Table of Contents
PART I.
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FINANCIAL INFORMATION
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II.
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OTHER INFORMATION
Item 6. Exhibits
SIGNATURES
EXHIBIT INDEX
EX-31.1
EX-31.2
EX-32
FORM 10-Q
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20002
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended April 30, 2005.
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 001-14565
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 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 .
-------- ----------
Indicate by check mark whether the registrant is an accelerated filer.
Yes X No
----------- -----------
The registrant had 39,815,181 shares of Class A voting, no par value common
stock outstanding as of June 3, 2005.
2
FRED'S, INC.
INDEX
Page No.
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Part I - Financial Information
- ------------------------------
Item 1 - Financial Statements (unaudited):
Condensed Balance Sheets as of
April 30, 2005 and January 29, 2005 4
Condensed Statements of Income
for the Thirteen Weeks Ended April 30, 2005
and May 1, 2004 5
Condensed Statements of Cash Flows
for the Thirteen Weeks Ended April 30, 2005
and May 1, 2004 6
Notes to Condensed Financial Statements 7 - 10
Item 2 - Management's Discussion and
Analysis of Financial Condition and
Results of Operations 10 - 15
Item 3 - Quantitative and Qualitative Disclosure
about Market Risk 14
Item 4 - Controls and Procedures 14 - 15
Part II - Other Information 16
- ---------------------------
Item 6 - Exhibits
Signatures 17
- ----------
3
Part 1 - FINANCIAL INFORMATION
------------------------------
Item 1. FINANCIAL STATEMENTS
FRED'S, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except for number of shares)
April 30, January 29,
2005 2005
--------- -----------
ASSETS: (unaudited)
Current assets:
Cash and cash equivalents $16,488 $5,365
Inventories 297,039 275,365
Receivables, less allowance for doubtful
accounts of $641 and $629, respectively 20,609 19,449
Other non-trade receivables 11,872 11,821
Prepaid expenses and other current assets 6,568 6,967
------- -------
Total current assets 352,576 318,967
Property and equipment, at depreciated cost 139,397 139,302
Equipment under capital leases, less accumulated
amortization of $3,845 and $3,722, respectively 1,122 1,245
Other noncurrent assets, net 6,551 5,710
-------- --------
Total assets $499,646 $465,224
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable $88,190 $70,503
Current portion of indebtedness 18 18
Current portion of capital lease obligations 655 666
Accrued expenses and other 29,680 26,708
Deferred income taxes 17,829 17,490
Income taxes payable 2,277 --
-------- -------
Total current liabilities 138,649 115,385
-------- -------
Long-term portion of indebtedness 27,928 23,181
Deferred income taxes 8,279 7,701
Capital lease obligations, long term portion 879 1,031
Other noncurrent liabilities 2,486 3,380
-------- -------
Total liabilities 178,221 150,678
-------- -------
Commitments and Contingencies
Shareholders' equity:
Preferred stock, nonvoting, no par value,
10,000,000 shares authorized, none outstanding --- ---
Preferred stock, Series A junior participating
nonvoting, no par value, 224,594 shares
authorized, none outstanding --- ---
Common stock, Class A voting, no par value,
60,000,000 shares authorized, 39,813,382
and 39,692,091 shares issued and outstanding,
respectively 133,388 132,511
Common stock, Class B nonvoting, no par value,
11,500,000 shares authorized, none outstanding --- ---
Retained earnings 190,658 184,732
Unearned compensation (2,621) (2,697)
-------- --------
Total shareholders' equity 321,425 314,546
-------- --------
Total liabilities and shareholders' equity $499,646 $465,224
======== ========
See accompanying notes to condensed consolidated financial statements.
4
FRED'S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except share and per share amounts)
Thirteen Weeks Ended
--------------------
April 30, May 1,
2005 2004
--------- ------
(as restated)
Net sales $382,738 $341,486
Cost of goods sold 273,709 244,692
-------- --------
Gross profit 109,029 96,794
Depreciation and amortization 6,643 6,764
Selling, general and administrative
Expenses 92,195 78,912
------ ------
Operating income 10,191 11,118
Interest expense 158 62
------ ------
Income before income taxes 10,033 11,056
Income taxes 3,311 3,854
------ ------
Net income $6,722 $7,202
====== ======
Net income per share:
Basic $ .17 $ .18
===== =====
Diluted $ .17 $ .18
===== =====
Weighted average shares outstanding:
Basic 39,549 39,060
Effect of dilutive stock options 165 646
------ ------
Diluted 39,714 39,706
====== ======
Dividends paid per common share $.02 $.02
==== ====
See accompanying notes to condensed consolidated financial statements.
