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 October 31, 1998.
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 11,946,316 shares of common stock outstanding as of December
4, 1998.
FRED'S, INC.
INDEX
Page No.
Part I - Financial Information
Item 1 - Financial Statements (unaudited):
Consolidated Balance Sheets as of
October 31, 1998 and January 31, 1998 ....................................3
Consolidated Statements of Operations for the Thirteen Weeks Ended and the
Thirty-Nine Weeks Ended October 31, 1998 and November 1, 1997 ........... 4
Consolidated Statements of Cash Flows
for the Thirty-Nine Weeks Ended October 31, 1998
and November 1, 1997 .....................................................5
Notes to Consolidated Financial Statements ................................6
Item 2 - Management's Discussion and
Analysis of Financial Condition and
Results of Operations ....................................7 - 10
Part II - Other Information ..................................................11
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Signatures ...................................................................12
- 2 -
Item 1. Financial Statements
FRED'S, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except for number of shares)
October 31, January 31,
1998 1998
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 499 $ 5,303
Receivables, less allowance for doubtful
accounts 8,366 7,086
Inventories 137,133 115,021
Deferred income taxes 4,138 5,441
Other current assets 2,249 1,005
-------- --------
Total current assets 152,385 133,856
Property and equipment, at depreciated cost 66,886 53,099
Equipment under capital leases, less
accumulated amortization 1,156 1,352
Deferred income taxes 2,758 3,284
Other noncurrent assets 4,601 3,816
-------- --------
Total assets $227,786 $195,407
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 49,086 $ 49,438
Current portion of indebtedness 14,725 --
Current portion of capital lease obligations 241 214
Accrued liabilities 12,013 11,817
Income taxes payable 1,162 1,716
-------- --------
Total current liabilities 77,227 63,185
Indebtedness 11,000 --
Capital lease obligations 1,181 1,368
Other noncurrent liabilities 1,631 1,495
-------- --------
Total liabilities 91,039 66,048
-------- --------
Shareholders' equity:
Common stock, Class A voting, no par value,
11,946,191 shares issued and outstanding
(11,866,789 shares at January 31, 1998) 66,945 65,700
Retained earnings 70,442 64,147
Deferred compensation on restricted
stock incentive plan (640) (488)
--------- --------
Total shareholders' equity 136,747 129,359
--------- --------
$227,786 $195,407
======== ========
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
October 31, November 1, October 31, November 1,
1998 1997 1998 1997
----------- ----------- ----------- ---------
Net sales $ 142,339 $ 114,021 $ 428,130 $ 336,885
Cost of goods sold 100,955 80,659 307,432 242,270
--------- --------- --------- ---------
Gross profit 41,384 33,362 120,698 94,615
Selling, general and administrative
expenses 36,936 29,623 107,255 84,663
--------- --------- --------- ---------
Operating income 4,448 3,739 13,443 9,952
Interest (income) expense, net 404 (49) 620 (125)
--------- --------- --------- ---------
Income before income taxes 4,044 3,788 12,823 10,077
Provision for income taxes 1,496 1,420 4,744 3,778
--------- --------- --------- ---------
Net income $ 2,548 $ 2,368 $ 8,079 $ 6,299
========= ========= ========= =========
Net income per share:
Basic $ .22 $ .20 $ .68 $ .54
========= ========= ========= =========
Diluted $ .21 $ .20 $ .67 $ .53
========= ========= ========= =========
Weighted average number of common shares
and common equivalent shares
outstanding
Basic 11,808 11,677 11,795 11,649
========= ========= ========= =========
Diluted 12,044 11,961 12,087 11,820
========= ========= ========= =========
See accompanying notes to consolidated financial statements
- 4 -
FRED'S, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Thirty-Nine Weeks Ended
October 31, November 1,
1998 1997
----------- ----------
Cash flows from operating activities:
Net income $ 8,079 $ 6,299
Adjustments to reconcile net income
to net cash flows from operating
activities:
Depreciation and amortization 6,291 5,081
Amortization of deferred compensation on
restricted stock incentive plan 173 135
Deferred income taxes 1,829 553
(Increase) decrease in assets:
Receivables (1,280) (1,258)
Inventories (22,112) (17,542)
Other current assets (1,244) (100)
Increase (decrease) in liabilities:
Accounts payable (352) 7,025
Accrued liabilities 585 4,500
Income taxes payable (348) (914)
Other noncurrent liabilities 136 170
-------- --------
Net cash (used in) provided by
operating activities (8,243) 3,949
-------- --------
Cash flows from investing activities:
Additions to property and equipment (19,003) (6,129)
Additions to intangible assets (1,664) (889)
--------- -------
Net cash (used in) provided by
investing activities (20,667) (7,018)
---------- -------
Cash flows from financing activities:
Proceeds from borrowings 25,725 --
Reduction of indebtedness and
capital lease obligations (160) (1,264)
Proceeds from exercise of
stock options 325 702
Cash dividends paid (1,784) (1,407)
-------- -------
Net cash (used in) provided by
financing activities 24,106 (1,969)
-------- -------
Increase (decrease) in cash and cash equivalents (4,804) (5,038)
Cash and cash equivalents:
Beginning of period 5,303 8,569
-------- --------
End of period $ 499 $ 3,531
======== ========
Supplemental disclosures of cash flow information:
Interest paid (received) $ 581 $ (123)
Income taxes paid $ 2,879 $ 3,200
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 January
31, 1998 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 October 31, 1998 are not necessarily indicative of the results to be
expected for the full fiscal year.
