approximately $7.1 million for Federal income tax purposes and
expire during the period 1996 through 1999 and $40.9 million for
state income tax purposes of which $14.8 million expire during
the period 2000 through 2008. If certain substantial changes in
the Company's ownership should occur, there would be an annual
limitation on the amount of carryforwards which can be utilized.
On the basis of tax returns filed, the Company has various tax
credit carryforwards totaling approximately $.8 million, which
are also subject to usage limitations and expire during the
period 1997 through 2000.
Seasonality
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. The fourth quarter is typically the most profitable
quarter because it includes the Christmas selling season. The
overall strength of the fourth quarter is mitigated, however, by
the inclusion of the month of January, which is generally the
least profitable month of the year.
Inflation
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.
Subsequent Event
On March 1, 1996, the Company signed a letter of intent to
acquire all of the outstanding stock of Rose's Stores, Inc.
("Rose's"), which operates 105 stores in the southeastern United
States. Pursuant to the proposed merger agreement, the Company
will exchange approximately three-tenths of a share of its Class
A Common Stock (approximately 2.4 million shares) for each
outstanding common share of Rose's. The merger is subject to the
execution of a definitive merger agreement, approval by the
shareholders of Fred's and Rose's, and certain other conditions.
At January 27, 1996, Rose's reported approximately $171 million
in total assets and $679 million in total sales for the year then
ended.
Impact of Proposed Accounting Standards
In March 1995, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" which is
effective for fiscal years beginning after December 15, 1995.
This statement addresses situations where information indicates
that a company might be unable to recover, through future
operations or sales, the carrying amount of long-lived assets.
If an impairment is determined to exist, the company must compute
the amount of impairment using discounted cash flow analysis.
The adoption of SFAS No. 121 is not expected to have a material
impact on Fred's.
In October 1995, the FASB issued SFAS No. 123, "Accounting
for Stock-Based Compensation" which is effective for fiscal years
beginning after December 15, 1995. This statement defines a
fair-value based method of accounting for employee stock options
or similar equity instruments and encourages all entities to
adopt that method of accounting for all their employee stock
compensation plans. However, it also allows an entity to
continue to measure compensation for those plans using the
intrinsic value based method currently prescribed by Accounting
Principles Board Opinion No. 25 provided certain pro forma
disclosures are made that disclose what the impact on net
earnings would have been had the company adopted the accounting
provisions of SFAS No. 123. Fred's plans to continue the current
accounting and make the disclosures required by SFAS No. 123.
Therefore, there will be no impact on Fred's from adopting this
standard.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
For the Year Ended
-------------------------------------
February 3, January 28, January 29,
1996(1) 1995 1994
- ---------------------------------------------------------------
Net sales $410,086 $380,702 $347,903
Cost of goods sold 305,668 277,991 255,934
------- ------- -------
Gross profit 104,418 102,711 91,969
Selling, general and
administrative expenses 99,647 89,148 76,725
------- ------- -------
Operating income 4,771 13,563 15,244
Interest expense, net 434 360 216
Other expenses 100 91
------- ------- -------
Income before taxes 4,337 13,103 14,937
Income taxes 1,604 4,730 5,195
------- ------- -------
Net income $ 2,733 $ 8,373 $ 9,742
======= ======= =======
Net income per share $ .29 $ .90 $ 1.05
======= ======= =======
Weighted average number
of common shares and
common equivalent
shares outstanding 9,322 9,307 9,307
======= ======= =======
(1) Results for the year ended February 3, 1996 include 53
weeks.
See accompanying notes to consolidated financial statements.
