SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended February 3, 1996 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 Number) 4300 New Getwell Road MEMPHIS, TENNESSEE 38118 (Address of Principal Executive Offices) Registrant's telephone number, including area code (901) 365-8880 Securities Registered Pursuant to Section 12(b) of the Act: Title of Each Class Name of Exchange on Which Registered Class A Common Stock, no par value NASDAQ Stock Market Securities Registered Pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ]. As of April 10, 1996, there were 9,335,232 shares outstanding of the Registrant's Class A no par value voting common stock. Based on the last reported sale price of $8.00 per share on the NASDAQ Stock Market on April 10, 1996, the aggregate market value of the Registrant's Common Stock held by those persons deemed by the Registrant to be non-affiliates was $59,745,192. As of April 10, 1996, there were no shares outstanding of the Registrant's Class B no par value non-voting common stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Annual Report to Shareholders for the year ended February 3, 1996 are incorporated by reference into Part II, Items 5, 6, 7 and 8, and into Part IV, Item 14. Portions of the Company's Registration Statement on Form S-1 (file no. 33-45637) are incorporated as exhibits into Part IV. With the exception of those portions that are specifically incorporated herein by reference, the aforesaid documents are not to be deemed filed as part of this report. PART I Item 1: Business General Fred's, Inc. ("Fred's" or the "Company"), founded in 1947, operates 201 discount general merchandise stores in ten states in the southeastern United States. Fred's stores generally serve low, middle and fixed income families located in small to medium sized towns (approximately 65% of Fred's stores are in markets with populations of 15,000 or fewer people). Eighty-seven of the Company's stores have full service pharmacies and there are five stand-alone Fred's Xpress pharmacies. The Company also markets goods and services to 34 franchised "Fred's" stores. Fred's stores stock over 12,000 frequently purchased items which address the everyday needs of its customers, including nationally recognized brand name products, proprietary "Fred's" label products and lower priced off-brand products. Fred's management believes its customers shop Fred's stores as a result of the stores' convenient location and size, low opening price points in key product categories, consistent discount positions in health and beauty aids and paper and cleaning supplies and regularly advertised departmental promotions and seasonal specials. Fred's stores have average selling space of 13,900 square feet and had average sales of $1,979,000 in 1995. Business Strategy The Company's strategy is to meet the general merchandise needs of the small to medium sized towns it serves by offering a wider variety of quality merchandise and a more attractive price- to-value relationship than either drug stores or smaller variety/dollar stores and a shopper-friendly format which is more convenient than larger sized discount merchandise stores. The major elements of this strategy include: Wide variety of frequently purchased, basic merchandise. Fred's combines everyday basic merchandise with certain specialty items to offer its customers a wide selection of general merchandise. The selection of merchandise is supplemented by seasonal specials, private label products and the inclusion of pharmacies in 87 of its stores. Discount prices. The Company provides value and low prices to its customers (i.e., a good "price-to-value relationship") through a coordinated discount strategy. As part of this strategy, Fred's maintains low opening price points on the basic items in each of its departments, maintains competitive prices on the entire stock in the health and beauty aids and paper and cleaning supplies departments, offers double value for manufacturers' coupons, and regularly offers seasonal specials and departmental promotions supported by strong tabloid, television and radio advertising. During December 1994, Fred's implemented a highly competitive pricing program that focuses on strong values day in and day out, while reducing the Company's reliance on promotional activities. Convenient shopper-friendly environment. Fred's stores are typically located in a convenient strip shopping center, which allows for easy access and shorter distances to the store entrance. Fred's stores are of a manageable size and have an understandable store layout, wide aisles and fast checkouts. Expansion Strategy The Company expects that expansion of the Fred's concept will occur primarily within its present market area and will be focused in small to medium sized towns, although the Company may also enter urban markets where it already has a market presence. Addition of Stores Fred's added a net of 17 new stores in 1995 and anticipates opening up to ten stores and closing ten stores in 1996. The Company's store prototype has from 10,000 to 15,000 square feet of selling space. Opening a new store currently costs between $350,000 and $450,000 for inventory, furniture, fixtures, equipment and leasehold improvements. Addition of Pharmacies The addition of pharmacies to existing stores has increased comparable store sales by adding sales of pharmaceuticals while maintaining sales of non-pharmaceutical items. The Company acquired 19 pharmacies in 1995, of which ten were incremental to stores that already had a pharmacy, five were established as stand- alone Fred's Xpress pharmacies, and four were additions to stores that had not previously had a pharmacy. The Company plans to acquire at least 15 more pharmacies in 1996. In substantially all cases, Fred's intends to add pharmacies through the acquisition of established independent