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 30, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
For the transition period from to
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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 11,979,846 shares of common stock outstanding as of December
13, 1999.
FRED'S, INC.
INDEX
Page No.
Part I - Financial Information
Item 1 - Financial Statements (unaudited):
Consolidated Balance Sheets as of
October 30, 1999 and January 30, 1999 3
Consolidated Statements of Operations
for the Thirteen Weeks Ended and the
Thirty-Nine Weeks Ended October 30, 1999
and October 31, 1998 4
Consolidated Statements of Cash Flows
for the Thirty-Nine Weeks Ended October 30, 1999
and October 31, 1998 5
Notes to Consolidated Financial Statements 6 - 8
Item 2 - Management's Discussion and
Analysis of Financial Condition and
Results of Operations 9 - 14
Part II - Other Information 15
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Signatures 16
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FRED'S, INC.
CONSOLIDATED BALANCE SHEETS
(unaudited)
(in thousands, except for number of shares)
October 30, January 30,
1999 1999
---- ----
ASSETS
Current assets:
Cash and cash equivalents $ 821 $ 2,406
Receivables, less allowance for doubtful
accounts 10,770 8,931
Inventories 155,643 126,577
Deferred income taxes 3,544 3,783
Other current assets 1,003 1,367
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Total current assets 171,781 143,064
Property and equipment, at depreciated cost 70,784 68,923
Equipment under capital leases, less
accumulated amortization 1,318 1,578
Deferred income taxes 2,362 2,598
Other noncurrent assets 3,886 4,594
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Total assets $ 250,131 $ 220,757
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 53,228 $ 46,767
Current portion of indebtedness 26,869 11,606
Current portion of capital lease obligations 347 308
Accrued liabilities 11,585 10,776
Income taxes payable 1,979 826
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Total current liabilities 94,008 70,283
Long term portion of indebtedness 10,552 10,264
Capital lease obligations 1,290 1,557
Other noncurrent liabilities 1,789 1,670
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Total liabilities 107,639 83,774
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Shareholders' equity:
Common stock, Class A voting, no par value,
11,978,660 shares issued and outstanding
(11,946,772 shares at January 30, 1999) 67,293 66,951
Retained earnings 75,618 70,596
Deferred compensation on restricted
stock incentive plan (419) (564)
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Total shareholders' equity 142,492 136,983
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Total liabilities and shareholders' equity $ 250,131 $ 220,757
========= =========
See accompanying notes to consolidated financial statements
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FRED'S, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share amounts)
Thirteen Weeks Ended Thirty-Nine Weeks Ended
October 30, October 31, October 30, October 31,
1999 1998 1999 1998
---- ---- ---- ----
Net sales $158,049 $142,339 $469,481 $428,130
Cost of goods sold 110,932 100,890 334,093 310,198
-------- -------- -------- --------
Gross profit 47,117 41,449 135,388 117,932
Selling, general and administrative
expenses 41,933 36,936 123,013 107,255
-------- -------- -------- --------
Operating income 5,184 4,513 12,375 10,677
Interest (income) expense, net 723 404 1,869 620
-------- -------- -------- --------
Income before income taxes 4,461 4,109 10,506 10,057
Provision for income taxes 1,565 1,541 3,687 3,773
-------- -------- -------- --------
Net income $ 2,896 $ 2,568 $ 6,819 $ 6,284
======== ======== ======== ========
Net income per share:
Basic $ .24 $ .22 $ .58 $ .53
======== ======== ======== ========
Diluted $ .24 $ .21 $ .57 $ .52
======== ======== ======== ========
Weighted average number of common shares
and common equivalent shares
outstanding
Basic 11,832 11,808 11,823 11,795
======== ======== ======== ========
Diluted 12,076 12,044 12,063 12,087
======== ======== ======== ========
See accompanying notes to consolidated financial statements
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FRED'S, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Thirty-Nine Weeks Ended
-----------------------
October 30, October 31,
1999 1998