CONSOLIDATED BALANCE SHEETS
(in thousands, except for number of shares)
February 3, January 28,
1996 1995
- -----------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 5,496 $ 5,944
Receivables, less allowance for
doubtful accounts of $857
($457 at January 28, 1995) 5,115 4,033
Inventories 85,211 82,163
Deferred income taxes 2,125 1,590
Other current assets 956 756
------- -------
Total current assets 98,903 94,486
Property and equipment, at
depreciated cost 51,681 49,550
Equipment under capital leases,
less accumulated amortization of
$683 ($931 at January 28, 1995) 560 951
Deferred income taxes 4,986 5,170
Other noncurrent assets 1,893 1,428
------- -------
$158,023 $151,585
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 29,793 $ 24,324
Current portion of indebtedness 1,660 1,629
Current portion of capital lease
obligations 301 408
Accrued liabilities 6,987 5,030
Income taxes payable 813 1,042
------- -------
Total current liabilities 39,554 32,433
Indebtedness 1,278 2,938
Capital lease obligations 501 802
Other noncurrent liabilities 1,120 955
------- -------
Total liabilities 42,453 37,128
------- -------
Commitments and contingencies (Notes 8 and 12)
Shareholders' equity:
Common stock, Class A voting, no
par value, 9,335,239 shares issued
and outstanding (9,307,373 shares
at January 28, 1995) 63,458 63,185
Retained earnings 52,424 51,555
Deferred compensation on restricted
stock incentive plan (169)
Loan to ESOP (143) (283)
------- -------
Total shareholders' equity 115,570 114,457
------- -------
$158,023 $151,585
======= =======
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY
(in thousands, except for number of shares)
Common Stock Retained Deferred Loan to
Shares Amount Earnings Compensation ESOP Total
- ----------------------------------------------------------------------------------------------
Balance, January 30, 1993 9,306,490 $63,160 $36,790 $ $ (569) $ 99,381
Cash dividends paid
($.16 per share) (1,489) (1,489)
Exercise of stock options 1,767 26 26
Repurchase of shares (830)
Contribution to ESOP
to reduce loan balance 143 143
Net income 9,742 9,742
--------- ------ ------ ------ ------ -------
Balance, January 29, 1994 9,307,427 63,186 45,043 (426) 107,803
Cash dividends paid
($.20 per share) (1,861) (1,861)
Repurchase of shares (54) (1) (1)
Contribution to ESOP
to reduce loan balance 143 143
Net income 8,373 8,373
--------- ------ ------ ------ ------ -------
Balance, January 28, 1995 9,307,373 63,185 51,555 (283) 114,457
Cash dividends paid
($.20 per share) (1,864) (1,864)
Repurchase of shares (134)
Issuance of restricted stock 28,000 273 (273)
Amortization and vesting
of deferred compensation
on restricted stock
incentive plan 104 104
Contribution to ESOP
to reduce loan balance 140 140
Net income 2,733 2,733
--------- ------ ------ ------ ------ -------
Balance, February 3, 1996 9,335,239 $63,458 $52,424 $ (169) $ (143) $115,570
========= ====== ====== ====== ===== =======
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Year Ended
-------------------------------------
February 3, January 28, January 29,
1996 1995 1994
- -------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 2,733 $ 8,373 $ 9,742
Adjustments to reconcile net income
to net cash flows from operating
activities:
Depreciation and amortization 5,493 4,571 3,545
Provision for uncollectible
receivables 595 153 370
Contribution to ESOP to reduce
ESOP loan balance 140 143 143
Deferred income taxes (351) 2,414 3,915
Amortization of deferred
compensation on restricted
stock incentive plan 104
(Increase) decrease in assets:
Receivables (1,591) (35) (266)
Inventories (427) (13,069) (9,396)
Other current assets (200) 288 (352)
Other noncurrent assets (764) (291) (596)
Increase (decrease) in liabilities:
Accounts payable 5,469 1,179 4,889
Accrued liabilities 1,957 233 (1,508)
Income taxes payable (229) 462 516
Other noncurrent liabilities 165 148 132
------ ------- ------
Net cash provided by operating
activities 13,094 4,569 11,134
------ ------- ------
Cash flows from investing activities:
Additions to property, equipment and
equipment under capital leases (6,694) (8,678) (7,833)
Acquisition of businesses, net of cash (2,947)
------ ------- ------
