SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A Amendment No. 1 ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended February 2, 2002 Commission File Number 1-14565 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: None Securities Registered Pursuant to Section 12(g) of the Act: Title of Each Class Class A Common Stock, no par value 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 [X]. As of April 19, 2002, there were 25,405,002 shares outstanding of the Registrant's Class A no par value voting common stock. Based on the last reported sale price of $36.95 per share on the NASDAQ Stock Market on April 19, 2002, the aggregate market value of the Registrant's Common Stock held by those persons deemed by the Registrant to be non-affiliates was $938,714,824. As of April 19, 2002, 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 2001 Annual Report to Shareholders for the year ended February 2, 2002 are incorporated by reference into Part II, Items 5, 6, 7 and 8, and into Part IV, Item 14. Portions of the Company's Proxy Statement for the 2002 annual shareholders meeting are incorporated by reference into Part III, Items 11, 12 and 13. 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. Explanatory Note This Amendment No. 1 to the Annual Report on Form 10-K (the "Form 10-K") of Fred's, Inc.(the "Company") for the fiscal year ended February 02, 2002 is being filed to amend the list of exhibits filed in Item 14 (Exhibits, Financial Statement Schedules and Reports on Form 8-K) pursuant to Item 601 of Regulation S-K under the Securities Exchange Act of 1934, and to include additional portions of the Company's 2001 Annual Report to Shareholders for the year ended February 2, 2002 as Exhibit 13.2. 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 16 through 31 of the 2001 Annual Report to Shareholders for the year ended February 2, 2002. Report of Independent Accountants. Consolidated Statements of Income for the years ended February 2, 2002, February 3, 2001, and January 29, 2000. Consolidated Balance Sheets as of February 2, 2002, and February 3, 2001. Consolidated Statements of Changes in Shareholders' Equity for the years ended February 2, 2002, February 3, 2001, and January 29, 2000. Consolidated Statements of Cash Flows for the years ended February 2, 2002, February 3, 2001, and January 29, 2000. Notes to Consolidated Financial Statements. (a)(2) Financial Statement Schedules Report of Independent Accountants on Financial Statement Schedules for each of the three years for the period ended February 2, 2002. II Valuation and qualifying accounts (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: 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]. 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]. 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]. 3.3 Articles of Amendment to the Charter of Fred's, Inc., dated September 6, 2001, as filed with the Secretary of the State of Tennessee. [incorporated by reference to exhibit 3.3 of amendment No. 1 to our Registration Statement on Form S-3 filed on September 10, 2001.] 4.1 Specimen Common Stock Certificate [incorporated herein by reference to Exhibit 4.2 to Pre-Effective Amendment No. 3 to the Form S-1]. 4.2 Preferred Share Purchase Plan [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended October 31, 1998]. 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] 10.1 Form of Fred's, Inc. Franchise Agreement [incorporated herein by reference to Exhibit 10.8 to the Form S-1]. 10.2 401(k) Plan dated as of May 13, 1991 [incorporated herein by reference to Exhibit 10.9 to the Form S-1]. 10.3 Employee Stock Ownership Plan (ESOP) dated as of January 1, 1987 [incorporated herein by reference to Exhibit 10.10 to the Form S-1]. 10.4* Incentive Stock Option Plan dated as of December 22, 1986 [incorporated herein by reference to Exhibit 10.11 to the Form S-1]. 10.5 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]. 10.6 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]. 10.7* 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]. 10.8 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 10.7) [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 29, 1995]. 10.9 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 10.7) [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended July 29, 1995]. 10.10 Seasonal Overline Revolving Credit Agreement between Fred's, Inc. and Union Planters National Bank dated as of July 23, 1996 [incorporated herein by reference to the Company's report on Form 10-Q for the quarter ended August 3, 1996]. 10.11 Addendum to Leasing Agreement and form of schedules 2 through 6 of Schedule A by and between Hogan Motor Leasing, Inc. and Fred's, Inc. dated December 19, 1996 (modifies the Lease Agreement included as Exhibit 10.6) [incorporated herein by reference to the Company's report on Form 10-K for the year ended February 1, 1997]. 10.12 Third Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of February 28, 1997 (modifies the Revolving Loan and Credit Agreement included as Exhibit 10.7) [incorporated herein by reference to the Company's report on Form 10-K for the year ended February 1, 1997]. 