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Cash flows from operating activities:
Net income $ 6,819 $ 6,284
Adjustments to reconcile net income
to net cash flows from operating
activities:
Depreciation and amortization 8,572 6,291
Amortization of deferred compensation on
restricted stock incentive plan 215 173
Deferred income taxes 475 1,537
(Increase) decrease in assets:
Receivables (1,839) (1,280)
Inventories (29,036) (19,346)
Other current assets 364 (1,244)
Increase (decrease) in liabilities:
Accounts payable 6,461 (352)
Accrued liabilities 809 585
Income taxes payable 1,153 (1,027)
Other noncurrent liabilities 119 136
-------- --------
Net cash used in
operating activities (5,888) (8,243)
-------- --------
Cash flows from investing activities:
Additions to property and equipment (9,196) (19,003)
Additions to intangible assets (270) (1,664)
-------- --------
Net cash used in
investing activities (9,466) (20,667)
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Cash flows from financing activities:
Proceeds from borrowings 16,763 25,725
Reduction of indebtedness and
capital lease obligations (1,440) (160)
Proceeds from exercise of stock options 241 325
Cash dividends paid (1,795) (1,784)
-------- --------
Net cash provided by
financing activities 13,769 24,106
-------- --------
Increase (decrease) in cash and cash equivalents (1,585) (4,804)
Cash and cash equivalents:
Beginning of period 2,406 5,303
-------- --------
End of period $ 821 $ 499
======== ========
Supplemental disclosures of cash flow information:
Interest paid $ 1,808 $ 581
Income taxes paid $ 2,200 $ 2,879
See accompanying notes to consolidated financial statements
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FRED'S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GENERAL
Fred's operates 320 discount general merchandise stores, including 26 franchised
Fred's stores, in ten states in the southeastern United States. One hundred and
eighty-four 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.
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
30, 1999 incorporated into the Company's Annual Report on Form 10-K.
The results of operations for the thirteen week and thirty-nine week period
ended October 30, 1999 are not necessarily indicative of the results to be
expected for the full fiscal year.
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The results of operations for the thirteen week and thirty-nine week period
ended October 31, 1998 have been restated to reflect the Company's adoption of
the last-in, first-out ("LIFO") method of accounting for its pharmacy
inventories during the fourth quarter of 1998.
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.
COMPUTATION OF NET INCOME PER SHARE
(unaudited)
(in thousands, except per share amounts)
Thirteen Weeks Ended Thirty-Nine Weeks Ended
October 30, October 31, October 30, October 31,
1999 1998 1999 1998
---- ---- ---- ----
Basic net income per share
Net income $ 2,896 $ 2,568 $ 6,819 $ 6,284
======= ======= ======= =======
Weighted average number of
common shares outstanding
during the period 11,832 11,808 11,823 11,795
======= ======= ======= =======
Net income per share $ .24 $ .22 $ .58 $ .53
======= ======= ======= =======
Diluted net income per share
Net income $ 2,896 $ 2,568 $ 6,819 $ 6,284
======= ======= ======= =======
Weighted average number of
common shares outstanding
during the period 11,832 11,808 11,823 11,795
Additional shares attributable
to common stock equivalents 244 236 240 292
------- ------- ------- -------
12,076 12,044 12,063 12,087
======= ======= ======= =======
Net income per share $ .24 $ .21 $ .57 $ .52
======= ======= ======= =======
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NOTE 3: INVENTORIES
Wholesale inventories are stated at the lower of cost or market using the FIFO
(first-in, first-out) method. Retail inventories are stated at the lower of cost
or market as determined by the retail inventory method. For pharmacy
inventories, which comprise approximately 17% of the retail inventories at
October 30, 1999, cost was determined using the LIFO (last-in, first-out)
method. For the remainder of the retail inventories, the FIFO method was
applied. The current cost of inventories exceeded the LIFO cost by approximately
$3,109,000 at both October 30, 1999 and January 30, 1999.
LIFO inventory costs can only be determined annually when inflation rates and
inventory levels are finalized; therefore, LIFO inventory costs for interim
financial statements are estimated.
