FORM 10-Q/A 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 November 1, 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 9,464,657 shares of common stock outstanding as of December 5, 1997, which shares have not been adjusted for December stock split. FRED'S, INC. INDEX Page No. Part I - Financial Information Item 1 - Financial Statements (unaudited): Consolidated Balance Sheets as of November 1, 1997 and February 1, 1997 3 Consolidated Statements of Operations for the Thirteen Weeks Ended and the Thirty-Nine Weeks Ended November 1, 1997 and November 2, 1996 4 Consolidated Statements of Cash Flows for the Thirty-Nine Weeks Ended November 1, 1997 and November 2, 1996 5 Notes to Consolidated Financial Statements 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 7 - 9 Part II - Other Information 11 - --------------------------- Signatures 13 - 2 - FRED'S, INC. CONSOLIDATED BALANCE SHEETS (unaudited) (in thousands, except for number of shares) November 1, February 1, 1997 1997 ASSETS Current assets: Cash and cash equivalents $ 3,531 $ 8,569 Receivables, less allowance for doubtful accounts 5,752 4,493 Inventories 106,347 88,505 Deferred income taxes 4,181 4,152 Other current assets 994 895 -------- -------- Total current assets 120,805 106,614 Property and equipment, at depreciated cost 50,104 48,379 Equipment under capital leases, less accumulated amortization 1,418 320 Deferred income taxes 3,340 3,921 Other noncurrent assets, net of accumulated amortization 2,318 1,914 -------- -------- $177,985 $161,148 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 34,888 $ 27,862 Current portion of indebtedness 173 1,278 Current portion of capital lease obligations 208 363 Accrued liabilities 13,435 8,935 Income taxes payable 734 1,648 -------- -------- Total current liabilities 49,438 40,086 Capital lease obligations 1,425 138 Other noncurrent liabilities 1,516 1,345 -------- -------- Total liabilities 52,379 41,569 -------- -------- Commitments and contingencies Shareholders' equity: Common stock, Class A voting, no par value, 9,448,299 shares issued and outstanding (9,328,822 shares at February 1, 1997) 64,878 63,369 Retained earnings 61,254 56,364 Deferred compensation on restricted stock incentive plan (526) (154) ------- ------- Total shareholders' equity 125,606 119,579 -------- -------- $177,985 $161,148 See accompanying notes to consolidated financial statements - 3 - FRED'S, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (in thousands, except per share amounts) Thirteen Weeks Ended Thirty-Nine Weeks Ended November 1, November 2, November 1, November 2, 1997 1996 1997 1996 --------- --------- --------- --------- Net sales .............................. $ 114,021 $ 99,283 $ 336,885 $ 300,069 Cost of goods sold ..................... 80,659 71,100 242,270 217,659 --------- --------- --------- --------- Gross profit ......................... 33,362 28,183 94,615 82,410 Selling, general and administrative expenses .............................. 29,623 25,648 84,663 75,751 -------- --------- --------- --------- Other expenses ......................... -- 429 -- 429 Operating income ..................... 3,739 2,535 9,952 6,659 Interest (income) expense, net ......... (49) 104 (125) 315 --------- --------- --------- --------- Income before income taxes ........... 3,788 2,002 10,077 5,915 Provision for income taxes ............. 1,420 741 3,778 2,188 --------- --------- --------- --------- Net income ............................. $ 2,368 $ 1,261 $ 6,299 $ 3,727 ========= ========= ========= ========= Net income per share ................... $ .25 $ .14 $ .67 $ .40 ========= ========= ========= ========= Weighted average number of common shares and common equivalent shares outstanding ........................... 9,569 9,322 9,456 9,331 ========= ========= ========= ========= See accompanying notes to consolidated financial statements - 4 - FRED'S, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands) Thirty-Nine Weeks Ended November 1, November 2, 1997 1996 ----------- ------ Cash flows from operating activities: Net income $ 6,299 $ 3,727 Adjustments to reconcile net income to net cash flows from operating activities: Depreciation and amortization 5,081 4,396 Contribution to ESOP to reduce ESOP loan balance - 143 Amortization of deferred compensation on restricted stock incentive plan 135 (106) Deferred income taxes 553 656 (Increase) decrease in assets: Receivables (1,258) (382) Inventories (17,542) (16,417) Other current assets (100) (360) Increase (decrease) in liabilities: Accounts payable 7,025 4,415 Accrued liabilities 4,500 1,544 Income taxes payable (914) 978 Other noncurrent liabilities 170 165 -------- -------- Net cash (used in) provided by operating activities 3,949 (1,241) -------- -------- Cash flows from investing activities: Additions to property and equipment (6,129) (2,634) Additions to intangible assets (889) (429) Net cash (used in) provided by investing activities (7,018) (3,063) -------- -------- Cash flows from financing activities: Proceeds from borrowings - 3,100 Reduction of indebtedness and capital lease obligations (1,264) (1,491) Proceeds and tax effect from exercise of stock options 702 - Cash dividends paid (1,407) (1,400) -------- -------- Net cash (used in) provided by financing activities (1,969) 209 -------- -------- Increase (decrease) in cash and cash equivalents (5,038) (4,095) Cash and cash equivalents: Beginning of period 8,569 5,496 -------- -------- End of period $ 3,531 $ 1,401 ======== ======== Supplemental disclosures of cash flow information: Interest paid (received) $ (123) $ 240 Income taxes paid $ 3,200 $ 555 See accompanying notes to consolidated financial statements - 5 - 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 in the Company's Annual Report on Form 10-K. The results of operations for the thirteen week and thirty-nine week periods ended November 1, 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 thirteen and thirty-nine weeks ended November 1, 1997, and November 2, 1996, respectively the Company's proforma earnings per share would have been as follows: Thirteen Weeks Ended Thirty-Nine Weeks Ended November 1, November 2, November 1, November 2, 1997 1996 1997 1996 ----------- ----------- ----------- ------- Basic earnings per share .25 .14 .67 .40 Diluted earnings per share .25 .14 .67 .40 - 6 - Management's Discussion and Analysis of Financial Condition and Results of Operations GENERAL The Private Securities Litigation Reform Act of 1995 ("the Act") provides a safe harbor for forward-looking statements made by or on behalf of the Company. Certain statements contained in Management's Discussion and Analysis and in other Company filings are forward-looking statements. These statements discuss among other things, expected growth, future revenues, future cash flows and future performance. The forward looking statements are subject to risks and uncertainties including but not limited to competitive pressures, inflation, consumer debt levels, currency exchange fluctuations, trade restrictions, changes in tariff and freight rates, capital market conditions, and other risks indicated in the Company's filings with the Securities and Exchange Commission. Actual results may materially differ from anticipated results described in these statements. Fred's operates 261 discount general merchandise stores and Xpress units in ten states in the southeastern United States. One hundred and thirty-nine of the stores have full service pharmacies. Fred's business is subject to seasonal influences, but the Company has tended to experience less seasonal fluctuation than many other retailers due to the Company's mix of everyday basic merchandise and pharmacy business. The fourth quarter is typically the most profitable quarter because it includes the Christmas selling season. The overall strength of the fourth quarter is partially mitigated, however, by the inclusion of the month of January, which is generally the least profitable month of the year. The impact of inflation on labor and occupancy costs can significantly affect Fred's operations. Many of Fred's employees are paid hourly rates related to the federal minimum wage and, accordingly, any increase affects Fred's. In addition, payroll taxes, employee benefits and other employee-related costs continue to increase. Occupancy costs, including rent, maintenance, taxes and insurance, also continue to rise. Fred's believes that maintaining adequate operating margins through a combination of price adjustments and cost controls, careful evaluation of occupancy needs, and efficient purchasing practices is the most effective tool for coping with increasing costs and expenses. - 7 - RESULTS OF OPERATIONS In August 1996, the federal minimum wage law was changed to increase the minimum wage from $4.25 per hour to $4.75 per hour effective October 1, 1996 and from $4.75 per hour to $5.15 per hour effective September 1, 1997. The Company estimates that these changes will result in an increase in wage expense during fiscal 1998 of approximately $1.4 million. In anticipation of the impacts of minimum wage on the Company's profitability, a consulting firm was engaged to review the business processes and productivity within the Company's retail operations. The improvements implemented as a result of this retail efficiency project will be significant in offsetting the financial impacts of the minimum wage increase. During 1996, the Company performed an evaluation of the impact of the year 2000 as it relates to its Information Systems. Based upon the current plan of action, management of the Company is of the opinion the required changes will not have a material effect on the results of operation or the financial condition of the Company. Thirteen Weeks Ended November 1, 1997 and November 2, 1996 Net sales increased from $99.3 million in 1996 to $114.0 million in 1997, an increase of $14.7 million or 14.8%. The increase was attributable to comparable store sales increases of 7.4% ($6.6 million) and sales by stores not yet included as comparable stores ($8.2 million). Wholesale sales to franchisees and independents decreased $.1 million or 0.7% in 1997. Gross profit increased from 28.4% of sales in 1996 to 29.3% in 1997 