Net cash used in investing
activities (9,641) (8,678) (7,833)
------ ------- ------
Cash flows from financing activities:
Proceeds from borrowings and increase
in capital lease obligations 4,500
Reduction of indebtedness and capital
lease obligations (2,037) (655) (396)
Proceeds from exercise of options 26
Repurchase of shares (1)
Payment of cash dividends (1,864) (1,861) (1,489)
------ ------- ------
Net cash provided by (used in)
financing activities (3,901) 1,983 (1,859)
------ ------- ------
Increase (decrease) in cash and cash
equivalents (448) (2,126) 1,442
Cash and cash equivalents:
Beginning of year 5,944 8,070 6,628
------ ------- ------
End of year $ 5,496 $ 5,944 $ 8,070
====== ======= ======
Supplemental disclosures of cash flow
information:
Interest paid $ 535 $ 328 $ 163
====== ======= ======
Income taxes paid $ 2,184 $ 1,854 $ 764
====== ======= ======
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Description of Business and Summary of Significant
Accounting Policies
Description of business. The primary business of Fred's, Inc.
(the "Company") is the sale of general merchandise through 201
retail discount stores located in the southeastern United States.
In addition, the Company sells general merchandise to its
franchisees through its wholesale division.
Consolidated financial statements. The consolidated financial
statements include the accounts of the Company and its
subsidiaries. All significant intercompany accounts and
transactions are eliminated.
Fiscal year. The Company utilizes a 52 or 53 week accounting
period which ends on the Saturday closest to January 31. The
year ended February 3, 1996 included 53 weeks. Fiscal years
1995, 1994 and 1993, as used herein, refer to the years ended
February 3, 1996, January 28, 1995 and January 29, 1994,
respectively.
Use of estimates. The preparation of financial statements in
accordance with generally accepted accounting principles requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses
during the reported period. Actual results could differ from
those estimates.
Inventories. Wholesale inventories are stated at the lower of
cost (first-in, first-out) or market. Retail inventories are
stated at the lower of cost (first-in, first-out) or market as
determined by the retail inventory method.
Depreciation and amortization. Depreciation is computed by use
of the straight-line method over the estimated useful lives of
buildings, furniture, fixtures and equipment. Leasehold costs
and improvements are amortized over the lesser of their estimated
useful lives or the remaining lease terms. Average useful lives
are as follows: buildings and improvements - 8 to 30 years;
furniture and fixtures - 5 to 10 years; and equipment - 3 to 10
years. Amortization on equipment under capital leases is
computed on a straight-line basis over the terms of the leases.
Selling, general and administrative expenses. The Company
includes buying, warehousing and occupancy costs in selling,
general and administrative expenses.
Advertising. The Company charges advertising, including
production costs, to expense on the first date of the advertising
period. Advertising expense for 1995, 1994 and 1993 was
$7,625,000, $7,276,000 and $6,821,000, respectively.
Preopening costs. The Company charges to expense the preopening
costs of new stores as incurred. These costs are primarily labor
to stock the store, preopening advertising, store supplies and
other expendable items.
Goodwill and other intangibles. Goodwill in connection with
acquired businesses is being amortized over periods ranging from
5 to 20 years. Goodwill, net of accumulated amortization,
totaled $451,000 at February 3, 1996 and $410,000 at January 28,
1995. Other identifiable intangibles associated with acquired
pharmacies are being amortized over five years. These
intangibles, net of accumulated amortization, totaled $1,331,000
at February 3, 1996 and $885,000 at January 28, 1995. At each
balance sheet date, the Company assesses whether there has been
an impairment in the value of such goodwill and intangibles by
determining whether projected undiscounted future cash flows from
operations exceeds its net book value as of the assessment date.