pharmacies (either by employment of formerly independent pharmacists or purchase of customer lists from retiring independent pharmacists). Proposed Acquisition of Rose's On March 1, 1996, the Company signed a letter of intent to acquire all of the outstanding stock of Rose's Stores, Inc., a retailer that operates 105 stores in ten states in the southeastern United States (primarily North Carolina and Virginia). The merger is subject to satisfaction of the execution of a definitive merger agreement, approval by the shareholders of Fred's and Rose's, and certain other conditions. Merchandising and Marketing Management believes that Fred's has a distinctive niche in that it offers a wider variety of merchandise at a more attractive price-to-value relationship than either a drug store or smaller variety/dollar store and is more shopper-friendly than a larger discount store. The variety and depth of merchandise offered at Fred's stores in high traffic departments, such as health and beauty aids and paper and cleaning supplies, are comparable to those of larger discount retailers. Management believes that its knowledge of regional and local consumer preferences, developed in almost fifty years of operation by the Company and its predecessors, enables the Company to compete effectively in its region. Purchasing The Company's buying activities are directed from the corporate office by the Executive Vice President-Merchandising who is supported by three Vice Presidents - Merchandising and a staff of 22 buyers and assistants. The buyers and assistants are participants in an incentive compensation program, which is based upon various factors primarily relating to gross margin returns on inventory controlled by each individual buyer. The Company believes that adequate alternative sources of products are available for all of its categories of merchandise. Sales Mix The Fred's store sales mix by major merchandise category during 1995 was as follows: Household Goods..................................27.1% Pharmaceuticals..................................17.7% Apparel and Linens...............................17.2% Health and Beauty Aids...........................16.0% Paper and Cleaning Supplies......................12.3% Food and Tobacco Products........................ 9.7% The sales mix varies from store to store depending upon local consumer preferences and whether the stores include pharmacies and a full-line of apparel. In 1995, the stores' average customer transaction size was approximately $11.25, and the number of customer transactions totaled approximately 33 million. The Company presently has 81 full-line stores (those stores with both pharmacy and apparel departments) that have been open longer than 12 months. The pharmacy department contributed 28% of the total sales by these full-line stores in 1995. Sales per selling square foot averaged $157 for full-line stores compared to $113 for non full-line stores. Average sales per store during 1995 were $2,585,000 for full-line stores compared to $1,434,000 for non full-line stores. Products sold under the "Fred's" private label program, including household cleaning supplies, health and beauty aids, disposable diapers, pet foods, paper products and a variety of beverage and other products, constituted approximately 4% of total sales in 1995. Private label products afford the Company higher than average gross margins while providing the customer with lower priced products that are of a quality comparable to that of competing branded products. An independent laboratory testing program is used for substantially all of the Company's private label products. Highly Competitive Pricing Strategy The implementation of a new pricing strategy in December 1994 included price reductions for many key items and the elimination of four sale events for 1995. The price reductions and fewer sale events resulted in lower sales and negatively impacted gross margins. However, management expects that as customers begin to recognize Fred's as a store that offers good values everyday, they will shop Fred's stores more regularly, not just during sale events. The Company plans to eliminate an additional four sale events in 1996. Advertising and Promotions Advertising and promotion costs represented 1.9% of sales in 1995. The Company uses direct mail, television, radio and newspaper advertising to promote its merchandise, special promotional events and discount retail image. The Company's advertising is directed towards a typical Fred's customer, a female over the age of 25 in a rural location with household income averaging $25,000. The Company's buyers have discretion to mark down slow moving items, and the Company runs regular clearances of seasonal merchandise and conducts sales and promotions of particular items. The Company also encourages its store managers to create in-store advertising displays and signage in order to increase customer traffic and impulse purchases. The store managers, with corporate approval, are permitted to tailor the price structure at their particular stores to meet competitive conditions within each store's marketing area. Store Operations All Fred's stores are open six days a week (Monday through Saturday), and many stores are open seven days a week. Store hours are generally from 9:00 a.m. to 9:00 p.m.; however, certain stores are open only until 6:00 p.m. Each Fred's store is managed by a full-time store manager. The Company's twelve district managers supervise the management and operation of Fred's stores. The Company has an incentive compensation plan for store managers, pharmacists and district managers based on meeting or exceeding targeted profit percentage contributions. Various factors included in determining profit percentage contribution are gross profits and controllable expenses at the store level. Management believes that this