10.13 Term Loan Agreement between Fred's, Inc. and Union Planters National Bank dated as of May 5, 1998 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended May 2, 1998]. 10.14 Fourth Modification Agreement between Fred's, Inc. and Union Planters National Bank dated as of September 1998 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended August 1, 1998]. 10.15 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated as of February 3, 1999 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended May 1, 1999]. 10.16 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated s of May 12, 1999 [incorporated herein by reference to the Company's Report on From 10-Q for the quarter ended May 1, 1999]. 10.17 Term Loan Agreement between Fred's, Inc. and First American National Bank dated as of April 23, 1999 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended May 1, 1999]. 10.18 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated as of August 3, 1999 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended July 31, 1999]. 10.19 Prime Vendor Agreement between Fred's Stores of Tennessee, Inc. and Bergen Brunswig Drug Company, dated as of November 24, 1999 [incorporated herein by reference to Company's Report on Form 10-Q for the quarter ended October 31, 1999]. 10.20 Addendum to Leasing Agreement and Form of Schedules 7 through 8 of Schedule A, by and between Hogan Motor Leasing, Inc. and Fred's, Inc dated September 20, 1999 (modifies the Lease Agreement included as Exhibit 10.6) [incorporated herein by reference to the Company's report on Form 10-K for the year ended January 29, 2000]. 10.21 Revolving Loan Agreement between Fred's, Inc. and Union Planters Bank, NA and Suntrust Bank dated April 3, 2000 [incorporated herein by reference to the Company's report on form 10-K for year ended January 29, 2000]. 10.22 Loan modification agreement dated May 26, 2000 (modifies the Revolving Loan Agreement included as Exhibit 10.23) [Incorporated herein by reference to the Company's report on Form 10-K for the year ended January 29, 2000]. 10.23 Seasonal Overline Agreement between Fred's, Inc. and Union Planters National Bank dated as of October 11, 2000 [incorporated herein by reference to the Company's Report on Form 10-Q for the quarter ended October 28, 2000]. 13.1 Annual report to shareholders for the year ended February 2, 2002 (to the extent incorporated herein by reference). 13.2** Management's Discussion and Analysis from the Company's Annual report to shareholders for the year ended February 2, 2002. 21.1 Subsidiaries of Registrant 23.1 Consent of PricewaterhouseCoopers LLP * Management Compensatory Plan ** Filed herewithin 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 24th day of October, 2002. FRED'S, INC. By: /s/ Michael J. Hayes ------------------------------------- Michael J. Hayes, Chief Executive Officer By: /s/ Jerry A. Shore -------------------------------- Jerry A. Shore, 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 24th day of October, 2002. Signature Title --------- ----- /s/ Michael J. Hayes Director, Managing Director, -------------------------- Chief Executive Officer Michael J. Hayes /s/ Roger T. Knox Director -------------------------- Roger T. Knox /s/ John R. Eisenman Director -------------------------- John R. Eisenman /s/ John D. Reier Director -------------------------- John D. Reier /s/ Thomas H. Tashjian Director -------------------------- Thomas H. Tashjian Exhibit 13.2 FRED'S INC. MANAGEMENT'S DISCUSSION AND ANALYSIS FISCAL 2001 Selected Financial Data (dollars in thousands, except per share amounts) 2001 2000(1) 1999 1998(2) 1997 ---- ------- ---- ------- ---- Statement of Income Data: Net sales $910,831 $781,249 $665,777 $600,902 $492,236 Operating income 31,751 25,720 18,943 14,711 15,511 Income before income taxes 30,140 22,494 16,439 13,605 15,660 Provision for income taxes 10,511 7,645 5,737 4,775 5,873 Net income 19,629 14,849 10,702 8,830 9,787 Net income per share:(3) Basic .83 .66 .48 .40 .45 Diluted .81 .65 .47 .39 .44 Selected Operating Data: Operating income as a percentage of sales 3.5% 3.3% 2.9% 2.4% 3.2% Increase in comparable store sales (4) 10.5% 9.2%(5) 5.2% 5.6% 8.3% Stores open at end of period 353 320 293 283 261 Balance Sheet Data (at period end): Total assets $284,059 $254,795 $240,222 $220,757 $195,407 Short-term debt (including capital leases) 1,240 2,678 30,736 11,914 214 Long-term debt (including capital leases) 1,320 31,705 11,761 11,821 1,368 Shareholders' equity 218,907 159,687 145,913 136,983 129,359 - ----------------- (1) Results for 2000 include 53 weeks. (2) Results for 1998 include the effect of the 1998 adoption of LIFO for pharmacy inventories. (3) Adjusted for the 5-for-4 stock split effected on June 18, 2001 and the 3-for-2 stock split effected on February 1, 2002. (4) A store is first included in the comparable store sales calculation after the end of the twelfth month following the store's grand opening month. (5) The increase in comparable store sales for 2000 is computed on the same 53-week period for 1999. Management's Discussion and Analysis Significant Accounting Policies The preparation of Fred's financial statements