Income taxes. The Company utilizes the provisions of Statement
of Financial Accounting Standards No. 109, "Accounting for Income
Taxes." Deferred income taxes are provided for temporary
differences between the financial reporting basis and income tax
basis of the Company's assets and liabilities.
Cash and cash equivalents. Cash on hand and in banks, together
with repurchase agreements having original maturities of three
months or less, are classified as cash equivalents by the
Company.
Net income per share. Net income per share is based on the
weighted average number of common shares and common equivalent
shares outstanding. Common equivalent shares represent dilutive
stock options and restricted stock shares, reduced by the number
of shares which could be repurchased at the average fair market
value during the year with the proceeds of the options and the
income tax savings available from recognizing compensation
expense as a tax deduction.
NOTE 2 - ACQUISITION
Effective October 9, 1995, the Company entered into an Asset
Purchase Agreement for the purchase of inventory and other
selected assets of Southern Wholesale Company for $2.9 million in
cash. Assets acquired consisted of inventory aggregating $2.6
million, receivables of $86,000 and fixtures of $160,000. The
purchase price paid in excess of the fair value of the tangible
assets acquired totaled $80,000 and was recorded as goodwill.
NOTE 3 - INVENTORIES
The components of inventories are as follows (in thousands):
February 3, January 28,
1996 1995
- ----------------------------------------------------------------
Wholesale $19,710 $20,715
Retail 65,501 61,448
------ ------
$85,211 $82,163
====== ======
NOTE 4 - PROPERTY AND EQUIPMENT
Property and equipment, at cost, consist of the following
(in thousands):
February 3, January 28,
1996 1995
- ----------------------------------------------------------------
Buildings and improvements $ 52,946 $ 52,386
Furniture, fixtures and equipment 49,132 43,061
------- -------
102,078 95,447
Less accumulated depreciation and
amortization 54,801 50,321
------- -------
47,277 45,126
4,404 4,424
------- -------
$ 51,681 $ 49,550
------- -------
Depreciation expense and amortization expense on equipment
under capital leases totaled $5,114,000, $4,275,000 and
$3,345,000 for 1995, 1994 and 1993, respectively.
NOTE 5 - ACCRUED LIABILITIES
The components of accrued liabilities are as follows (in
thousands):
February 3, January 28,
1996 1995
- ----------------------------------------------------------------
Payroll and benefits $ 989 $ 1,121
Sales and use taxes 1,699 1,154
Insurance 1,691 1,130
Other 2,608 1,625
------- -------
$ 6,987 $ 5,030
======= =======
NOTE 6 - INCOME TAXES
The provision for income taxes consists of the following (in
thousands):
For the Year Ended
-------------------------------------
February 3, January 28, January 29,
1996 1995 1994
- ---------------------------------------------------------------
Current
Federal $ 1,653 $ 1,808 $ 653
State 302 508 627
------ ------ ------
1,955 2,316 1,280
Deferred
Federal (150) 2,302 3,910
State (201) 112 5
------ ------ ------
(351) 2,414 3,915
------ ------ ------
$ 1,604 $ 4,730 $ 5,195
====== ====== ======
Deferred tax assets (liabilities) comprise the following (in
thousands):
February 3, January 28,
1996 1995
- ----------------------------------------------------------------
Current deferred tax assets:
Inventory cost capitalization $ 1,313 $ 1,175
Accrual for inventory shrinkage 946 811
Allowance for doubtful accounts 462 341
Insurance accruals 575 368
Other 247 78
------ ------
Gross current deferred tax assets 3,543 2,773
Deferred tax asset valuation allowance (1,125) (870)
------ ------
2,418 1,903
Current deferred tax liabilities (293) (313)
------ ------
Net current deferred tax assets $ 2,125 $ 1,590
====== ======
Noncurrent deferred tax assets:
Net operating loss carryforwards $ 3,840 $ 4,424
Tax credit carryforwards 773 773
Depreciation 802 867
Postretirement benefits other than
pensions 429 366
Other 810 665
------ ------
Gross noncurrent deferred tax assets 6,654 7,095
Deferred tax asset valuation allowance (1,636) (1,891)
------ ------
5,018 5,204
Noncurrent deferred tax liabilities (32) (34)
------ ------
Net noncurrent deferred tax assets $ 4,986 $ 5,170
====== ======
The ultimate realization of these assets is dependent upon
the generation of future taxable income sufficient to offset the
related deductions and loss carryforwards within the applicable
carryforward periods as described below. The valuation allowance
is based upon management's conclusion that certain tax
carryforward items will expire unused.