incentive compensation plan, together with the Company's store management training program, are instrumental in maximizing store performance. The following tables set forth certain information with respect to stores and pharmacies for each of the last five years: 1991 1992 1993 1994 1995 Stores open at beginning of period 136 144 156 170 184 Stores opened/acquired during period 9 13 18 20 31 Stores closed during period (1) (1) (4) (6) (14) ------ ------ ------ ------ ------ Stores open at end of period 144 156 170 184 201 ====== ====== ====== ====== ====== Pharmacies open at beginning of period 40 45 60 75 83 Pharmacies opened/acquired during period 6 15 16 8 9 Pharmacies closed during period (1) - (1) - - ------ ------ ------ ------ ------ Pharmacies open at end of period 45 60 75 83 92 ====== ====== ====== ====== ====== Square feet of selling space at end of period (in thousands) 1,877 2,071 2,311 2,625 2,797 ====== ====== ====== ====== ====== Average square feet of selling space per store 13,033 13,277 13,594 14,266 13,915 ====== ====== ====== ====== ====== Franchise stores at end of period 43 39 37 35 34 ====== ====== ====== ====== ====== Pharmacy Operations Fred's operates 87 in-store pharmacies and five Fred's Xpress pharmacies, all of which offer brand name and generic pharmaceuticals and are staffed by licensed pharmacists. Pharmacy sales have become an increasingly important segment of the Company's sales, increasing from 9.4% of retail sales in 1988 to 17.7% in 1995. The addition of acquired pharmacies in the Company's stores has resulted in increased store sales and sales per selling square foot. Management believes that in-store pharmacies also increase customer traffic and repeat visits. The pharmacies in Fred's stores that are clustered together typically operate at a lower cost because three pharmacists are able to staff two Fred's stores (versus competitors' typical two pharmacists per store). This competitive advantage will accelerate because the Company is continuing to add pharmacies in clustered stores. Inventory Control and Distribution SWORD and POS Systems The Company's computerized central management information system (known as "SWORD," which stands for Store Warehouse Order Replenishment and Distribution) maintains a daily SKU level inventory and current and historical sales information for each store and the distribution center. This system is supported by in- store point-of-sale ("POS") cash registers which capture SKU and other data at the time of sale for daily transmission to the Company's central computer. Data received from the stores is used to automatically replenish frequently purchased merchandise on a weekly basis and to assist the Company's buyers in their decision making process. Maintaining an "in-stock" supply of high-turn, low gross margin items, such as health and beauty aids and paper and cleaning supplies and frequently consumed items in other categories, preserves customer loyalty which leads to purchases of higher gross margin items in other product categories. Over the past three years, the Company has installed enhanced POS register systems in all of its stores. The new registers have improved labor productivity at the stores and continue to be the data gathering device for the SWORD system. The scanning and price look-up features included in the new system significantly reduce the amount of labor required to tag merchandise in connection with the Company's sale events and reduce the number of cashier errors. Distribution Fred's has an 800,000 square foot centralized distribution center in Memphis, Tennessee (see "Properties" below). Excess capacity exists in the distribution center which will accommodate the Company's expansion plans for Fred's stores for the next two years. The Company is reviewing opportunities to enhance the logistics of the distribution center and to modernize the related sortation and handling equipment in order to increase the center's capacity and efficiencies. Approximately 78% of the merchandise received by Fred's stores in 1995 was shipped through the distribution center, with the remainder (primarily pharmaceuticals, certain snack food items, greeting cards, beverages and tobacco products) being shipped directly to the stores by vendors. For distribution, the Company uses owned and leased trailers and leased tractors, as well as common carriers. Wholesale and Franchise Sales The Company engages in wholesale sales to its 34 franchised "Fred's" stores and to certain other retailers. The franchised stores utilize the Company's SWORD system. Revenues from wholesale sales during the last three years were $40,300,000 in 1995, $39,000,000 in 1994 and $40,800,000 in 1993. In addition, franchise and other fees totaling approximately $2 million have been earned by Fred's in each of the three years (recorded as a reduction to the Company's operating expenses). Each of the Company's franchised stores operates under a franchise agreement whereby the Company is the primary provider of merchandise and the store is granted an exclusive market area. Franchisees purchase merchandise from the Company at wholesale prices and pay a franchise fee for the right to use the Fred's tradename. The fee is equal to 3% of the retail price of a franchisee's purchases. A franchisee may elect to have merchandise delivered by the Company for a fee ranging from 1.75% to 2.75% of the retail value of the merchandise delivered, varying with the distance between the Company's distribution center and the franchisee's store. Franchisees participate in advertising for "Fred's" stores in their marketing area by paying for the cost of advertising on television and distributing tabloid advertisements. At this time, the Company is not soliciting new franchisees. Employees At February 3, 1996, the Company had approximately 4,800 full- time and part-time