5
FRED'S, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
Thirteen Weeks Ended
--------------------
April 30, May 1,
2005 2004
--------- -------
(as restated)
Cash flows from operating activities:
Net income $6,722 $7,202
Adjustments to reconcile net income
to net cash flows from operating activities:
Depreciation and amortization 6,643 6,764
Provision for uncollectible receivables 12 --
Lifo reserve increase 343 367
Deferred income taxes 917 429
Amortization of deferred compensation on
restricted stock incentive plan 75 --
Income tax benefit on exercise of stock options 116 121
(Increase)decrease in assets:
Receivables (840) 2,845
Inventories (22,018) (24,308)
Other assets 399 (1,190)
Increase (decrease) in liabilities:
Accounts payable and accrued liabilities 19,284 (1,225)
Income taxes payable 2,277 1,906
Other noncurrent liabilities 100 66
------- ------
Net cash provided by (used in) operating activities 14,030 (7,023)
------- ------
Cash flows from investing activities:
Capital expenditures (6,116) (8,165)
Asset acquisition (primarily intangibles) (1,340) (475)
------ ------
Net cash used in investing activities (7,456) (8,640)
------- -------
Cash flows from financing activities:
Payments of indebtedness and capital lease obligations (166) (183)
Proceeds from revolving line of credit, net of payments 4,750 16,061
Proceeds from exercise of stock options 761 399
Cash dividends paid (796) (782)
------- -------
Net cash provided by financing activities 4,549 15,495
------- -------
Increase (decrease) in cash and cash equivalents 11,123 (168)
Beginning of period cash and cash equivalents 5,365 4,741
------ -------
End of period cash and cash equivalents $16,488 $4,573
======= ======
Supplemental disclosures of cash flow information:
Interest paid $ 143 $62
===== ===
Income taxes paid $ -- $1,400
======= ======
See accompanying notes to condensed consolidated financial statements.
6
FRED'S, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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NOTE 1: BASIS OF PRESENTATION
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Fred's, Inc. ("We", "Our" or "Us") operates as of April 30, 2005, 607
discount general merchandise stores, including 25 franchised Fred's stores, in
15 states in the southeastern United States. 265 of the stores have full service
pharmacies.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles
("GAAP") for interim financial information and are presented in accordance with
the requirements of 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 GAAP. 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 GAAP. The statements should be read in conjunction with the
Notes to the Consolidated Financial Statements for the fiscal year ended January
29, 2005 incorporated into Our Annual Report on Form 10-K.
The results of operations for the thirteen-week period ended April 30, 2005
are not necessarily indicative of the results to be expected for the full fiscal
year.
As previously disclosed in the Company's periodic reports filed with the
Securities and Exchange Commission (the "SEC"), the Company restated its audited
financial statements for the fiscal years 2003 and 2002, by means of its Form
10-K for the fiscal year ended January 29, 2005, which was filed on April
29,2005. The restatement involved accounting for leases and related property and
equipment. Certain prior amounts have also been reclassified to conform to the
2005 presentation.
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NOTE 2: RECENT ACCOUNTING PRONOUNCEMENTS
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In December 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004),
"Share-Based Payment." SFAS No. 123R establishes standards that require
companies to record the cost resulting from all share-based payment transactions
using the fair value method. Transition under SFAS No. 123R requires using a
modified version of prospective application under which compensation costs are
recorded for all unvested share-based payments outstanding or a modified
retrospective method under which all prior periods impacted by SFAS No. 123R are
restated. In April 2005, the Securities and Exchange Commission ("SEC")
announced the adoption of a new rule that delays the compliance date for the
adoption of SFAS No. 123R. The SEC's new rule will allow implementation at the
beginning of the next fiscal year that begins after June 15, 2005, with early
adoption permitted. The Company intends to adopt SFAS No. 123R in 2006.