A reconciliation of the statutory Federal income tax rate to
the effective tax rate is as follows:
For the Year Ended
-------------------------------------
February 3, January 28, January 29,
1996 1995 1994
- ----------------------------------------------------------------
Income tax provision at
statutory rate 35.0% 35.0% 35.0%
State income taxes, net
of federal benefit 1.5 3.1 2.8
Effect of change in tax
rate on net deferred
tax assets (1.5)
Other .5 (2.0) (1.5)
---- ---- ----
37.0% 36.1% 34.8%
==== ==== ====
At February 3, 1996, the Company has certain net operating
loss carryforwards which were acquired in reorganizations and
certain purchase transactions which are available to reduce
income taxes, subject to usage limitations. These carryforwards
total approximately $7,100,000 for Federal income tax purposes
and expire during the period 1996 through 1999 and $40,900,000
for state income tax purposes of which $14,800,000 expire during
the period 2000 through 2008. If certain substantial changes in
the Company's ownership should occur, there would be an annual
limitation on the amount of carryforwards which can be utilized.
On the basis of tax returns filed, the Company has various tax
credit carryforwards totaling approximately $773,000, which are
also subject to usage limitations and expire during the period
1997 through 2000.
NOTE 7 - INDEBTEDNESS
Indebtedness consists of the following (in thousands):
February 3, January 28,
1996 1995
- ----------------------------------------------------------
Indebtedness to a bank $ 2,795 $ 4,284
Indebtedness of ESOP to a bank 143 283
------ ------
2,938 4,567
Less current portion 1,660 1,629
------ ------
$ 1,278 $ 2,938
====== ======
On May 15, 1992, the Company and a bank entered into a
Revolving Loan and Credit Agreement (the "Agreement"). The
Agreement, as amended, provides the Company with an unsecured
revolving line of credit commitment of up to $12 million and
bears interest at the lesser of 1% below prime rate or a
LIBOR-based rate. The term of the Agreement extends to May 1,
1998, and borrowings under the Agreement are subject to a
borrowing base, as defined. Under the most restrictive covenants
of the Agreement, the Company is required to maintain specified
shareholders' equity and net income levels. There were no
borrowings outstanding under the Agreement at February 3, 1996
and January 28, 1995. The Company is required to pay a
commitment fee to the bank at a rate per annum equal to .25% on
the unutilized portion of the revolving line commitment over the
term of the Agreement.
In December 1993, the Company entered into a line of credit
agreement with a bank for the purpose of financing the purchase
of new point-of-sale equipment and a new mainframe computer. The
commitment was for up to $4.5 million, and the entire line was
drawn during 1994. Repayment terms for individual draws consist
of a six-month interest only period followed by a 36-month full
payout. At February 3, 1996, the effective rates on all
outstanding draws ranged from 5.70% to 7.47% with a weighted
average of 6.80%.
The Company's ESOP also has bank borrowings outstanding
which are reflected as indebtedness and a reduction of
shareholders' equity. The note requires four annual payments of
$143,000 which began on June 30, 1993 and bears interest at the
bank's prime rate which was 8.5% at February 3, 1996. The note
is secured by shares of the Company's common stock held by the
ESOP trust.
The principal maturities of all long-term debt subsequent to
1996 are $1,278,000 in 1997.