employees, comprising 500 corporate employees and 4,300 store employees. The number of employees varies during the year, reaching a peak during the Christmas selling season. The Company's labor force is not subject to a collective bargaining agreement. Almost all of the Company's salaried employees not covered by the store or merchandising incentive compensation programs are covered by incentive compensation plans, under which compensation is payable based upon the Company meeting or exceeding profit targets. Item 2: Properties As of February 3, 1996, the geographical distribution of Fred's 201 Company-owned stores was as follows: State Number of Stores Mississippi 63 Arkansas 42 Tennessee 38 Louisiana 19 Georgia 16 Alabama 15 North Carolina 3 Missouri 2 Kentucky 2 Florida 1 The Company owns the real estate and the buildings for 61 store locations, of which five are subject to ground leases. The Company leases the remaining 140 locations from third parties pursuant to leases that provide for monthly rental payments primarily at fixed rates (although a few provide for additional rent based on sales). Fred's stores range in size from 5,000 square feet to 27,000 square feet. One hundred and forty-two of Fred's stores are in strip centers or adjoined with a downtown shopping district, with the remainder being free-standing. It is anticipated that existing buildings and buildings to be developed by others will be available for lease to satisfy the Company's present store growth intentions in the near term. It is management's intention to enter into leases of relatively moderate length with renewal options, rather than entering into long-term leases. The Company will thus have maximum flexibility in store relocation in the future, since continued availability of existing buildings is anticipated in the Company's market areas. The Company owns its distribution center and corporate headquarters situated on a 60 acre complex in Memphis, Tennessee. The distribution center contains approximately 800,000 square feet of space. The site also contains 250,000 square feet of office and retail space. Presently, the Company utilizes 90,000 square feet of office space and 22,000 square feet of retail space at the complex; of the balance, approximately 75,000 square feet is leased to the U.S. Government. The retail space is operated as a Fred's store and is used to test new products, merchandising ideas and technology. Item 3: Legal Proceedings The Company is 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. Item 4: Submission of Matters to a Vote of Security Holders No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended February 3, 1996. PART II Item 5: Market for the Registrant's Common Stock and Related Stockholder Matters The information required by this item is furnished by incorporation by reference of Page 25 of the Annual Report to Shareholders for the year ended February 3, 1996. Item 6: Selected Financial Data The selected financial data for the five years ended February 3, 1996, which appears on page 8 of the Annual Report to Shareholders is incorporated herein by reference. Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations Management's Discussion and Analysis of financial condition and results of operations appearing on pages 9 through 11 of the Annual Report to Shareholders is incorporated herein by reference. Item 8: Financial Statements and Supplementary Data The consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated March 8, 1996, appearing on pages 12 through 24 of the Annual Report to Shareholders are incorporated herein by reference. Item 9: Changes In and Disagreements With Accountants on Accounting and Financial Disclosure None. PART III Item 10: Directors and Executive Officers of the Registrant The following information is furnished with respect to each of the directors and executive officers of the Registrant: Name Age Positions and Offices Michael J. Hayes(1) 54 Director, Managing Director (2), Chief Executive Officer and President David A. Gardner(1) 48 Director and Managing Director (2) John R. Eisenman(1) 54 Director Roger T. Knox(1) 58 Director Michael K. Spear 51 Executive Vice President - Merchandising Bruce D. Smith 37 Executive Vice President and Chief Financial Officer Victor Saig 60 Senior Vice President - Store Operations Blanchard J. Box 57 Senior Vice President - Management Information Systems John A. Casey 49 Senior Vice President - Pharmacy Operations Charles S. Vail 52 Corporate Secretary, Vice President - Legal Services and General Counsel (1) Four directors, constituting the entire Board of Directors, are to be elected at the Annual Meeting to serve one year or until their successors are elected. (2) According to the By-laws of the Company, the Managing Directors (Messrs. Hayes and Gardner) are the chief executive officers of the Company and have general supervisory responsibility for the business of the Company. Michael J. Hayes was elected a director of the Company in January 1987 and has been a Managing Director of the Company since October 1989. Mr. Hayes has been Chief Executive Officer since October 1989 and President since May 1991. Additionally, Mr. Hayes is a Managing Director of Hayes Financial Corp. He was previously employed by Oppenheimer & Company, Inc. in various capacities from 1976 to 1985, including Managing Director and Executive Vice President - Corporate Finance and Financial Services. David A. Gardner was elected a director of the Company in January 1987 and has been a Managing Director of the Company since October 1989. Mr. Gardner has been President of Gardner Capital Corporation, a real estate and venture capital investment firm since April 1980. Additionally, Mr. Gardner is a director of Gulfstar Energy, Inc. and Joyce International, Inc. John R. Eisenman is involved in real estate investment and development with