In November 2004, the FASB issued Statement of Financial Accounting
Standards No. 151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4"
("SFAS 151"). The purpose of this statement is to clarify the accounting of
abnormal amounts of idle facility expense, freight, handling costs and waste
material. ARB No. 43 stated that under some circumstances these costs may be so
abnormal that they are required to be treated as current period costs. SFAS 151
requires that these costs be treated as current period costs regardless if they
meet the criteria of "so abnormal." The provisions of SFAS 151 shall be
7
effective for inventory costs incurred during fiscal years beginning after June
15, 2005. Although the Company will continue to evaluate the application of SFAS
151, management does not believe adoption will have a material impact on its
results of operations or financial position.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153, "Exchanges of Nonmonetary Assets, and Amendment of APB
Opinion No. 29" ("SFAS 153"). SFAS 153 is based on the principle that exchanges
of nonmonetary assets should be measured based on the fair value of the assets
exchanged. SFAS 153 is effective for nonmonetary asset exchanges occurring in
fiscal periods beginning after June 15, 2005, with earlier application
permitted. Although the Company will continue to evaluate the application of
SFAS 153, management does not believe adoption will have a material impact on
its results of operations or financial position.
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NOTE 3: INVENTORIES
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Warehouse 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 ("RIM"). Under RIM,
the valuation of inventories at cost and the resulting gross margin are
calculated by applying a calculated cost-to-retail ratio to the retail value of
inventories. RIM is an averaging method that has been widely used in the retail
industry due to its practicality. Also, it is recognized that the use of the RIM
will result in valuing inventories at lower of cost or market if markdowns are
currently taken as a reduction of the retail value of inventories. Inherent in
the RIM calculation are certain significant management judgments and estimates
including, among others, initial markups, markdowns, and shrinkage, which
significantly impact the ending inventory valuation at cost as well as resulting
gross margin. These significant estimates, coupled with the fact that the RIM is
an averaging process, can, under certain circumstances, produce distorted or
inaccurate cost figures. Based upon our historical information we have not
experienced any significant change in our cost valuation to date. Management
believes that the Company's RIM provides an inventory valuation which reasonably
approximates cost and results in carrying inventory at the lower of cost or
market.
For pharmacy inventories, which are $35.1 million and $35.1 million at
April 30, 2005 and January 29, 2005, respectively, cost was determined using the
retail LIFO (last-in, first-out) method in which inventory cost are maintained
using the RIM method, then adjusted by application of the Producer Price Index
published by the U.S. Department of Labor for the cumulative annual periods. The
current cost of inventories exceeded the LIFO cost by $10.1 million at April 30,
2005 and $9.7 million at January 29, 2005. LIFO pharmacy inventory costs can
only be determined annually when inflation rates and inventory levels are
finalized; therefore, LIFO pharmacy inventory costs for interim financial
statements are estimated.
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NOTE 4: INCENTIVE STOCK OPTIONS
- --------------------------------------------------------------------------------
We account for our stock-based compensation plans using the intrinsic value
method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations. No stock-option based
employee compensation expense is reflected in net income because the exercise
price of our incentive employee stock options equals the market price of the
underlying stock on the date of grant. The following table illustrates the
effect on net income and earnings per share if we had applied the fair value
recognition provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS No. 123), to stock-based
employee compensation.
8
For the Quarter Ended
April 30, 2005 May 1, 2004
-------------- -----------
(In thousands, except per share data) (as restated)
Net income $ 6,722 $ 7,202
SFAS No. 123 pro forma compensation
expense, net of income taxes (168) (164)
----- -----
SFAS No. 123 pro forma
net income $ 6,554 $ 7,038
=========== ============
Pro forma earnings per share:
Basic $ 0.17 $ 0.18
Diluted $ 0.17 $ 0.18
Earnings per share, as reported:
Basic $ 0.17 $ 0.18
Diluted $ 0.17 $ 0.18
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NOTE 5: Property and Equipment
- --------------------------------------------------------------------------------
Property and Equipment are carried at cost. Depreciation is recorded using the
straight-line method over the estimated useful lives of the assets. Improvements
to leased premises are amortized using the straight-line method over the shorter
of the initial term or the lease of the useful life of the improvement.