NOTE 4: RESTRUCTURING RESERVE
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. This charge related to an accrual for closed facility
lease obligations ($1,156,000) and the write-off of fixed assets and other store
closing costs ($1,044,000). In addition, $660,000 of costs to eliminate certain
product lines were incurred. These product lines were eliminated in 1997 and the
reserves were fully utilized upon such disposition. Fixed asset write-offs were
taken against assets being disposed. The remaining lease obligation reserves at
October 30, 1999 represent future base payments required for two locations that
have been closed.
The 1999 activity in this reserve is as follows:
January 30, October 30,
(in thousands) 1999 Charges 1999
----------- ------- -----------
Lease obligations $ 400 $ (186) $ 214
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Management's Discussion and Analysis of Financial
Condition and Results of Operations
RESULTS OF OPERATIONS
Thirteen Weeks Ended October 30, 1999 and October 31, 1998. Net sales increased
to $158.0 million in 1999 from $142.3 million in 1998, an increase of $15.7
million or 11.0%. The increase was attributable to comparable store sales
increases of 6.0% ($7.8 million) and sales by stores not yet included as
comparable stores ($8.9 million). Sales to franchisees decreased $1 million in
1999. The sales mix for the period was 48.5% Hardlines, 32.7% Pharmacy, 13.7%
Softlines, and 5.1% Franchise. This compares with 50.7% Hardlines, 29.0%
Pharmacy, 13.8% Softlines, and 6.5% Franchise for the same period last year.
Gross profit increased to 29.8% of sales in 1999 compared with 29.1% of sales in
the prior-year period. Gross profit margins benefitted from higher initial
purchase margins, strong quarterly sales in various higher margin departments,
such as home furnishings, domestics, footwear and electronics, and a reduction
in franchise sales as a percentage of total sales, which carry substantially
lower gross margins than the retail business.
Selling, general and administrative expenses increased to $41.9 million in 1999
from $36.9 million in 1998. As a percentage of sales, expenses increased to
26.5% of sales compared with 25.9% of sales last year. Selling, general and
administrative expenses were impacted by higher employee benefit costs,
increased marketing expenses associated with additional promotional activities
during the quarter, higher store labor and supply costs associated with the
opening or upgrading of 10 locations during the quarter, and a decrease in
franchise sales as a percentage of total sales, which carries a significantly
lower selling, general and administrative ratio than retail sales.
Interest expense increased to $.7 million in 1999 from $.4 million in 1998. The
increased interest expense reflects higher average revolver borrowings for
inventory purchases, as well as interest costs on term loan borrowings to
finance a distribution center upgrade and acquisition of a new mainframe
computer system. The company's average borrowing cost for the third quarter of
1999 was approximately 6.3%.
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Thirty-Nine Weeks Ended October 30, 1999 and October 31, 1998. Net sales
increased to $469.5 million in 1999 from $428.1 million in 1998, an increase of
$41.4 million or 9.7%. The increase was attributable to comparable store sales
increases of 3.8% ($14.8 million) and sales by stores not yet included as
comparable stores ($29.5 million). Sales to franchisees decreased $2.9 million
in 1999. The sales mix for the period was 48.5% Hardlines, 32.2% Pharmacy, 14.0%
Softlines, and 5.3% Franchise. This compares with 52.0% Hardlines, 27.3%
Pharmacy, 14.2% Softlines, and 6.5% Franchise for the same period last year.
Gross profit increased to 28.8% of sales in 1999 compared with 27.5% of sales in
the prior-year period. Gross profit margins improved as a result of higher
initial purchase margins, strong sales in various higher margin categories, and
a reduction in franchise sales as a percentage of total sales, which carry
substantially lower gross margins than the retail business. Gross profit margins
were also impacted by a reduction in the LIFO inventory provision, as a
percentage of sales, in comparison to 1998.
Selling, general and administrative expenses increased to $123.0 million in 1999
from $107.3 million in 1998. As a percentage of sales, expenses increased to
26.2% of sales compared with 25.0% of sales last year. Selling, general and
administrative expenses were impacted by a reduction in franchise sales as a
percentage of total sales, which carry a significantly lower expense ratio than
retail sales, higher employee benefit costs, and increased levels of store
labor, supply and repair and maintenance costs associated with store appearance
upgrades at many of the stores throughout the year.