REMAX Island Realty, Inc., located in Hilton Head Island, South Carolina. Mr. Eisenman has been engaged in commercial and industrial real estate brokerage and development since 1983. Previously, he founded and served as President of Sally's, a chain of fast food restaurants from 1976 to 1983, and prior thereto held various management positions in manufacturing and in securities brokerage. Roger T. Knox has served the Memphis Zoological Society as its President and Chief Executive Officer since January 1989. Mr. Knox was the President and Chief Operating Officer of Goldsmith's Department Stores, Inc. (a full-line department store in Memphis and Jackson, Tennessee) from 1983 to 1989 and its Chairman of the Board and Chief Executive Officer from 1987 to 1989. Prior thereto, Mr. Knox was with Foley's Department Stores in Houston, Texas for 20 years. Michael K. Spear was hired in March 1995 as Executive Vice President - Merchandising. Mr. Spear had previously spent 21 years with Wal-Mart Stores, Inc., including 4 years in store operations, followed by 17 years in merchandising. Most recently he served Wal-Mart as Vice President, Divisional Merchandise Manager for the Sam's Clubs. Bruce D. Smith joined the Company in September 1991 as Executive Vice President and Chief Financial Officer. Prior to joining the Company, Mr. Smith was employed by Price Waterhouse LLP for eleven years and attained the position of Senior Audit Manager. Victor Saig is the Senior Vice President - Store Operations, a position he has held since November 1989. Mr. Saig joined the Company in 1963. Prior to this appointment, Mr. Saig served as Vice President - Hard Lines Merchandising and in various other operational and merchandising positions. Blanchard J. Box is the Senior Vice President - Management Information Systems of the Company, a position he has held since May 1991. Mr. Box, who joined the Company in 1989, was previously Vice President - Management Information Systems. Prior thereto, Mr. Box was responsible for management information systems at OTASCO, Inc., an Oklahoma retailer, from 1984 until 1989. John A. Casey was promoted to Senior Vice President - Pharmacy Operations in January 1994. Mr. Casey joined the Company in 1979. Prior to this appointment, Mr. Casey was Vice President - Pharmacy Operations from 1990 to 1994 and Director of Pharmacy Operations from 1988 to 1990. Prior to 1988, Mr. Casey was a pharmacy district manager and a pharmacist. Charles S. Vail has served the Company for more than nine years as Corporate Secretary, Vice President - Legal Services and General Counsel. Mr. Vail joined the Company in 1973. Based solely upon a review of reports of beneficial ownership of the Company's Common Stock and written representations furnished to the Company by its officers, directors and principal shareholders, the Company is not aware of any such reporting person who or which failed to file with the Securities and Exchange Commission on a timely basis any required reports of changes in beneficial ownership. Item 11: Executive Compensation The following table sets forth the cash compensation paid, as well as certain other compensation paid or accrued, to the Company's chief executive officer and to each of the other four most highly compensated executive officers whose aggregate salary and bonus cash compensation exceeded $100,000 during the indicated fiscal years (the "Named Executives"). SUMMARY COMPENSATION TABLE Long Term Annual Compensation Compensation Name and Restricted Option All Other Principal Salary Bonus Stock Awards Awards Compensation Position Year ($) ($) ($) (#) (1) ($) Michael J. Hayes 1995 180,000 -- -- -- 946 Managing Director, Chief 1994 180,000 -- -- -- 940 Executive Officer and 1993 180,000 -- -- -- 270 President David A. Gardner(2) 1995 120,000 -- -- -- -- Managing Director 1994 120,000 -- -- -- -- 1993 120,000 -- -- -- -- Michael K. Spear (3) 1995 145,962 30,730 195,000 20,000 -- Executive Vice President- 1994 -- -- -- -- -- Merchandising 1993 -- -- -- -- -- Joe M. Carter (4) 1995 66,462 -- -- -- 544 Executive Vice President- 1994 108,000 -- -- 8,500 1,015 Strategic Development 1993 107,077 22,000 -- -- 1,042 Gary E. Hendren (5) 1995 -- -- -- -- -- Executive Vice President- 1994 113,403 -- -- 8,500 1,169 Retail Operations 1993 156,000 14,000 -- -- 1,144 _________________________ (1) Company contributions to defined contribution plans (401-k and ESOP). (2) Payments for Mr. Gardner's services are made to Gardner Capital Corporation under a contractual relationship between that company and Fred's. (3) Mr. Spear joined the Company on March 6, 1995. (4) Mr. Carter left the employ of the Company on August 25, 1995. (5) Mr. Hendren left the employ of the Company on October 21, 1994. Option Grants, Exercises and Fiscal Year End Values During the last fiscal year, no stock options were exercised by any of the Named Executives. The following table sets forth information on stock option grants pursuant to the Fred's, Inc. 1993 Long-Term Incentive Plan during the last fiscal year for each of the Named Executives. OPTION/SAR GRANTS IN LAST FISCAL YEAR Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation for Individual Grants Option Term Number of Securities Underlying % of Total Options/ Options/SARs Exercise SARs Granted to or Base Granted Employees Price Expiration Name (#) in Fiscal Year ($/Sh) Date 5% ($)/10% ($) Michael K. Spear(1) 40,000 56.1 9.75 3/6/00 107,750/238,099 ___________________ (1) All options shown vested 25% at date of grant and vest 25% each year thereafter until fully vested three years after the date of grant. Shown below is information with respect to unexercised options to purchase Common Shares granted to the Named Executives and held by them at February 3, 1996. AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES Number of Securities Value of Underlying