Leasehold improvements added late in the lease term are amortized over the
shorter of the remaining term of the lease (including the upcoming renewal
option, if the renewal is reasonably assured) or the useful life of the
improvement, whichever is lesser. Assets under capital leases are amortized in
accordance with the Company's normal depreciation policy for owned assets or
over the lease term (regardless of renewal options), if shorter, and the charge
to earnings is included in depreciation expense in the consolidated financial
statements. Gains or losses on the sale of assets are recorded at disposal as a
component of operating income. The following illustrates the break-down of the
major categories within Property and Equipment:
April 30, January 29,
2005 2005
(unaudited)
Building and building improvements $ 76,673 $ 73,830
Furniture, fixtures and equipment $188,100 $180,157
Leasehold improvements $ 31,769 $ 30,949
Automobiles and vehicles $ 5,982 $ 11,143
Airplane $ 4,697 $ 4,697
-------- --------
$307,221 $300,776
9
Less: Accumulated Depreciation and
Amortization ($172,269) ($166,322)
---------- ----------
$134,952 $134,454
Construction in Progress $ 169 $ 572
Land $ 4,276 $ 4,276
-------- --------
Total Property and Equipment, at
depreciated cost $139,397 $139,302
======== ========
In the fourth quarter of 2004, the Company changed the estimated lives of
certain store fixtures from five to ten years. Based on the Company's historical
experience, ten years is a closer approximation of the actual lives of these
assets. The change in estimate was applied prospectively. Expenses for the first
quarter of 2005 were favorably impacted by approximately $1.2 ($.02 per diluted
share) million as a result of this change.
Item 2:
Management's Discussion and Analysis of Financial
Condition and Results of Operations
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GENERAL
- --------------------------------------------------------------------------------
Executive Overview
- ------------------
In 2005, Fred's will continue its strategy of growth initiatives and
productivity improvements. We plan to open 60 to 70 new stores and between 20
and 25 pharmacies to our chain. Our selling square footage will increase 12% to
14%. Another important roll-out will be a new refrigerated foods program, which
will add a totally new merchandise category and greatly enhance the convenience
of our stores. The program is planned to be a sound traffic generator while
lifting our average customer transaction amount. Stores equipped with the
refrigerated foods program will qualify to accept government assistance cards.
In the first quarter, the Company opened 21 new stores. The majority of our new
store openings were in Alabama, Georgia, Florida, and South Carolina.
Additionally, we have opened seven new pharmacies during the quarter.
We continue to focus our merchandising and store direction on maintaining a
competitive differentiation within the $25 shopping trip. Our unique store
format and strategy combine the attractive element of a discount dollar store,
drug store and mass merchant. Our average customer transaction was approximately
$18.29. In comparison, the discount dollar stores average $8 - $9 and chain
drugs and mass merchants average in the range of $40 - $80 per transaction. Our
stores operate equally well in rural and urban markets. Our everyday low pricing
strategy is supplemented by 14 promotional circulars per year. Our product
selection is enhanced by a private label program and opportunistic buys.
During the year, the Company expects to see continued payback on key technology
initiatives we have implemented. These initiatives include store POS systems
upgrades, allocation system upgrades, and radio frequency devices in the stores
to facilitate scanning in-store deliveries and correct inventory counts.
Our business is subject to seasonal influences, but has tended to experience
less seasonal fluctuation than many other retailers due to the mix of everyday
basic merchandise and pharmacy business. Our fiscal 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
our operations. Many of our employees are paid hourly rates related to the
federal minimum wage and, accordingly, any increase affects us. In addition,
10
payroll taxes, employee benefits and other employee-related costs continue to
increase. Occupancy costs, including rent, maintenance, taxes and insurance,
also continue to rise. We believe that maintaining adequate operating margins
through a combination of price adjustments and cost controls, careful evaluation
of occupancy needs, and efficient purchasing practices are the most effective
tools for coping with increasing costs and expenses.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
- --------------------------------------------------------------------------------
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's condensed financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States. The critical accounting matters that are particularly
important to the portrayal of the Company's financial condition and results of
operations and require some of management's most difficult, subjective and
complex judgments are described in detail in the Company's Annual Report on Form
10-K for the fiscal year ended January 29, 2005. The preparation of condensed
financial statements requires the Company to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenue and expenses, and
related disclosure of contingent assets and liabilities. On an ongoing basis,
the Company evaluates its estimates, including those related to inventories,
income taxes, insurance reserves, contingencies and litigation. The Company
bases its estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. There
have been no material changes in the critical accounting policies during the
thirteen weeks ended April 30, 2005.