Interest expense increased to $1.9 million in 1999 from $.6 million in 1998,
reflecting higher average revolver borrowings than last year, as well as
interest costs on term loan borrowings to finance modernization and automation
of the Company's distribution center and acquisition of a new mainframe computer
system.
Income tax provision decreased to 35.1% in 1999 from 37.5% in 1998. The Company
completed a realignment of its corporate organizational structure during the
fourth quarter of 1998, which resulted in a reduction in the Company's liability
for taxes.
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.
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Cash flow used in operating activities totaled ($5.9) million during the
thirty-nine week period ended October 30, 1999. Cash was primarily used to
increase inventories. Total inventories increased approximately $29.0 million in
the first nine months of 1999. This increase was primarily attributable to new
stores and pharmacies added in the first nine months of 1999, accelerated
seasonal import receipts due to delays experienced in the prior year, improved
store in-stock positions in comparison to the beginning of the year, and
duplicate inventories resulting from the introduction of several new
merchandising programs. Accounts payable increased approximately $6.5 million in
the first nine months of 1999.
Cash flows used in investing activities totaled ($9.5) million, and consisted
primarily of $2.3 million of payments for the replacement of the Company's
mainframe computer system and capital expenditures associated with the Company's
store and pharmacy expansion program. During the first nine months, the Company
opened 21 stores, closed 10 stores, and upgraded 6 stores. The Company expects
to open 3 to 4 stores over the balance of the year.
Cash flows provided by financing activities totaled $13.8 million and included
$2.3 million of borrowings under a term loan agreement for the replacement of
the Company's mainframe computer system, and $14.5 million of borrowings under
the Company's primary and seasonal revolvers for inventory needs.
The Company has available up to $35 million of unsecured credit commitments
under a revolving Loan and Credit Agreement and Seasonal Overline Revolving
Credit Agreement. The agreements bear interest at the lesser of 1.5% below prime
rate or a LIBOR-based rate and mature at December 31, 1999 ($20 million) and
June 1, 2003 ($15 million). Borrowings outstanding under these agreements
totaled $24.7 million at October 30, 1999 compared to $13.7 million at October
31, 1998.
On May 5, 1998, the Company and a bank entered into a Loan Agreement (the "Loan
Agreement"). The Loan Agreement provided the Company with an unsecured term loan
of $12 million to finance the modernization and automation of the Company's
distribution center and corporate facilities. The Loan Agreement bears interest
of 6.82% per annum and matures on November 1, 2005. Borrowings outstanding under
this Loan Agreement totaled $10.7 million at October 30, 1999. Borrowings under
this Loan Agreement totaled $12.0 million at October 31, 1998.
On April 23, 1999, the Company and a bank entered into a Loan Agreement (the
"Loan Agreement"). The Loan Agreement provided the Company with a four-year
unsecured term loan of $2.3 million to finance the replacement of the Company's
mainframe computer system. The Loan Agreement bears interest of 6.15% per annum
and matures on April 15, 2003. The Loan Balance at October 30, 1999 was $2.0
million.
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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.
YEAR 2000
The "Year 2000 Issue" relates to the inability of certain computer hardware and
software to properly recognize and process date sensitive information for the
Year 2000 and beyond. Without corrective measures, the Company's computer
applications could fail and/or produce erroneous results. To address this
concern, the Company has a Year 2000 compliance project in place to identify the
potential issues that could affect its business. The following discussion is an
update on where the Company stands on this important matter.
The Year 2000 Compliance Project is monitored by a Year 2000 oversight
committee, consisting of senior level management, that meets and reviews
progress towards the Company's targeted completion dates on a regular basis. The
Year 2000 compliance project at Fred's includes:
Upgrading store point of sale and pharmacy hardware and software
systems to be Year 2000 compliant. All work related to this activity
is complete.