Unexercised Unexercised In-the-Money(1) Options/SARs Options/SARs at FY-End (#) at FY-End ($) Exercisable/ Exercisable/ Name Unexercisable Unexercisable Michael K. Spear 10,000/30,000 -- (1) At February 3, 1996, the unexercised options were not "in-the- money". Compensation Committee The Compensation Committee reviews and approves the salaries and incentive compensation of officers and approves the grants of restricted stock and stock options under Fred's long-term incentive plans. The Compensation Committee, which is comprised of Messers. Eisenman, Gardner and Knox, met one time during the last fiscal year, and all Committee members were in attendance. The Compensation Subcommittee, comprised of Messers. Hayes and Gardner, approves the grant of stock options to Messers. Eisenman and Knox. The Subcommittee met one time during the last fiscal year, and both members were in attendance. Executive Compensation COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION The Compensation Committee of the Board of Directors of Fred's, Inc. (the "Committee") is pleased to present its report on executive compensation. This Committee report documents the components of Fred's executive officer compensation programs and describes the basis on which 1995 compensation determinations were made by the Committee with respect to the executive officers of Fred's, including the executive officers that are named in the compensation tables (the "Named Executives"). Compensation Philosophy and Overall Objectives of Executive Compensation Programs It is the philosophy of Fred's that executive compensation be linked to improvements in corporate performance and increases in shareholder value. The following objectives have been adopted by the Committee as guidelines for compensation decisions: - Provide a competitive total compensation package that enables Fred's to attract and retain key executives. - Integrate all pay programs with Fred's annual and long- term business objectives and strategy, and focus executive behavior on the fulfillment of those objectives. - Provide variable compensation opportunities that are linked with the performance of Fred's and that align executive remuneration with the interests of shareholders. Compensation Program Components The Committee reviews Fred's compensation program annually to ensure that pay levels and incentive opportunities are competitive and reflect the performance of Fred's. The particular elements of the compensation program for executive officers are further explained below. Base Salary - Base pay levels are largely determined through comparisons with other retailing companies. Actual salaries are based on individual performance contributions within a salary structure that is established through job evaluation and job market considerations. Base pay levels for the executive officers are competitive within the middle of a range that the Committee considers to be reasonable and necessary. No increases in base salary were recommended by the Chief Executive Officer in fiscal 1995 for the Named Executives, based on performance and competitive considerations, and the Committee acted in accordance with the recommendation. Incentive Compensation - Fred's officers are eligible to participate in an annual incentive compensation plan with awards based primarily on the attainment of various specified levels of operating profits. The objective of this plan is to deliver competitive levels of compensation for the attainment of financial objectives that the Committee believes are primary determinants of earnings growth. Targeted awards for executive officers of Fred's under this plan are consistent with targeted awards of other retailing companies of similar size and complexity to Fred's. Actual awards are recommended by senior management and are subject to decrease or increase on the basis of Fred's performance and at the discretion of the Committee. No awards were made to the Named Executives of Fred's during 1995 due to the failure to achieve the targeted level of operating profit. In order to attract Mike Spear to Fred's, Mr. Spear was paid a signing bonus in accordance with his employment contract. Stock Option Program - The Committee strongly believes that by providing those persons who have substantial responsibility for the management and growth of Fred's with an opportunity to increase their ownership of Company stock, the best interests of shareholders and executives will be closely aligned. Therefore, executives are eligible to receive stock options from time to time, giving them the right to purchase shares of Common Stock of Fred's in the future at a specified price. The number of stock options granted to executive officers is based on competitive practices, with the value of such options estimated by using assumed annual rates of appreciation of 5% and 10% in Fred's's stock during the option term. Discussion of 1995 Compensation for the Chief Executive Officer In considering the compensation for the Chief Executive Officer for fiscal year 1995, the Committee has reviewed his existing compensation level and both Company and individual performances. Based on this review, the Committee has made the following determinations regarding the compensation of Mr. Hayes: - Base salary remains unchanged. The Committee determined that Mr. Hayes' base salary continues to be at the desired competitive level relative to industry practices. - Mr. Hayes' high level of beneficial ownership of Fred's Common Stock is adequate incentive to link his performance to the interests of the other shareholders of Fred's. Summary After its review of all existing programs, the Committee continues to believe that the total compensation program for executives of Fred's is competitive with the compensation programs provided by other companies with which Fred's competes. The Committee believes that