FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the quarterly period ended May 3, 1997. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from __________ to ____________. Commission file number 000-19288 FRED'S, INC. (Exact name of registrant as specified in its charter) Tennessee 62-0634010 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4300 New Getwell Rd., Memphis, Tennessee 38118 (Address of principal executive offices) (zip code) (901) 365-8880 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X . No . -------- -------- The registrant had 9,384,741 shares of Class A voting, no par value common stock outstanding as of May 3, 1997. FRED'S, INC. INDEX Page No. -------- Part I - Financial Information - ------------------------------ Item 1 - Financial Statements (unaudited): Consolidated Balance Sheets as of May 3, 1997 and February 1, 1997 3 Consolidated Statements of Income for the Thirteen Weeks Ended May 3, 1997 and May 4, 1996 4 Consolidated Statements of Cash Flows for the Thirteen Weeks Ended May 3, 1997 and May 4, 1996 5 Notes to Consolidated Financial Statements 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 7 - 8 Part II - Other Information 9 - --------------------------- Signatures 10 - ---------- FRED'S, INC. CONSOLIDATED BALANCE SHEETS (unaudited) (in thousands, except for number of shares) May 3, February 1, 1997 1997 ------- ----------- ASSETS - ------ Current assets: Cash and cash equivalents $ 7,541 $ 8,569 Receivables, less allowance for doubtful accounts 5,005 4,493 Inventories 92,914 88,505 Deferred income taxes 4,152 4,152 Other current assets 1,386 895 -------- -------- Total current assets 110,998 106,614 Property and equipment, at depreciated cost 48,355 48,379 Equipment under capital leases, less accumulated amortization 1,548 320 Deferred income taxes 3,439 3,921 Other noncurrent assets 2,048 1,914 -------- -------- $166,388 $161,148 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 27,353 $ 27,862 Current portion of indebtedness 882 1,278 Current portion of capital lease obligations 189 363 Accrued liabilities 11,024 8,935 Income taxes payable 2,139 1,648 -------- -------- Total current liabilities 41,587 40,086 Indebtedness - - Capital lease obligations 1,532 138 Other noncurrent liabilities 1,402 1,345 -------- -------- Total liabilities 44,521 41,569 -------- -------- Commitments and contingencies Shareholders' equity: Common stock, Class A voting, no par value, 9,384,741 shares issued and outstanding (9,328,822 shares at February 1, 1997) 63,962 63,369 Retained earnings 58,587 56,364 Deferred compensation on restricted stock incentive plan (682) (154) -------- --------- Total shareholders' equity 121,867 119,579 -------- --------- $166,388 $161,148 ======== ========= See accompanying notes to consolidated financial statements FRED'S, INC. CONSOLIDATED STATEMENTS OF INCOME (unaudited) (in thousands, except per share amounts) Thirteen Weeks Ended -------------------- May 3, May 4, 1997 1996 -------------------- Net sales $112,668 $101,758 Cost of goods sold 81,594 73,976 -------- -------- Gross profit 31,074 27,782 Selling, general and administrative expenses 26,807 24,467 -------- -------- Operating income 4,267 3,315 Interest expense (Income), net (21) 94 -------- -------- Income before income taxes 4,288 3,221 Provision for income taxes 1,608 1,169 -------- -------- Net income $ 2,680 $ 2,052 ======== ======== Net income per share $ .29 $ .22 ======== ======== Weighted average number of common shares and common equivalent shares outstanding 9,330 9,326 ======== ======== See accompanying notes to consolidated financial statements FRED'S, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands) Thirteen Weeks Ended ------------------------------ May 3, May 4, 1997 1996 --------- -------- Cash flows from operating activities: Net income $ 2,680 $ 2,052 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization 1,600 1,470 Deferred income taxes 482 353 Amortization of deferred compensation on restricted stock incentive plan 60 30 (Increase) decrease in assets: Receivables (512) 146 Inventories (4,409) (8,355) Other current assets (491) 87 Increase (decrease) in liabilities: Accounts payable (509) (2,281) Accrued liabilities 2,089 (999) Income taxes payable 491 823 Other noncurrent liabilities 57 49 --------- -------- Net cash provided by (used in) operating activities 1,538 (6,625) --------- -------- Cash flows from investing activities: Additions to property, equipment and equipment under capital leases (1,385) (736) Additions to intangible assets (257) (116) --------- -------- Net cash (used in) provided by investing activities (1,642) (852) --------- -------- Cash flows from financing activities: Proceeds from borrowings and increase in capital lease obligations - 3,900 Reduction of indebtedness and capital lease obligations (458) (441) Cash dividends paid (466) (467) --------- -------- Net cash provided by (used in) financing activities (924) 2,992 --------- -------- Increase (decrease) in cash and cash equivalents (1,028) (4,485) Beginning of period cash and cash equivalents 8,569 5,496 --------- -------- End of period cash and cash equivalents $ 7,541 $ 1,011 ========= ======== Supplemental disclosures of cash flow information: Interest paid (earned) $ (36) $ 70 Income taxes paid $ - $ - See accompanying notes to consolidated financial statements FRED'S, INC. ------------ NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ NOTE 1: BASIS OF PRESENTATION - ------------------------------ The accompanying unaudited consolidated financial statements of Fred's, Inc. ("Fred's" or the "Company") have been prepared in accordance with the instructions to Form 10-Q and therefore do not include