Included in ending inventory are capitalized costs of the product itself,
inbound freight and duties and the costs associated with purchasing, receiving,
handling, and securing the product.
Cost of merchandise sold includes the cost of the product sold, along with all
costs associated with inbound freight.
Selling, general and administrative expenses include the costs associated with
purchasing, receiving, handling, securing, and storing the product. These costs
are associated with products that have been sold and no longer remain in ending
inventory.
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RESULTS OF OPERATIONS
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Thirteen Weeks Ended April 30, 2005 and May 1, 2004
- ---------------------------------------------------
Net sales increased to $382.7 million in 2005 from $341.5 million in 2004, an
increase of $41.2 million or 12.1%. The increase was attributable to comparable
store sales increases of 3.0% ($10.5 million) and sales by stores not yet
included as comparable stores ($31.0 million). Sales to franchisees decreased
$.3 in 2005 compared to the same quarter last year. The decrease in sales to
franchised locations results primarily from the closing of one franchise store.
It is anticipated that this category of business will continue to decline as a
percentage of total Company sales since the Company has not added and does not
intend to add any additional franchises. The sales mix for the period was 34.0%
Pharmaceuticals, 21.4% Household Goods, 14.0% Apparel and Linens, 11.7% Food and
Tobacco, 8.3% Health and Beauty Aids, 8.3% Paper and Cleaning Supplies, and 2.3%
Franchise. This compares with 33.7% Pharmaceuticals, 21.3% Household Goods,
14.0% Apparel and Linens, 11.3% Food and Tobacco, 9.0% Health and Beauty Aids,
8.1% Paper and Cleaning Supplies, and 2.6% Franchise for the same period last
year.
11
Gross profit for the first quarter increased to 28.5% of sales in 2005 from
28.3% of sales in 2004. In the quarter, gross profit margin was unfavorably
affected by the continued product mix shift toward more basic and consumable
product. We believe that a major reason for the continued product mix shift has
been the impact of rising fuel prices on our low-to-middle income shopper. The
reduction in general merchandise initial margin was approximately .3% in the
first quarter. This reduction was offset by better pharmacy margins of .4% and
store shrinkage improvements of .1%.
Selling, general and administrative expenses increased to $98.8 million in 2005
from $85.7 million in 2004. Selling, general and administrative expenses
increased primarily due to higher labor and advertising by $5.7 million and $1.4
million respectively, as well as increases in fuel prices of $1.5 million and
utilities expenses of $.8 million. As a percentage of sales, expenses increased
to 25.8% of sales compared to 25.1% of sales last year. Store operating expenses
as a percentage of sales increased by 1% over the same period last year. While
selling, general and administrative expenses increased in total, the pharmacy,
corporate, and distribution departments experienced a favorable decrease as a
percentage of sales of .30%. This favorable decrease resulted from a .07%
decrease in pharmacy, .18% decrease in corporate and .05% decrease in
distribution. A change made in the prior year to estimated lives of certain
store fixtures from five to ten years resulted in a favorable impact on
depreciation expense by approximately $1.2 million.
For the first quarter of 2005 interest expense was $.2 million compared to $.1
million in 2004. The increase in interest results from higher borrowings to fund
inventory purchases coupled with higher rates than a year ago.
For the first quarter, the effective income tax rate was 33.0%, as compared to
34.9% in the first quarter of last year. We anticipate the tax rate for the
remainder of the year to be in the 33% to 34% range.