requires management to make estimates and judgments in the reporting of assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. Our estimates are based on historical experience and on other assumptions that we believe applicable under the circumstances, the results of which form the basis for making judgments about the values of assets and liabilities that are not readily apparent from other sources. While we believe that the historical experience and other factors considered provide a meaningful basis for the accounting policies applied in the consolidated financial statements, the Company cannot guarantee that the estimates and assumptions will be accurate under different conditions and/or assumptions. A summary of our critical accounting policies and related estimates and judgments, can be found in Note 1 to the consolidated financial statements. Results of Operations The following Table provides a comparison of Fred's financial results for the past three years. In this table, categories of income and expense are expressed as a percentage of sales. 2001 2000 1999 - ------------------------------------------------------------------------------------------------------ Net sales 100.0% 100.0% 100.0% Cost of goods sold 72.6 72.5 71.8 ------------------------------------ Gross profit 27.4 27.5 28.2 Selling, general and administrative expenses 23.9 24.2 25.3 ------------------------------------ Operating income 3.5 3.3 2.9 Interest expense, net 0.2 0.4 0.4 ------------------------------------ Income before taxes 3.3 2.9 2.5 Income taxes 1.1 1.0 0.9 ------------------------------------ Net income 2.2% 1.9% 1.6% ------------------------------------ Fiscal 2001 Compared to Fiscal 2000 Sales Net sales increased 16.6% ($129.6 million) in 2001. Approximately $54.0 million of the increase was attributable to the addition of 33 new or upgraded stores, and 7 pharmacies during 2001, together with the sales of 31 store locations and 16 pharmacies that were opened or upgraded during 2000 and contributed a full year of sales in 2001. During 2001, the Company closed 3 pharmacy locations. Comparable store sales, consisting of sales from stores that have been open for more than one year, increased 10.5% in 2001. The Company's front store (non-pharmacy) sales increased approximately 15.5% over 2000 front store sales. Front store sales growth benefited from the above mentioned store additions and improvements, and solid sales increases in categories such as home furnishings, floor coverings, bath, giftware, small appliances, photo finishing, girl's apparel, missy ready-to-wear, infants and toddler apparel, beverages, food and snacks. Fred's pharmacy sales grew to 34.4% of total sales in 2001 from 33% of total sales in 2000 and continues to rank as the largest sales category within the Company. The total sales in this department, including the Company's mail order operation, increased 21.2% over 2000, with third party prescription sales representing approximately 85% of total pharmacy sales, compared with 83% of total pharmacy sales in 2000. The Company's pharmacy sales growth continued to benefit from an ongoing program of purchasing prescription files from independent pharmacies, the addition of pharmacy departments in existing store locations, and inflation caused by drug manufacturer increases. Sales to Fred's 26 franchised locations decreased approximately $.8 million in 2001 and represented 3.7% of the Company's total sales, as compared to 4.0% in 2000. It is anticipated that this category of business will decline as a percentage of total Company sales since the Company has not added and does not intend to add any additional franchisees. Gross Margin Gross margin as a percentage of sales was 27.4% in 2001 compared to 27.5% in 2000. The decrease in gross margin is a result of margin reduction in the pharmacy department partially offset by margin improvements in general merchandise departments. Selling, General and Administrative Expenses Selling, general and administrative expenses were 23.9% of net sales in 2001 compared with 24.2% of net sales in 2000. Labor expenses improved in the stores and pharmacies as a result of the strong sales coupled with store productivity initiatives. Distribution center labor expense also improved as a percentage of volume processed. Corporate communications expense improved as a result of installing new technology that reduced expenses. Operating Income Operating income increased approximately $6.0 million or 23.5% to $31.8 million in 2001 from $25.7 million in 2000. Operating income as a percentage of sales increased to 3.5% in 2001 from 3.3% in 2000, due to the above-mentioned reasons. Interest Expense, Net Interest expense for 2001 totaled $1.6 million or .2% of sales compared to net interest expense of $3.2 million or .4% of sales in 2000. The significant reduction results from the funds raised from our public offering of 1,585,000 company shares in September 2001(unadjusted for 3-for-2 stock split completed February 1, 2002), lower interest rates, and improved inventory turnover and expense control Income Taxes The effective income tax rate increased to 34.9% in 2001 from 34.0% in 2000, due to increased income levels which eliminated the benefit of graduated tax rates. At February 2, 2002, the Company has certain net operating loss carryforwards which were acquired in reorganizations and purchase transactions which are available to reduce income taxes, subject to usage limitations. These carryforwards total approximately $43.9 million for state income tax purposes, and expire at various times during the period 2003 through 2023. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of carryforwards which can be utilized. Net Income Net income for 2001 was $19.6 million (or $ .81 per diluted share) or approximately 32.2% higher than the $14.8 million (or $.65 per diluted share) reported in 2000. Fiscal 2000 Compared to Fiscal 1999 Sales Net sales increased 17.3% ($115 million) in 2000. Approximately $57 million of the increase was attributable to the addition of 31 new or upgraded stores, and 16 pharmacies during 2000, together with the sales of 20 store locations and 2 pharmacies that were opened or upgraded during 1999 and contributed a full year of sales in 2000. During 2000, the Company also closed 4 store locations. Comparable store sales based on a 53-week comparison, consisting of sales from stores that have been open for more than one year, increased 9.2% in 2000. The Company's front store (non-pharmacy) sales increased approximately 15% over 1999 front store sales. Front store sales growth benefited from the above mentioned store additions, and solid performances in categories such as home furnishings, floor coverings, bath, small appliances, giftware, ladies intimate, ladies accessories, men's and boy's apparel, ethnic products, beverages, food and snacks, and tobacco. Lawn and garden sales decreased due to reduced emphasis of large lawn and garden equipment that carried lower margins and required additional labor outside the stores. Fred's pharmacy sales grew to 33% of total sales in 2000 from 31% of total sales in 1999 and continues to rank as the largest sales category within the Company. The total sales in this department, including the Company's mail order operation, increased 25% over 1999, with third party prescription sales representing approximately 83% of total pharmacy sales, compared with 77% of total pharmacy sales in 1999. The Company's pharmacy sales growth continued to benefit from an ongoing program of purchasing prescription files from independent pharmacies, the addition of pharmacy departments in existing store locations, and inflation caused by drug manufacturer increases. Sales to Fred's 26 franchised locations increased approximately $1 million in 2000 and represented 4% of the Company's total sales, as compared to 5% in 1999. It is anticipated that this category of business will decline as a percentage of total Company sales since the Company has not added and does not intend to add any additional franchisees. Gross Margin Gross margin as a percentage of sales was 27.5% in 2000 compared to 28.2% in 1999. The decrease in gross margin is primarily attributed to the changes in sales mix and promotional activities to increase customer traffic. Selling, General and Administrative Expenses Selling, general and administrative expenses were 24.2% of net sales in 2000 compared with 25.3% of net sales in 1999. Labor expenses improved in the stores and pharmacies as a result of the strong sales coupled with store productivity initiatives. Advertising expense improved as a percentage of sales by reducing the cost of advertising circulars while maintaining the same number of circulars issued during the year. Other expenses such as store supplies and distribution center equipment rental also improved as a result of cost control efforts. Operating Income Operating income increased approximately $6.8 million or 35.8% to $25.7 million in 2000 from $18.9 million in 1999. Operating income as a percentage of sales increased to 3.3% in 2000 from 2.9% in 1999, due to the above-mentioned reasons. Interest Expense, Net Interest expense for 2000 totaled $3.2 million compared to net interest expense of $2.5 million in 1999. The interest expense for 2000 reflects higher average revolver borrowings for inventory purchases, caused by significantly improved in-stock positions over 1999 and inventory for the new stores opened throughout the year. Higher interest rates during 2000 were also a factor in the higher expense. Income Taxes The effective income tax rate decreased to 34.0% in 2000 from 34.9% in 1999, due to changes made in the Company's organizational structure during the fourth quarter of 1998 and the implementation of a federal program to generate employment related tax credits, which resulted in a reduction in the Company's liability for taxes. At February 3, 2001, the Company had certain net operating loss carryforwards which were acquired in reorganizations and certain purchase transactions and are available to reduce income taxes, subject to usage limitations. These carryforwards total approximately $43.8 million for state income tax purposes, which expire during the period 2002 through 2022. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of carryforwards which can be utilized. Net Income Net income for 2000 was $14.8 million (or $.65 per diluted share) or approximately 39% higher than the $10.7 million (or $.47 per diluted share) reported in 1999. Liquidity and Capital Resources Fred's primary sources of working capital have traditionally been cash flow from operations and borrowings under its credit facility. In September 2001 the Company raised proceeds of $38.2 million from a secondary offering of 1,585,000 Company shares (unadjusted for 3-for-2 stock split completed February 1, 2002). The Company had working capital of $138.4 million, $110.5 million, and $79.7 million at year-end 2001, 2000 and 1999, respectively. Working capital fluctuates in relation to profitability, seasonal inventory levels, net of trade accounts payable, and the level of store openings and closings. Cash and cash equivalents were $15.9 million at the end of 2001 compared to $2.6 million at year-end 2000. Short-term investment objectives are to maximize yields while minimizing company risk and maintaining liquidity. Accordingly, limitations are placed on amounts and types of investments. In April, 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement. The agreement provides the Company with an unsecured revolving line of credit commitment of up to $40 million and bears interest at 1.5% below prime rate or a LIBOR-based rate (weighted average interest rate of 5.2% on 2001 outstanding borrowings). The credit capacity is used to accommodate the Company's continued growth and seasonal inventory needs. Under the most restrictive covenants of the Agreement, we are required to maintain specific shareholders' equity and net income levels. We are required to pay a commitment fee to the bank at a rate per annum equal to .18% on the unutilized portion of the revolving line commitment over the term of the agreement. The credit commitment extends to April 3, 2003. There were no borrowings outstanding under this agreement at February 2, 2002 and $22.6 million outstanding borrowings at February 3, 2001. The reduction in borrowings from the prior year results from cash flow from current operations, continued focus on asset management, and from the proceeds of the secondary public offering completed during the fiscal year. In April 1999, the Company entered into 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 at 6.15% per annum and matures on April 15, 2003. At year-end 2001, the outstanding principal balance on the term loan was approximately $ .7 million compared with $1.3 million at year-end 2000. In May, 1998, the Company and a bank entered into a Loan Agreement (the "Term Loan Agreement"). The Term 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 Term Loan Agreement bore interest of 6.82% per annum and would have matured on November 1, 2005. The Company used the proceeds of the public offering to pay off the Agreement and the borrowings outstanding under the Agreement at February 3, 2001 totaled $8.8 million. Off-Balance Sheet Arrangements The Company has no off-balance sheet financing arrangements. Contractual Obligations and Commercial Commitments As discussed in Note 6 of consolidated financial statements, the Company leases certain of its store locations under noncancelable operating leases expiring at various dates through 2031. Many of these leases contain renewal options and require the Company to pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased properties. In addition, the Company leases various equipment under noncancelable operating leases and certain transportation equipment under capital leases. The future minimum rental payments under all operating and capital leases as of February 2, 2002 are $87.7 million and $2.4 million, respectively. As discussed in Note 10 of the consolidated financial statements, the Company had commitments approximating $9.1 million at February 2, 2002 on issued letters of credit which support purchase orders for merchandise. Additionally, the Company had outstanding letters of credit aggregating $6.8 million at February 2, 2002 utilized as collateral for their risk management programs. Net cash flow provided by operating activities totaled $26.4 million in 2001 compared to $27.1 million in 2000 and cash used in operations of $.8 million in 1999. In fiscal 2001, cash was primarily used to increase inventories by approximately $14.3 million during the fiscal year. This increase is primarily attributable to our adding 33 new stores, upgrading six stores and adding a net of 4 new pharmacies, as well as supporting the improved comparable store sales. Accounts payable and accrued liabilities increased by $3.5 million due primarily to higher inventory purchases. Income taxes payable decreased by approximately $2.4 million as a result of required income tax payments Year-end 2000 cash was primarily used to increase inventories by approximately $ 8.7 million during the fiscal year. Also, accounts receivable increased $4.6 million due to increased pharmacy sales involving third party carriers. Accounts payable and accrued liabilities increased by $5.1 million due primarily to higher inventory purchases. Income taxes payable increased as a result of tax strategies put in place in prior years