NOTE 2: NET INCOME PER SHARE
Basic income per share is based on the weighted average number of common shares
outstanding, and diluted net income per share is based on the weighted average
number of common shares and common equivalent shares outstanding. See Exhibit
11.
- 6 -
Item 2. 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, the ability to
efficiently distribute goods to our stores, 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 311 discount general merchandise stores including 30 franchise
Fred's stores in ten states in the southeastern United States. One hundred and
seventy-one 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.
Year 2000
In fiscal 1997, the Company completed its plan of action and assessment of the
impact of the Year 2000 as it relates to its information systems (processing
concerns created by the changes in the century and the traditional two-digit
year fields embedded in most data processing systems commonly referred to as the
"Year 2000" concern).
- 7 -
The Company operates its Merchandising and Inventory Replenishment/ Distribution
Systems with software that is not Year 2000 compliant. However, the Company is
rewriting this software to be Year 2000 compliant, and is approximately 90%
complete with the process. The Company's financial information systems are
heavily dependent on date fields and are also in the process of being rewritten.
The expected completion date for this system to be Year 2000 compliant is
October 1999.
Costs of addressing Year 2000 issues are anticipated to total less than $1
million and are not expected to have a material adverse impact on the Company's
financial position, results of operations or cash flows in future periods.
The Company depends heavily on its major vendors to meet the purchasing
requirements dictated by the Company's business needs, and therefore, has
explored the impact Year 2000 issues will have on their ability to source
products for the Company and process purchase orders with the delivery
requirements and terms involving the Year 2000. Each of these vendors has
likewise taken measures to address the risks imposed by the Year 2000 and
adequately prepare their own processing systems so that their businesses will
not be interrupted as a result of this issue. Accordingly, the Company believes
there will be no significant interruption of its ability to source its product
needs from significant vendors. As an ongoing measure, the Company will continue
to address this risk with each new significant vendor to ensure similar
safeguards.
Finally, the Company recognizes the potential impact the Year 2000 issue may
have relative to its customers, creditors, and other service providers. The
Company has reviewed its exposure to business interruption or substantial loss
in these areas and believes that any risks previously identified will be
resolved before the end of fiscal 1999 and that, as of today, is not aware of
any other risk of material adverse consequences.
RESULTS OF OPERATIONS
Thirteen Weeks Ended October 31, 1998 and November 1, 1997
Net sales increased from $114.0 million in 1997 to $142.3 million in 1998, an
increase of $28.3 million or 24.8%. The increase was attributable to comparable
store sales increases of 6.8% ($6.8 million) and sales by stores not yet
included as comparable stores ($22.0 million). Sales to franchisees decreased
$.5 million or 0.4% in 1998.
Gross profit decreased from 29.3% of sales in 1997 to 29.1% in 1998 primarily
due to lower initial purchase margins associated with the timing of import
receipts and a weakness in several higher-margin sales categories due to the
unseasonably warm weather experienced during October.
- 8 -
Selling, general and administrative expenses increased from $29.6 million in
1997 to $36.9 million in 1998. As a percentage of sales, these expenses were
flat at 26% for both third quarter periods. The expense leverage gains from a
6.8% comparable store sales increase were offset by higher labor cost connected
with the modernization and automation of the Company's Distribution Center,
labor inefficiencies caused by delayed receipt of import shipments and record
receipts and shipment volumes being processed through the Distribution Center.
Thirty-Nine Weeks Ended October 31, 1998 and November 1, 1997
Net sales increased from $336.9 million in 1997 to $428.1 million in 1998, an
increase of $91.2 million or 27.1%. The increase was attributable to comparable
store sales increases of 6.6% ($20.0 million) and sales by stores not yet
included as comparable stores ($71.6 million). Sales to franchisees decreased
$.4 million or 0.1% in 1998.