The Company has updated guidance for future quarters and fiscal 2005 and
currently believes that sales will increase in the range of 12% to 13% for the
year. Comparable store sales are expected to increase in the range of 3% to 4%
for the year. The quarterly breakdown of comparable store sales is expected to
be in the ranges of 1% to 3% in the second quarter, 2% to 4% in the third
quarter, and 3% to 5% in the fourth quarter. We expect earnings per diluted
share to be $0.10 to $0.12 in the second quarter and have not changed the range
for 2005 which has been $0.86 to $0.91, adjusted for the effects of lease
accounting changes.
Our business is subject to seasonal influences, but has tended to experience
less seasonal fluctuation than many other retailers due to the 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
our operations. Many of our employees are paid hourly rates related to the
federal minimum wage and, accordingly, any increase affects us. 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. We believe that maintaining adequate operating margins
through a combination of price adjustments and cost controls, careful evaluation
of occupancy needs, and efficient purchasing practices are the most effective
tools for coping with increasing costs and expenses.
12
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LIQUIDITY AND CAPITAL RESOURCES
- --------------------------------------------------------------------------------
Due to the seasonality of our 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 $14.0 million during the
thirteen-week period ended April 30, 2005. Cash was primarily used to increase
inventories by approximately $22.0 million in the first quarter of 2005. This
increase was primarily attributable to 21 new stores and 6 remodeled stores in
the first quarter of 2005. The average store merchandise inventory decreased by
4.6% as compared to the same period last year.
Cash flows used in investing activities totaled $7.5 million, and consisted
primarily of capital expenditures associated with the store and pharmacy
expansion program ($5.9 million) and for technology and other corporate
expenditures ($.2 million). During the first quarter, we opened 21 stores,
closed 3 stores, opened 7 pharmacies, and remodeled 6 stores. We expect to open
15 to 20 stores in the second quarter and approximately 60 to 70 stores for the
year. In 2005, the Company is planning capital expenditures totaling
approximately $35.7 million. Expenditures are planned totaling approximately
$27.5 million for upgrades, remodels, or new stores and pharmacies; $5.1 million
for technology upgrades, $3.1 million for distribution center equipment and
capital maintenance. In addition the Company also plans expenditures of $2.6
million for the acquisition of customer lists and other pharmacy related items.
Depreciation expense for the year will be approximately $30 million.
Cash flows provided by financing activities totaled $4.5 million and included
$4.8 million of borrowings under the Company's revolving credit agreement for
inventory needs.
We believe 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.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
- --------------------------------------------------------------------------------
Other than statements based on historical facts, many of the matters discussed
in this Form 10-Q relate to events which we expect or anticipate may occur in
the future. Such statements are defined as "forward-looking statements" under
the Private Securities Litigation Reform Act of 1995 (the "Reform Act"), 15
U.S.C.A. Sections 77z-2 and 78u-5 (Supp. 1996). The Reform Act created a safe
harbor to protect companies from securities law liability in connection with
forward-looking statements. Fred's, Inc. ("Fred's" or the "Company") intends to
qualify both its written and oral forward-looking statements for protection
under the Reform Act and any other similar safe harbor provisions.
The words "believe", "anticipate", "project", "plan", "expect", "estimate",
"objective", "forecast", "goal", "intend", "will likely result", or "will
continue" and similar expressions generally identify forward-looking statements.
All forward-looking statements are inherently uncertain, and concern matters
that involve risks and other factors which may cause the actual performance of
the Company to differ materially from the performance expressed or implied by
these statements. Therefore, forward-looking statements should be evaluated in
the context of these uncertainties and risks, including but not limited to:
13
- Economic and weather conditions which affect buying patterns of our
customers and supply chain efficiency;
- Changes in consumer spending and our ability to anticipate buying patterns
and implement appropriate inventory strategies;
- Continued availability of capital and financing;
- Competitive factors;
- Changes in reimbursement practices for pharmaceuticals;
- Governmental regulation;
- Increases in fuel and utility rates;
- Other factors affecting business beyond our control.
Consequently, all forward-looking statements are qualified by this cautionary
statement. We undertake no obligation to update any forward-looking statement to
reflect events or circumstances arising after the date on which it was made.
Item 3.