all information and notes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. The statements do reflect all adjustments (consisting of only normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of financial position in conformity with generally accepted accounting principles. The statements should be read in conjunction with the Notes to the Consolidated Financial Statements for the fiscal year ended February 1, 1997 incorporated into the Company's Annual Report on Form 10-K. The results of operations for the thirteen week period ended May 3, 1997 are not necessarily indicative of the results to be expected for the full fiscal year. NOTE 2: NET INCOME PER SHARE - ----------------------------- Net income per share is based on the weighted average number of common shares and common equivalent shares outstanding. See Exhibit 11. In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, Earnings Per Share ("FAS 128"). FAS 128 changes the computation, presentation and disclosure requirements of earnings (loss) per share that has previously been followed by the Company. FAS 128 is effective for years ending after December 15, 1997 and early adoption is not permissible. If the provisions of FAS 128 were adopted for the three months ending May 3, 1997, and May 4, 1996, the Company's proforma basic earnings per share would have been $.29 and $.22, respectively and its proforma diluted earnings per share would have been $.29 and $.22, respectively. Management's Discussion and Analysis of Financial Condition and Results of Operations FINANCIAL CONDITION - ------------------- Fred's operates 217 discount general merchandise stores in ten states in the southeastern United States. One hundred and five of the stores have full service pharmacies. Due to the seasonality of Fred's business and the continued increase in the number of stores and pharmacies, inventories are generally lower at year end than at each quarter end of the following year. As shown on the consolidated statement of cash flows, inventories increased $4,408,000 during the thirteen week period ended May 3, 1997. In addition, cash was used to reduce balances with trade vendors ($507,000), and fund capital expenditures ($1,392,000) and cash dividends ($466,000). The increased inventory levels and other cash outlays were financed from net income ($2,680,000) and existing cash. The Company believes that sufficient capital resources are available in both the short-term and long-term through currently available cash and cash generated from future operations and, if necessary, the ability to obtain additional financing. The Company has a $12,000,000 revolving credit commitment available from a bank. At May 3, 1997, no borrowings have been made under the revolving credit agreement. During the fourth quarter of 1996, the Company recorded a $2,860,000 accrual for the closure of certain underperforming stores and the repositioning of certain merchandise categories. As of the end of the thirteen weeks ended May 3, 1997, there have been no material changes in the Company's restructuring plan or in the estimates of charges accrued with respect to the restructuring plan as of the end of fiscal 1996. RESULTS OF OPERATIONS - --------------------- Thirteen Weeks Ended May 3, 1997 and May 4, 1996 - ------------------------------------------------ Net sales increased from $101.8 million in 1996 to $112.7 million in 1997, an increase of $10.9 million or 10.7%. The increase was attributable to comparable store sales increases of 8.6% ($7.9 million) and sales by stores not yet included as comparable stores ($3.0 million). Wholesale sales to franchisees and independents increased $.1 million in 1997. Gross profit increased from 27.3% of sales in 1996 to 27.6% in 1997, primarily due to strong quarterly sales in certain seasonal categories such as lawn and garden which finished with a solid double-digit increase over the first quarter of 1996. This combined with the higher margins in the pharmacy segment, contributed to the overall improved margins. Another factor in the higher gross margin was an increase in the proportion of retail sales, which carry higher margins than wholesale sales. Selling, general and administrative expenses increased from $24.5 million in 1996 to $26.8 million in 1997. As a percentage of sales, expenses decreased from 24.0% to 23.8%. The improvement in comparable store sales for the quarter contributed to a higher leveraging of expenses and, therefore, an improved expense ratio. This leveraging more than offset the adverse impact of the recent minimum wage increase and higher-than-expected health insurance costs compared with the first quarter of 1996. EFFECT OF 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. 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 partially mitigated, however, by the inclusion of the month of January, which is generally the least profitable month of the year. PART II. OTHER INFORMATION Item 1. Legal Proceedings Not Applicable. Item 2. Changes in Securities Not Applicable. Item 3. Defaults Upon Senior Securities Not Applicable. Item 4. Submission of Matters to a Vote of Securities Holders Not Applicable. Item 5. Other Information Not Applicable. Item 6. Exhibits and Reports on Form 8-K Exhibits: Exhibit 11 - Computation of Net Income Per Share Exhibit 27 - Financial Data Schedule (EDGAR Filing Only) Reports on Form 8-K: Not Applicable. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FRED'S, INC. /s/ Michael J. Hayes ----------------------- Michael J. Hayes Date: June 16, 1997 Chief Executive Officer - -------------------- /s/ Richard B. Witaszak ----------------------- Richard B. Witaszak Date: June 16, 1997 Chief Financial Officer - --------------------