Gross profit increased from 28.1% of sales in 1997 to 28.2% in 1998 primarily
due to strong year-to-date sales in certain higher margin departments, combined
with a decrease in lower margin franchise sales as a percentage of total sales.
Selling, general and administrative expenses increased from $84.7 million in
1997 to $107.3 million in 1998. As a percentage of sales, these expenses were
flat at 25.1% for both thirty-nine week periods. The improvement in comparable
store sales for the first nine months of 1998 contributed to higher leveraging
of expenses. However, higher labor costs associated with the modernization and
automation of the Company's Distribution Center, along with a decreased
percentage of franchise sales which carry a lower expense percentage than retail
sales offset any expense benefit. Selling, general and administrative expenses
for the first nine months of 1998 also included an additional 40 store and
pharmacy locations than in the first nine months of 1997.
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 used by operating activities totaled ($8,243,000) during the
thirty-nine week period ended October 31, 1998. Cash generated from operations
of $13,869,000 was used to partially fund capital expansion programs and
seasonal inventory build of $22,112,000.
Cash flows used by investing activities totaled ($20,667,000) and was primarily
used to fund $12,000,000 of payments on the modernization and automation of the
Company's Distribution Center and the balance on the Company's Store and
Pharmacy Expansion program and normal capital expenditure requirements.
- 9 -
Cash flows provided by financing activities totaled $24,106,000 and include
$13,725,000 of borrowings under the Company's revolver for seasonal inventory
needs, and $12,000,000 of borrowings under the Company's term loan agreement to
primarily fund payments on the modernization and automation of the Company's
distribution center and corporate facilities.
The Company has a $15,000,000 revolving credit commitment available from a bank
through June 1, 2003. At October 31, 1998, $13,725,000 in borrowings have been
made under the revolving credit agreement.
The Company has a $12,000,000 term loan Agreement with a bank that was primarily
used to finance the automation and modernization of the Company's distribution
center and corporate facilities. The loan bears interest at 6.82% and requires
monthly payments sufficient to amortize the loan over 84 months.
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.
IMPACT OF RECENT ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 131, "Disclosure about Segments
of an Enterprise and Related Information". SFAS No. 131 revises the current
requirements for reporting business segments by redefining such segments as the
way management desegregates the business for purposes of making operating
decisions and allocating internal resources. SFAS No. 131 is effective for
fiscal years beginning after December 15, 1997, and although management believes
that SFAS No. 131 will not impact the Company's presentation, the Company has
adopted SFAS No. 131 in fiscal 1998.
In February 1998, the FASB issued SFAS No. 132, "Employers Disclosures about
Pensions and Other Postretirement Benefits". SFAS No. 132 standardizes the
disclosure requirements for pensions and other postretirement benefits. The
statement is effective for fiscal years beginning after December 15, 1997 and
has been adopted by the Company in fiscal 1998.
- 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 10.18 - Preferred Share Purchase Plan
Exhibit 11 - Computation of Net Income Per Share
Exhibit 27 - Financial Data Schedule (Edgar
Filing only)
Reports on Form 8-K:
Form 8-K filed October 21, 1998 - Preferred Share Purchase
Plan.
- 11 -
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: December 11, 1998 Chief Executive Officer
- ------------------------
/s/Richard B. Witaszak
----------------------
Richard B. Witaszak
Date: December 11, 1998 Chief Financial Officer
- ------------------------
- 12 -
EXHIBIT 11
FRED'S, INC.
COMPUTATION OF NET INCOME PER SHARE
(unaudited)
(in thousands, except per share amounts)
Thirteen Weeks Ended Thirty-Nine Weeks Ended
October 31, November 1, October 31, November 1,
1998 1997 1998 1997
-------- -------- -------- -------
Basic net income per share
Net income $ 2,548 $ 2,368 $ 8,079 $ 6,299
======= ======= ======= =======
Weighted average number of common shares
outstanding during the period 11,808 11,677 11,795 11,649
======= ======= ======= =======
Net income per share $ .22 $ .20 $ .68 $ .54
======= ======= ======= =======
Diluted net income per share
Net income $ 2,548 $ 2,368 $ 8,079 $ 6,299
======= ======= ======= =======
Weighted average number of common shares
outstanding during the period 11,808 11,677 11,795 11,649
Additional shares attributable to common
stock equivalents 236 284 292 171
------- ------- ------- -------
12,044 11,961 12,087 11,820
======= ======= ======= =======
Net income per share $ .21 $ .20 $ .67 $ .53
======= ======= ======= =======