any amounts paid under the incentive compensation plan will be appropriately related to corporate and individual performance, yielding awards that are linked to the annual financial and operational results of Fred's. The Committee also believes that the stock option program provides opportunities to participants that are consistent with the returns that are generated on behalf of Fred's shareholders. Committee members: John R. Eisenman, David A. Gardner and Roger T. Knox STOCK PRICE PERFORMANCE GRAPH The following graph compares the cumulative total returns for Fred's, the NASDAQ Retail Trade Stocks Index and the NASDAQ Stock Market (U.S.) Index. [Performance graph submitted supplementally to Branch Chief pursuant to Regulation S-T, Item 304(d).] Total Return Analysis 3/18/92 1/30/93 1/29/94 1/28/95 2/3/96 ------- ------- ------- ------- ------ Fred's, Inc. $100.00 $106.04 $ 95.80 $ 65.55 $ 51.62 Nasdaq Retail Trade $100.00 $ 88.61 $ 95.39 $ 79.69 $ 95.18 Nasdaq Composite (US) $100.00 $110.46 $126.45 $123.47 $176.92 Comparison of Cumulative Total Return The total cumulative return on investment assumes that $100 was invested in Fred's, the NASDAQ Retail Trade Stocks Index and the NASDAQ Stock Market (U.S.) Index on March 18, 1992 and that all dividends were reinvested. Fred's stock was not publicly traded before its public offering on March 18, 1992 at $14.50 per share. Compensation Committee Interlocks and Insider Participation Mr. Gardner, a managing director of Fred's, served as a member of the Compensation Committee for fiscal 1994. See "Ownership of Common Stock by Directors, Officers and Certain Beneficial Owners" and "Arrangements for the Election of Directors" for information concerning MRILP and the Shareholders Agreement, which provides that certain parties will vote for the election of certain persons as directors. Fred's does not currently intend to enter into material transactions involving its principal shareholders except for the continuing utilization of the services of Messrs. Hayes and Gardner as Managing Directors, which services management believes are on terms as favorable as those that could be obtained from independent third parties. Item 12: Security Ownership of Certain Beneficial Owners and Management To the best knowledge of the Company based on information filed with the Securities and Exchange Commission and the Company's stock records, the following table sets forth the beneficial ownership of the Company's Common Stock as of April 30, 1996, by (i) beneficial owners of more than five percent of the Company's Common Stock, (ii) each director, (iii) each nominee for director and (iv) all directors and officers of the Company as a group. Shares of the Company's Common Stock Beneficially Owned (1) Beneficial Owner Shares Percent(2) Michael J. Hayes (3) 975,164 10.2 Memphis Retail Investors Limited Partnership (3)(5) 890,395 9.3 FMR Corp.(4) 890,300 9.3 David A. Gardner (5) 840,188 8.8 Franklin Resources, Inc. 745,200 7.8 Electra Investment Trust, PLC 541,608 5.6 Roger T. Knox (6) 7,125 * John R. Eisenman (6) 6,625 * All Directors and Officers as a Group (10 persons including the current directors named above)(7) 1,929,382 20.1 * Less than 1% (1) As used in this table, beneficial ownership means the sole or shared power to vote, or direct the voting of, a security, or the sole or shared power to dispose, or direct the disposition, of a security. Except as otherwise indicated, all persons listed above have (i) sole voting power and investment power with respect to their shares of Common Stock, except to the extent that authority is shared by spouses under applicable law, and (ii) record and beneficial ownership with respect to their shares of Common Stock. (2) Calculated as the number of shares beneficially owned, divided by 9,588,652 which consists of the total of the Company's outstanding shares of Common Stock (9,335,232) and vested options (253,420) as of April 30, 1996. (3) Amounts included as beneficially owned by Mr. Hayes include 1,500 shares owned by his 3 children, 200 shares owned by his wife and 890,295 shares owned by Memphis Retail Investors Limited Partnership ("MRILP") which are attributable to Mr. Hayes, his wife and three children. (4) Pursuant to FMR Corp.'s most recent filing with the Securities and Exchange Commission with respect to the Company's Common Stock, FMR Corp. does not participate in the power to vote the Company's shares. (5) Amounts included as beneficially owned by Mr. Gardner include 100 shares owned by MRILP. Mr. Gardner disclaims beneficial ownership of the 94,402 shares of the Company's Common Stock owned by his wife, which are not included in the table. (6) Includes the right to acquire 5,625 shares upon the exercise of vested options. (7) Includes the right to acquire 62,300 shares upon the exercise of vested options. (8) The address of MRILP and Mr. Hayes is 4300 New Getwell Road, Memphis, Tennessee 38118. Mr. Gardner's address is 445 Park Avenue, Suite 1600, New York, New York 10022. The address of Franklin Resources, Inc. is 777 Mariners Island Blvd., San Mateo, California 94404. The domestic address of Electra Investment Trust, PLC is 70 E. 55th Street, New York, New York 10022. The address of FMR Corp. is 82 Devonshire Street, Boston, Massachusetts 02109. The addresses of Messrs. Eisenman and Knox, respectively, are 11 South Live Oak Road, Hilton Head Island, South Carolina 29928 and 360 Tara Lane, Memphis, Tennessee 38111. Item 13: Certain Relationships and Related Transactions In connection with the sale of the Company's Debentures in 1986, certain parties that were holders of shares of Common Stock and Debentures (which Debentures were converted into Common Stock in 1989) entered into an agreement (the "Shareholders Agreement"). The Shareholders Agreement provides that the parties will vote for the election of