primarily due to strong quarterly sales in several higher margin departments, along with an excellent sell through in seasonal and softline categories without the need for markdown levels experienced in prior years. Selling, general and administrative expenses increased from $25.6 million in 1996 to $29.6 million in 1997. As a percentage of sales, these expenses increased from 25.8% to 26.0%. The improvement in comparable store sales for the quarter contributed to a higher leveraging of expenses, however, the benefit was offset by start-up costs associated with the 8% increase in our store base during the third quarter, the impact from the minimum wage increase in September, and non-recurring consulting fees associated with the development of a new warehouse management system. - 8 - Thirty-Nine Weeks Ended November 1, 1997 and November 2, 1996 Net sales increased from $300.0 million in 1996 to $336.9 million in 1997, an increase of $36.9 million or 12.3%. The increase was attributable to comparable store sales increases of 8.0% ($21.7 million) and sales by stores not yet included as comparable stores ($14.9 million). Wholesale sales to franchisees and independents increased $.3 million or 1.1% in 1997. Gross profit increased from 27.5% of sales in 1996 to 28.1% in 1997 for the aforementioned reasons due to lower levels of markdowns experienced in prior years combined with a slightly higher initial purchase margin resulting from improved sourcing and higher volumes of opportunistic purchases. Selling, general and administrative expenses increased from $75.8 million in 1996 to $84.7 million in 1997. As a percentage of sales, these expenses decreased from 25.2% to 25.1%. The improvement in comparable store sales for the first nine months of 1997 contributed to 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 the higher- than-expected property, health, and workers compensation insurance costs compared with the first nine months of 1997. Selling, general and administrative expenses for the first nine months of 1997 also included an additional 50 store and pharmacy locations than in the first nine months of 1996. LIQUIDITY AND CAPITAL RESOURCES Due to the seasonality of Fred's business and the continued increase in the number of stores and pharmacies, inventories are generally lower at year-end than at each quarter-end of the following year. Cash flows provided by operating activities totaled $3,949,000 during the thirty-nine week period ended November 1, 1997. Cash was primarily used to increase inventories $17,542,000. These cash outlays were financed primarily from net income $6,299,000, higher levels of accrued liabilities of $4,500,000 and an increase in trade vendors by $7,025,000. Cash flows used by investing activities totaled ($7,018,000) which was primarily used to fund upgrades to the distribution center management system and new store and pharmacy capital expenditures ($6,129,000). Cash flows used by financing activities totaled ($1,969,000) which was used to pay cash dividends ($1,407,000) and reduce indebtedness ($1,264,000). The Company has a $12,000,000 revolving credit commitment available from a bank. At November 1, 1997, no borrowings have been made under the revolving credit agreement. - 9 - 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. - 10 - 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 2.1 - Asset Purchase Agreement between CVS Revco D.S., Inc., Fred's Stores of Tennessee, Inc., CVS corporation and Fred's, Inc., dated as of October 10, 1997 (incorporated herein by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K dated December 1, 1997)* Exhibit 2.2 - Letter Agreement between CVS Revco D.S., Inc. Fred's Stores of Tennessee, Inc., CVS Corporation and Fred's, Inc. dated as of November 1, 1997 (incorporated herein by reference to Exhibit 2.2 to the Company's Current Report on Form 8-K dated December 1, 1997) Exhibit 27 - Financial Data Schedule (Edgar Filing only) Exhibit 99.1 - Press Release dated October 14, 1997 announcing the asset purchase (incorporated herein by reference to Exhibit 99.1 to the Company's Current Report on Form 8-K dated December 1, 1997) - 11 - Exhibit 99.2 - Press Release dated November 24, 1997, announcing the completion of the asset purchase and the Fred's stock split and dividend (incorporated herein by reference to Exhibit 99.2 to the Company's Current Report on Form 8-K dated December 1, 1997) *The Registrant hereby agrees to furnish supplementally a copy of any omitted schedules to this Agreement to the Securities and Exchange Commission upon its request. Reports on Form 8-K: Current Report on Form 8-K dated December 1, 1997 (filed December 2, 1997) reporting under Item 5, Other Events, information related to the Company's acquisition of 17 stores from CVS Revco, D.S., Inc., and announcement Board of Director approval of five-for-four stock split and declaration of a quarterly cash dividend of $.05 per share. - 12 - 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/ Richard B. Witaszak Richard B. Witaszak Date: December 18, 1997 (Duly authorized representative) - ------------------------ - 13 -