Unassociated Document
UNITED
STATES
SECURITIES AND EXCHANGE
COMMISSION
WASHINGTON, D.C.
20549
FORM 10-K
þ
|
ANNUAL REPORT PURSUANT TO
SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the Fiscal Year Ended January 30, 2010
Or
o
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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
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:
Title of Class
|
|
Name of exchange on which
registered
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Class A
Common Stock, no par value
Preferred
Share Purchase Rights
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The
NASDAQ Global
Select Market
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Securities
Registered Pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o
No þ
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes o
No þ
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 Indicate by check mark
whether the registrant has submitted electronically and posted on its corporate
website, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the
preceding 12 months (of for such shorter period that the registrant was required
to submit and post such files). Yes þ
No o
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 þ No
o
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 þ.
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer o
|
|
Accelerated
filer þ
|
|
Non-accelerated
filer o
(Do
not check if a smaller reporting company)
|
|
Smaller
reporting company o
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes o No
þ
Aggregate
market value of the voting stock held by non-affiliates of the Registrant, based
upon the last reported sale price on such date by the NASDAQ Stock Market, Inc.
on August 1, 2009, the last business day of the registrant’s most recently
completed second fiscal quarter, was approximately $541 million. Shares of
voting stock held by executive officers, directors and holders of more than 10%
of the outstanding voting shares have been excluded from this calculation
because such persons may be deemed to be affiliates. Exclusion of such shares
should not be construed to indicate that any of such persons possess the power,
direct or indirect, to control the Registrant, or that such person is controlled
by or under common control of the Registrant.
As of
April 14, 2010, there were 39,306,359 shares outstanding of the
Registrant’s Class A no par value voting common stock.
As of
April 14, 2010, 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 Company’s Proxy Statement for the 2010 annual shareholders meeting, to be
filed within 120 days of the registrant’s fiscal year end, are incorporated
into Part III of this Annual Report on Form 10-K by reference. 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.
FRED’S,
INC.
FORM
10-K
TABLE
OF CONTENTS
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Page No.
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PART
I
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ITEM
1. — Business
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4
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ITEM
1A. — Risk Factors
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10
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ITEM
1B. — Unresolved Staff Comments
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12
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ITEM
2. — Properties
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13
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ITEM
3. — Legal Proceedings
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13
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ITEM
4. — Reserved
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14
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PART
II
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ITEM
5. — Market for the Registrant’s Common Equity, Related Stockhoder Matters
and Issuer Purchases of Equity Securities
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15
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ITEM
6. — Selected Financial Data
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16
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ITEM
7. — Management’s Discussion and Analysis of Financial Condition and
Results of Operations
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17
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ITEM
7A. — Quantitative and Qualitative Disclosure about Market
Risk
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29
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ITEM
8. — Financial Statements and Supplementary Data
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30
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ITEM
9. — Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
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53
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ITEM
9A. — Controls and Procedures
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53
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ITEM
9B. — Other Information
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56
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PART
III
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ITEM
10. — Directors, Executive Officers and Corporate
Governance
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56
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ITEM
11. — Executive Compensation
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57
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ITEM
12. — Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
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57
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ITEM
13. — Certain Relationships and Related Transactions and Director
Independence
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57
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ITEM
14. — Principal Accounting Fees and Services
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57
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PART
IV
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ITEM
15. — Exhibits, Financial Statement Schedules
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58
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SIGNATURES
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63
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EXHIBIT
INDEX
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Exhibit
21.1
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Exhibit
23.1
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Exhibit
31.1
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Exhibit
31.2
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Exhibit
32
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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-K 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
variations of such words 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:
|
o
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Economic
and weather conditions which effect buying patterns of our customers and
supply chain efficiency;
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o
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Changes
in consumer spending and our ability to anticipate buying patterns and
anticipate and implement appropriate inventory
strategies;
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o
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Continued
availability of capital and
financing;
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|
o
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Changes
in reimbursement factors for
pharmaceuticals;
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o
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Governmental
regulation;
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o
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Increase
in fuel and utility rates;
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o
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Other
factors affecting business beyond our control, including (but not limited
to) those discussed under Part I, ITEM 1A “Risk Factors”
herein.
|
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.
General
FRED’S,
founded in 1947, operates 645 (as of January 30, 2010) discount general
merchandise stores in fifteen states primarily in the southeastern United
States. FRED’S stores generally serve low, middle and fixed income
families located in small- to medium- sized towns (approximately 83% of FRED’S
stores are in markets with populations of 15,000 or fewer people). Full service
pharmacies are included in 307 of the Company’s stores (as of January 30, 2010).
The Company also markets goods and services to 24 franchised “FRED’S” stores.
The Company is headquartered in Memphis, Tennessee.
FRED’S
stores stock over 12,000 frequently purchased items which address the everyday
needs of its customers, including nationally recognized brand name products,
proprietary “FRED’S” label products and lower priced off-brand products. FRED’S
management believes its customers shop FRED’S stores as a result of their
convenient locations and consumer friendly sizes, consistent availability of
products at everyday low prices and regularly advertised departmental promotions
and seasonal specials. FRED’S stores have average selling space of 14,411 square
feet and had average sales of $2,710,000 in fiscal 2009. No single store
accounted for more than 1.0% of net sales during fiscal 2009.