Mr. Michael J. Hayes as a director. The number of shares subject to the Shareholders Agreement represent an aggregate of 32.8% of the Common Stock. PART IV Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K (a)(1) Consolidated Financial Statements The following consolidated financial statements are incorporated herein by reference from pages 12 through 24 of the Annual Report to Shareholders for the year ended February 3, 1996. Consolidated Statements of Income for the years ended February 3, 1996, January 28, 1995 and January 29, 1994. Consolidated Balance Sheets as of February 3, 1996 and January 28, 1995. Consolidated Statements of Changes in Shareholders' Equity for the years ended February 3, 1996, January 28, 1995 and January 29, 1994. Consolidated Statements of Cash Flows for the years ended February 3, 1996, January 28, 1995 and January 29, 1994. Notes to Consolidated Financial Statements. Report of Independent Accountants. (a)(2) Financial Statement Schedules: All schedules are omitted because they are not applicable or not required, or because the information is included in the financial statements or notes thereto. (a)(3) Those exhibits required to be filed as Exhibits to this Annual Report on Form 10-K pursuant to Item 601 of Regulation S-K are as follows: 3.1 Certificate of Incorporation, as amended [incorporated herein by reference to Exhibit 3.1 to the Form S-1 as filed with the Securities and Exchange Commission February 7, 1992 (SEC File No. 33-45637) (the "Form S- 1")]. 3.2 By-laws, as amended [incorporated herein by reference to Exhibit 3.2 to the Form S-1]. 4.1 See Exhibits 3.1 and 3.2 hereto. 4.2 Specimen Common Stock Certificate [incorporated herein by reference to Exhibit 4.2 to Pre-Effective Amendment No. 3 to the Form S-1] 9.1 Baddour, Inc. (Registrant changed its name to "Fred's, Inc." in 1991) Shareholders Agreement dated as of June 28, 1986 [incorporated herein by reference to Exhibit C, pages C-1 through C-42 to Baddour, Inc.'s Report on Form 8-K dated July 1, 1986] 10.6 Lease Agreement dated November 12, 1991 with the U.S. Government [incorporated herein by reference to Exhibit 10.6 to the Form S-1]. 10.8 Form of Fred's, Inc. Franchise Agreement [incorporated herein by reference to Exhibit 10.8 to the Form S-1]. 10.9 401(k) Plan dated as of May 13, 1991 [incorporated herein by reference to Exhibit 10.9 to the Form S-1]. 10.10 Employee Stock Ownership Plan (ESOP) dated as of January 1, 1987 [incorporated herein by reference to Exhibit 10.10 to the Form S-1]. 10.11* Incentive Stock Option Plan dated as of December 22, 1986 [incorporated herein by reference to Exhibit 10.11 to the Form S-1]. 10.15 Lease Agreement by and between Hogan Motor Leasing, Inc. and Fred's, Inc. dated February 5, 1992 for the lease of truck tractors to Fred's, Inc. and the servicing of those vehicles and other equipment of Fred's, Inc. [incorporated herein by reference to Exhibit 10.15 to Pre-Effective Amendment No. 1 to the Form S-1]. 10.17 Revolving Loan and Credit Agreement between Fred's, Inc. and Union Planters National Bank dated as of May 15, 1992 [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended May 2, 1992]. 10.18 Note and Security Agreement between National Bank of Commerce as Trustee for the ESOP of Fred's, Inc., together with the Limited Guaranty of Fred's, Inc. dated as of May 29, 1992 [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended August 1, 1992]. 10.19* 1993 Long Term Incentive Plan dated as of January 21, 1993 [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 31, 1993]. 10.20 Negative Pledge and Loan Agreement between Fred's, Inc. and National Bank of Commerce dated as of February 17, 1994 [incorporated herein by reference to the Company's report on Form 10-K for the year ended January 29, 1994]. 10.21 Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of May 31, 1995 (modifies the Revolving Loan and Credit Agreement included as Exhibit 10.17) [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 29, 1995]. 10.22 Second Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of July 31, 1995 (modifies the Revolving Loan and Credit Agreement included as Exhibit 10.17) [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 29, 1995]. 10.23 Seasonal Overline Revolving Credit Agreement between Fred's, Inc. and Union Planters National Bank dated as of July 31, 1995 [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 29, 1995]. 10.24** Employment Agreement between Fred's, Inc. and Michael K. Spear dated as of March 6, 1995. 11.1** Computation of Net Income per Share 13.1** Annual report to shareholders for the year ended February 3, 1996 (to the extent incorporated herein by reference). 21.1** Subsidiaries of Registrant 23.1** Consent of Price Waterhouse LLP. 27. ** Financial Data Schedule. (b) No reports on Form 8-K were filed by the registrant during the last quarter of the period covered by this report. However, a report on Form 8-K dated March 1, 1996 was filed subsequent to the fourth quarter regarding the proposed acquisition by merger of Rose's Stores, Inc. by Fred's. * Management Compensatory Plan ** Filed herewith SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on this 30th day of May, 1996. FRED'S, INC. By: /s/ Michael J. Hayes -------------------------------------- Michael J. Hayes, Chief Executive Officer and President By: /s/ Bruce D. Smith -------------------------------------- Bruce D. Smith, Executive Vice President and Chief Financial Officer (Principal Accounting and Financial Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 30th day of May, 1996. Signature Title /s/ Michael J. Hayes Director, Managing Director, Michael J. Hayes Executive Officer and President Chief /s/ David A. Gardner Director and Managing Director David A. Gardner /s/ Roger T. Knox Director Roger T. Knox /s/ John R. Eisenman Director John R. Eisenman