that had a favorable effect in 2000. Year-end 1999 inventory levels were impacted by improved in-stock positions and store and pharmacy growth. Accounts payable were impacted by the accelerated repayment of $7.5 million. Capital expenditures in 2001 totaled $17.4 million compared with $15.8 million in 2000 and $14.0 million in 1999. The 2001 capital expenditures included approximately $13.5 million of expenditures associated with upgraded, remodeled, or new stores and pharmacies. Approximately $3.8 million in expenditures related to technology upgrades, distribution center equipment, freight equipment, and capital maintenance. The 2000 capital expenditures included approximately $12.2 million of expenditures associated with upgraded, remodeled, or new stores and pharmacies. Approximately $3.6 million in expenditures related to technology upgrades, distribution center equipment, freight equipment, and capital maintenance. The 1999 capital expenditures included approximately $11.7 million of expenditures associated with upgraded, remodeled, or new stores and pharmacies. Approximately $2.3 million in expenditures related to technology upgrades, distribution center equipment, freight equipment, and capital maintenance. Cash used for investing activities also includes $1.0 million in 2001, $2.8 million in 2000, and $.8 million in 1999 for the acquisition of customer lists and other pharmacy related items. The Company believes that sufficient capital resources are available in both the short-term and long-term through currently available cash, cash generated from future operations and, if necessary, the ability to obtain additional financing. Recent Accounting Pronouncements In June 2001, the FASB issued SFAS No. 141, Business Combinations. SFAS No. 141 supercedes Accounting Principles Board Opinion ("APB") No. 16, Business Combinations, and SFAS No. 38, Accounting for Preacquisition Contingencies of Purchased Enterprises. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The Company does not expect the adoption of SFAS No. 141 to have a material impact on its financial statements. In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 supercedes APB No. 17, Intangible Assets, and its provisions are effective for fiscal years beginning after December 15, 2001. SFAS No. 142 requires that: 1) goodwill and indefinite lived intangible assets will no longer be amortized; 2) goodwill will be tested for impairment at least annually at the reporting unit level (reporting unit levels to be determined upon adoption); 3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually; and 4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. As of February 2, 2002, the Company has intangible assets, net of accumulated amortization, of $4.8 million and has recognized amortization expense of approximately $1.8 million during the year February 2, 2002. The Company will continue to amortize intangible assets in accordance with its existing policy and accordingly does not anticipate a material impact on adoption of SFAS No. 142. In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, effective for years beginning after December 15, 2001. This Statement supersedes SFAS No. 121,Accounting for the Impairment of Long-Lived Assets to Be Disposed of, but retains the fundamental provision of SFAS 121 for recognition and measurement of the impairment of long-lived assets to be held and used and measurement of long-lived assets to be held for sale. The statement requires that whenever events or changes in circumstances indicate that a long-lived asset's carrying value may not be recoverable, the asset should be tested for recoverability. The statement also requires that a long-lived asset classified as held for sale should be carried at the lower of its carrying value or fair value, less cost to sell. The Company is evaluating the potential impact the provisions of SFAS 144 could have on it's financial statements but does not believe there will be a material effect on the financial statements upon adoption. Cautionary Statement Regarding Forward-looking Information Statements, other than those based on historical facts that the Company expect or anticipate 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. Our ability to achieve such results is subject to certain risks and uncertainties, including: o Economic and weather conditions which affect buying patterns of our customers; o Changes in consumer spending and our ability to anticipate buying patterns and implement appropriate inventory strategies; o Continued availability of capital and financing; o Competitive factors; o Changes in reimbursement practices for pharmaceuticals; o Governmental regulation; and o Other factors affecting business beyond our 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 us will be realized or that they will have the expected effects on our business or operations. Actual results, performance or achievements can differ materially from results suggested by these forward-looking statements because of a variety of factors. We undertake no obligation to update any forward-looking statement to reflect events or circumstances arising after the date on which it was made.