Verifying Year 2000 compliance of computer hardware and software
providers and obtaining Year 2000 product warranties as necessary. All
work related to this activity is complete.
Having key suppliers and service providers demonstrate or certify
their Year 2000 compliance, ensuring their ability to continue to
supply and provide service to the Company up to and beyond January 1,
2000. The Company is also evaluating, correcting and testing
electronic data interchange systems between Fred's, and its key
suppliers. This process is approximately 98% complete and the targeted
completion date for the remainder is December 20, 1999. Although there
can be no assurance that the Company will not be adversely affected by
the Year 2000 issues of its key suppliers and service providers,
management believes that ongoing communications will continue to
minimize its risk.
Evaluate, test and correct the Company's personal computer hardware
and software, voice and data communication systems, and other date
sensitive operating devices, to ensure Year 2000 compliance. The
evaluation and testing phase of this process has been completed and
all required replacement systems have been installed.
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The Company's distribution center hardware and software were replaced
during 1997 and 1998, and are completely Year 2000 compatible. The
Company operates its merchandising and inventory
replenishment/distribution systems with software that is being
modified for Year 2000 compatibility. All mission critical systems
have been rewritten and implemented, and the remaining non-critical
systems are being rewritten and corrected and will be 100% completed
by December 17, 1999.
The Company's financial information systems are heavily dependent on
date fields and have been rewritten and corrected to be Year 2000
compatible.
The Company's payroll and human resource systems are moderately
dependent on date fields. The systems have been rewritten and tested
and are Year 2000 compatible.
The potential risks associated with failing to remediate Year 2000 issues
include: temporary disruptions in store operations; temporary disruptions in the
ordering, receiving and shipping of merchandise and in the ordering and
receiving of other goods and services; temporary disruptions in the billing and
collecting of accounts receivable; temporary disruptions in services provided by
banks and other financial institutions; temporary disruptions in communication
services; and temporary disruptions in utility services.
The Company currently estimates that the incremental cost associated with
completing its Year 2000 compliance project will be approximately $.5 million,
most of which has already been incurred. The cost to resolve the Year 2000
issues are being funded through operating cash flows. These costs are in
addition to the costs incurred to replace the Company's distribution center
hardware and software, since these systems were to be replaced irrespective of
Year 2000 issues.
The Company is currently in the process of completing a contingency plan for
each area in the organization that could be affected by the Year 2000 issue, in
the event that any of the above remediation activities prove unsuccessful.
Although the Company currently anticipates minimal business disruption, the
failure of either the Company or one or more of its major business partners to
remediate critical Year 2000 issues could have a materially adverse impact on
the Company's business, operations and financial condition. Please read the
"Cautionary Statement Regarding Forward Looking Statements" section below.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Statements, other than those based on historical facts, including the discussion
of management's expectations for Year 2000 compliance, which address activities,
events, or developments that the Company expects or anticipates may occur in the
future are forward-looking statements which are based upon a number of
assumptions concerning future conditions that may ultimately prove to be
inaccurate. Actual events and results may materially differ from anticipated
results described in such statements. The Company's ability to achieve such
results is subject to certain risks and uncertainties, including, but not
limited to, economic and weather conditions which affect buying patterns of the
Company's customers, changes in consumer spending and the Company's ability to
anticipate buying patterns and implement appropriate inventory strategies,
continued availability of capital and financing, competitive factors, and other
factors affecting business beyond the Company's control. Consequently, all of
the forward-looking statements are qualified by these cautionary statements and
there can be no assurance that the results or developments anticipated by the
Company will be realized or that they will have the expected effects on the
Company or its business or operations.
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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 10.19 - Prime Vendor Agreement between Fred's Stores of
Tennessee, Inc. and Bergen Brunswig Drug Company, dated as of
November 24, 1999
Exhibit 27 - Financial Data Schedule (Edgar Filing only)
Reports on Form 8-K:
Not Applicable.
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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 13, 1999 Chief Executive Officer
/s/ Richard B. Witaszak
-----------------------
Richard B. Witaszak
Date: December 13, 1999 Chief Financial Officer
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