- --------------------------------------------------------------------------------
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
- --------------------------------------------------------------------------------
We have no holdings of derivative financial or commodity instruments as of April
30, 2005. We are exposed to financial market risks, including changes in
interest rates. All borrowings under our Revolving Credit Agreement bear
interest at 1.5% below prime rate or a LIBOR-based rate. An increase in interest
rates of 100 basis points would not significantly affect our income. All of our
business is transacted in U.S. dollars and, accordingly, foreign exchange rate
fluctuations have not had a significant impact on us, and they are not expected
to in the foreseeable future.
Item 4.
- --------------------------------------------------------------------------------
CONTROLS AND PROCEDURES
- --------------------------------------------------------------------------------
(a) Disclosure Controls and Procedures. As of the end of the period covered by
this report, the Company carried out an evaluation, under the supervision and
with the participation of our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the Company's disclosure controls and
procedures (as defined in Rule 13a - 15(e) under the Securities Exchange Act of
1934, as amended (the "Exchange Act")). Based on that evaluation, the Chief
Executive Officer and the Chief Financial Officer concluded that, as of the date
of their evaluation, the Company's disclosure controls and procedures are
effective in timely alerting them to material information required to be
included in the Company's periodic SEC reports.
(b) Changes in Internal Control Over Financial Reporting. During the quarter
ended April 30, 2005, the Company instituted procedures to remediate the
material weakness in internal control that resulted from the inappropriate
application of Generally Accepted Accounting Principles related to the
accounting for leases (straight-line rent) and the depreciable lives of
leasehold improvements (as previously disclosed by the Company in its report on
internal control over financial reporting in Form 10-K for the fiscal year ended
January 29, 2005). The Company will be testing these procedures over the
upcoming quarters to ensure that this material weakness is remediated in the
current fiscal year.
14
Additionally, the Company reported a material weakness in internal control in
Form 10-K for the fiscal year ended January 29, 2005, related to the financial
closing process. During the first fiscal quarter, the Company has implemented
procedural and staff improvements as steps toward remediation of this weakness.
However, additional improvements will be required over the upcoming quarters,
with the intention of remediating this material weakness in the current fiscal
year.
There have been no other changes in the Company's internal control over
financial reporting that occurred during the Company's first fiscal quarter that
have materially affected or are reasonably likely to materially affect the
Company's internal control over financial reporting.
15
PART II. OTHER INFORMATION
Item 6. Exhibits
Exhibits:
31.1 Certification of Chief Executive Officer.
31.2 Certification of Chief Financial Officer.
32 Certification of Chief Executive Officer and Chief
Financial Officer pursuant to rule 13a-14(b) under the
Securities Exchange Act of 1934 and 18 U.S.C. Section
1350.
16
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FRED'S, INC.
/s/Michael J. Hayes
---------------------------
Michael J. Hayes
Date: June 9, 2005 Chief Executive Officer
- -------------------
/s/Jerry A. Shore
---------------------------
Jerry A. Shore
Date: June 9, 2005 Chief Financial Officer
- -------------------
17
Exhibit 31.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Michael J. Hayes, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Fred's, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors:
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: June 9, 2005 /s/ Michael J. Hayes
------------------------------
Michael J. Hayes
Chief Executive Officer
18
Exhibit 31.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Jerry A. Shore, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Fred's, Inc.
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any changes in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors:
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: June 9, 2005 /s/ Jerry A Shore
------------------------------
Jerry A. Shore
Executive Vice President and
Chief Financial Officer
19
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
PURSUANT TO RULE 13 a OR 15 (d) UNDER THE SECURITIES EXCHANGE ACT OF 1934 AND 18
U.S.C. SECTION 1350
Each of the undersigned hereby certifies that to his knowledge the Quarterly
Report on Form 10-Q for the fiscal quarter ended April 30, 2005 of Freds, Inc
(the "Company") filed with the Securities and Exchange Commission on the date
hereof fully complies with the requirements of section 13(a) or 15(d) of the
Securities Exchange Act of 1934 and that the information contained in such
report fairly presents, in all material respects, the financial condition and
results of operation of the Company.
Date: June 9, 2005 /s/ Michael J. Hayes
----------------------------
Michael J. Hayes
Chief Executive Officer
/s/ Jerry A. Shore
----------------------------
Jerry A. Shore
Executive Vice President and
Chief Financial Officer
20