NOTE 8 - LONG-TERM LEASES
The Company leases certain of its store locations under
noncancelable operating leases expiring at various dates through
2029. Many of these leases contain renewal options and require
the Company to pay taxes, maintenance, insurance and certain
other operating expenses applicable to the leased properties. In
addition, the Company leases various equipment under
noncancelable operating leases and certain transportation
equipment under capital leases.
Total rent expense under operating leases for the respective
periods was as follows (in thousands):
1993 $ 5,627
1994 $ 6,506
1995 $ 7,924
Minimum rental payments under all operating and capital
leases as of February 3, 1996 are as follows (in thousands):
Operating Capital
Leases Leases
- -----------------------------------------------------------------
1996 $ 6,380 $ 429
1997 5,432 429
1998 4,116 143
1999 2,425
2000 1,181
Thereafter 3,522
------- ------
Total minimum lease payments $ 23,056 1,001
=======
Imputed interest 199
------
Present value of net minimum lease
payments, including $301
classified as current portion
of capital lease obligations $ 802
======
NOTE 9 - SHAREHOLDERS' INTEREST
The Company has 30 million shares of Class A voting common
stock authorized. The Company's authorized capital also consists
of 11.5 million shares of Class B nonvoting common stock, of
which no shares have been issued. In addition, the Company has
authorized 10 million shares of preferred stock, of which no
shares have been issued.
NOTE 10 - EMPLOYEE BENEFIT PLANS
Incentive stock option plan. The Company has two long-term
incentive plans under which an aggregate of 500,000 shares may
be granted. At February 3, 1996, options for a total of 464,554
shares of Class A common stock had been granted under the
incentive stock option portion of the plans, including 2,017
shares for which options have been subsequently exercised and
172,487 shares for which options have been canceled or terminated
unexercised. These options expire five years from the date of
grant and options outstanding at February 3, 1996 expire in 1997
through 2000.
A summary of activity in the plans follows:
For the Year Ended
-----------------------------------
February 3, January 28, January 29,
1996 1995 1994
- ----------------------------------------------------------------
Outstanding at beginning
of year 292,655 274,455 293,120
------- ------- -------
Options granted
$14.25 per share 85,150
$13.75 per share 2,600
$10.00 per share 1,000
$ 9.75 per share 70,300 1,600
------- ------- -------
Total granted 71,300 89,350
------- ------- -------
Options exercised
$15.25 per share 47
$14.50 per share 1,720
------- ------- -------
Total exercised 1,767
------- ------- -------
Options canceled 73,905 71,150 16,898
------- ------- -------
Outstanding at end of year 290,050 292,655 274,455
======= ======= =======
Exercisable at end of year 221,585 197,920 154,695
======= ======= =======
The options exercisable at February 3, 1996 are exercisable
at prices ranging from $9.75 to $15.25 per share.
Restricted stock. During 1995, 28,000 restricted shares were
issued under the restricted stock portion of the long-term
incentive plan to key employees. Compensation expense related to
the shares issued is recognized over the period for which
restrictions apply.
Employee stock ownership plan. The Company has a
non-contributory employee stock ownership plan for the benefit of
qualifying employees who have completed one year of service and
attained the age of 18. Benefits are fully vested upon
completion of seven years of service. Company contributions are
limited by the maximum deduction allowed by the Internal Revenue
Code, except that such amount may be exceeded if the contribution
is required to enable the plan to make payments on outstanding
indebtedness. The Company's contribution expense for the years
ended February 3, 1996, January 28, 1995 and January 29, 1994 was
$163,000, $168,000 and $173,000, respectively.
As discussed in Note 7, the ESOP has borrowings outstanding
from a bank. Interest expense on the borrowings was $20,000,
$25,000 and $30,000 for the years ended February 3, 1996, January
28, 1995 and January 29, 1994, respectively.
Salary reduction profit sharing plan. The Company has a defined
contribution profit sharing plan for the benefit of qualifying
employees who have completed one year of service and attained the
age of 21. Participants may elect to make contributions to the
plan up to a maximum of 15% of their compensation. Company
contributions are made at the discretion of the Company's Board
of Directors. Participants are 100% vested in their
contributions and earnings thereon. Contributions by the Company
and earnings thereon are fully vested upon completion of seven
years of service. The Company's contributions for the years
ended February 3, 1996, January 28, 1995 and January 29, 1994
were $58,000, $58,000 and $52,000, respectively.
Postretirement benefits. The Company provides certain health
care benefits to its full-time employees that retire between the
ages of 58 and 65 with certain specified levels of credited
service. Health care coverage options for retirees under the
plan are the same as those available to active employees. The
Company's accumulated postretirement benefit obligation is as
follows (in thousands):
February 3, January 28,
1996 1995
- ----------------------------------------------------------------
Retiree benefit obligation $ 12 $ 25
Fully eligible active benefit
obligation 83 85
Other active benefit obligation 1,108 867
------ -----
1,203 977
Unrecognized net loss (83) (22)
------ -----
$ 1,120 $ 955
====== =====
The medical care cost trend used in determining this
obligation is 10.0%, decreasing annually before leveling at 6.5%
in 2003. This trend rate has a significant effect on the amounts
reported. To illustrate, increasing the health care cost trend
by 1% would increase the accumulated postretirement benefit
obligation by $177,000. The discount rates used in calculating
the obligation were 8.0% and 8.25% at February 3, 1996 and
January 28, 1995, respectively.
The annual net postretirement cost is as follows (in
thousands):
For the Year Ended
-----------------------------------
February 3, January 28, January 29,
1996 1995 1994
- ----------------------------------------------------------------
Service cost $ 124 $ 101 $ 78
Interest cost on accumulated
postretirement benefit
obligation 92 74 60
---- ---- ----
$ 216 $ 175 $ 138
==== ==== ====
The Company's policy is to fund claims as incurred. Claims
paid in 1995, 1994 and 1993 totaled $51,000, $67,000 and $16,000,
respectively.
NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS
At February 3, 1996, the Company did not have any
outstanding derivative instruments. The recorded value of the
Company'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 Company's
indebtedness is estimated based on the current borrowing rates
available to the Company for bank loans with similar terms and
average maturities.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Commitments. At February 3, 1996, the Company had
commitments approximating $2,900,000 on issued letters of credit
which support purchase orders for merchandise. Additionally, the
Company had outstanding letters of credit aggregating $2,254,000
utilized as collateral for their risk management programs.
Concentration of credit risk. Financial instruments which
potentially subject the Company to concentration of credit risk
are primarily cash and cash equivalents.
Litigation. The Company is a party to several pending legal
proceedings and claims. Although the outcome of the proceedings
and claims cannot be determined with certainty, management of the
Company is of the opinion that it is unlikely that these
proceedings and claims will have a material effect on the results
of operations or the financial condition of the Company.
NOTE 13 - SUBSEQUENT EVENT (UNAUDITED)
On March 1, 1996, the Company signed a letter of intent to
acquire all of the outstanding stock of Rose's Stores, Inc.
("Rose's"), a publicly traded retailer that operates 105 stores
in the southeastern United States. The acquisition will be
accounted for as a purchase, and accordingly, the results of
operations of the acquired business will be included in the
Company's consolidated financial statements after consummation of
the transaction. Pursuant to the proposed merger agreement, the
Company will exchange approximately three-tenths of a share of
its Class A Common Stock (approximately 2.4 million shares) for
each outstanding common share of Rose's. The merger is subject
to the execution of a definitive merger agreement, approval by
the shareholders of Fred's and Rose's, and certain other
conditions. At January 27, 1996, Rose's reported approximately
$171 million in total assets and $679 million in total sales for
the year then ended.
NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
(in thousands, except per share data) Quarter Quarter Quarter Quarter
- ------------------------------------------------------------------------------
Year Ended February 3, 1996
Net sales $97,050 $93,295 $95,598 $124,143
Gross profit 25,538 22,942 24,911 31,027
Net income 2,255 (427) 121 784
Net income per share(1) .24 (.05) .01 .08
Cash dividends paid per share .05 .05 .05 .05
Year Ended January 28, 1995
Net sales $90,904 $88,108 $91,376 $110,314
Gross profit 24,223 24,113 24,910 29,465
Net income 2,779 1,312 1,523 2,759
Net income per share .30 .14 .16 .30
Cash dividends paid per share .05 .05 .05 .05
(1) Quarterly share amounts are based on average shares outstanding
during each quarter and may not add to the total for the year.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Fred's, Inc.
In our opinion, the accompanying consolidated balance sheets and
the related consolidated statements of income, of changes in
shareholders' equity and of cash flows present fairly, in all
material respects, the financial position of Fred's, Inc. and its
subsidiaries at February 3, 1996 and January 28, 1995, and the
results of their operations and their cash flows for the three
years in the period ended February 3, 1996, in conformity with
generally accepted accounting principles. These financial
statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the
opinion expressed above.
Memphis, Tennessee
March 8, 1996
CORPORATE INFORMATION
Board of Directors
Michael J. Hayes
Chief Executive Officer and President
Fred's, Inc.
David A. Gardner
Managing Director
Fred's, Inc.
President
Gardner Capital Corporation
(a real estate and venture capital investment firm)
John R. Eisenman
Real Estate Investments
REMAX Island Realty, Inc.
Former President of Sally's, Inc.
(a restaurant chain)
Former commercial real estate developer
Roger T. Knox
Chief Executive Officer and President
Memphis Zoological Society
Former Chairman of the Board and
Chief Executive Officer
Goldsmith's Department Stores
(retailing)
Officers
Michael J. Hayes
Chief Executive Officer and President
David A. Gardner
Managing Director
Michael K. Spear
Executive Vice President--Merchandising
Bruce D. Smith
Executive Vice President and Chief Financial Officer
Victor Saig
Senior Vice President--Store Operations
John A. Casey
Senior Vice President--Pharmacy Operations
Blanchard J. Box
Senior Vice President--Information Systems
Charles S. Vail
Corporate Secretary, Vice President--Legal Services
and General Counsel
Corporate Offices
Fred's, Inc.
4300 New Getwell Road
Memphis, Tennessee 38118
901/362-3733
Transfer Agent
Union Planters National Bank
Memphis, Tennessee
Independent Accountants
Price Waterhouse LLP
Memphis, Tennessee
General Counsel
Waring Cox
Memphis, Tennessee
Annual Report on Form 10-K
A copy of the Company's Annual Report on Form 10-K for the
year ended February 3, 1996, as filed with the Securities and
Exchange Commission, may be obtained by shareholders of record
without charge upon written request to Bruce D. Smith, Executive
Vice President and Chief Financial Officer.
Stock Market Information
The Company's common stock trades on the Nasdaq Stock Market
under the symbol FRED (CUSIP No. 356108-10-0). At April 10,
1996, the Company had approximately 4,400 shareholders, including
beneficial owners holding shares in nominee or "street" name.
The table below sets forth the high and low stock prices,
together with cash dividends paid per share, for each fiscal
quarter in the past two fiscal years:
Dividends
High Low Per Share
- ---------------------------------------------------------
1994
First $ 14 3/4 $ 13 $ .05
Second $ 14 1/2 $ 11 $ .05
Third $ 14 1/4 $ 10 1/2 $ .05
Fourth $ 12 $ 9 $ .05
1995
First $ 10 1/2 $ 9 $ .05
Second $ 10 1/2 $ 9 3/4 $ .05
Third $ 10 1/2 $ 8 $ .05
Fourth $ 8 $ 7 $ .05