Business
Strategy
The
Company’s strategy is to meet the general merchandise and pharmacy needs of the
small- to medium- sized towns it serves by offering a wider variety of quality
merchandise and a more attractive price-to-value relationship than either drug
stores or smaller variety/dollar stores and a shopper-friendly format which is
more convenient than larger sized discount merchandise stores. The major
elements of this strategy include:
Wide variety of frequently
purchased, basic merchandise — FRED’S combines everyday
basic merchandise with certain specialty items to offer its customers a wide
selection of over 12,000 frequently purchased items of general merchandise. The
selection of merchandise is supplemented by seasonal specials, private label
products, surprise and delight items, and the inclusion of pharmacies in many of
its stores.
Discount prices — The Company provides value
and low prices to its customers (i.e., a good “price-to-value relationship”)
through a coordinated discount strategy and an “Everyday Low Pricing” program
that focuses on strong values daily, while minimizing the Company’s reliance on
promotional activities. As part of this strategy, FRED’S maintains low opening
price points and competitive prices on key products across all departments, and
regularly offers seasonal specials and departmental promotions supported by
direct mail, television, radio and newspaper advertising.
Convenient shopper-friendly
environment —
FRED’S stores are typically located in convenient shopping and/or
residential areas. Approximately 43% of the Company’s stores are freestanding as
opposed to being located in strip shopping center sites. Freestanding sites
allow for easier access and shorter distances to the store entrance. FRED’S
stores are of a manageable size, and have a customer centric store layout and
fast checkouts. By offering general merchandise and refrigerated foods together
with pharmacies in many of its stores, we provide a full selection of
merchandise to our customer.
Expansion
Strategy
In 2010,
the Company plans a moderate expansion approach and intends to open
approximately 20 - 25 stores and pharmacies and close an estimated 10 stores and
5 pharmacies.
The
Company expects that expansion will occur primarily within its present
geographic area and will be focused in small-to medium- sized towns. The Company
may also enter larger metropolitan and urban markets where it already has a
market presence in the surrounding area. As part of the Company’s
continuing operations, we perform research to discover potential underperforming
stores. The Company uses such research and analysis to identify
potential store closures.
FRED’S
opened 15 stores and closed 9 stores in 2009. The majority of new stores opened
in 2009 were located in South Carolina and Alabama. The Company’s new store
prototype has 16,000 square feet of space. Opening a new store currently costs
between $450,000 and $600,000 for inventory, furniture, fixtures, equipment and
leasehold improvements.
In 2009,
the Company added 26 new pharmacies and closed 3 pharmacies. Approximately 48%
of FRED’S stores as of January 30, 2010 contain a pharmacy and sell prescription
drugs. The Company’s primary strategy for obtaining customers for new pharmacies
is through the acquisition of prescription files from independent pharmacies.
These acquisitions provide an immediate sales benefit, and in many cases, the
independent pharmacist will become an employee of FRED’S, thereby providing
continuity in the pharmacist-patient relationship.
The
following tables set forth certain information with respect to stores and
pharmacies for each of the last five fiscal years:
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2009
|
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|
2008
|
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|
2007
|
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2006
|
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|
2005
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|
Stores
open at beginning of period
|
|
|
639 |
|
|
|
692 |
|
|
|
677 |
|
|
|
621 |
|
|
|
563 |
|
Store
opened/acquired during period
|
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|
15 |
|
|
|
21 |
|
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|
35 |
|
|
|
59 |
|
|
|
65 |
|
Stores
closed during period
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|
|
(9 |
) |
|
|
(74 |
) |
|
|
(20 |
) |
|
|
(3 |
) |
|
|
(7 |
) |
Stores
open at end of period
|
|
|
645 |
|
|
|
639 |
|
|
|
692 |
|
|
|
677 |
|
|
|
621 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Number
of stores with pharmacies at end of period
|
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|
307 |
|
|
|
284 |
|
|
|
296 |
|
|
|
289 |
|
|
|
275 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Square
feet of selling space at end of period (in thousands)
|
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|
9,360 |
|
|
|
9,323 |
|
|
|
10,215 |
|
|
|
9,946 |
|
|
|
9,091 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Average
square feet of selling space per store
|
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|
14,411 |
|
|
|
14,590 |
|
|
|
15,239 |
|
|
|
15,290 |
|
|
|
15,269 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Franchise
stores at end of period
|
|
|
24 |
|
|
|
24 |
|
|
|
24 |
|
|
|
24 |
|
|
|
24 |
|
FRED’S “Xpress” Designation:
The term “Xpress” is given to a location that is intended to transition
to a typical FRED’S store. These locations range in size from 1,000 to 8,000
square feet, and enable the Company to enter a new market with an initial
investment of under $400,000. These locations typically sell only
pharmaceuticals and other health and beauty related items. Xpress locations
usually originate from an acquisition and are in a location that is not suitable
for the typical layout of a FRED’S store. Therefore, the new store location is
given the Xpress designation, and is targeted for conversion to a typical FRED’S
store once a suitable location can be obtained. The Xpress designation is not a
business strategy or a new line of business. It is simply a way of describing a
small number of atypical stores in our chain that are awaiting conversion to a
typical larger FRED’S store layout. In all other ways, including resource
allocation, management, training, marketing and corporate support, it is treated
just as any other location in the chain. Given their smaller physical size,
however, they are not stocked with the full breadth of merchandise in all
departments that are carried by our other stores.
Within
the population of Xpress locations, acquisitions are routinely being added and
stores are being converted as suitable locations are found. At any given time
the Company has approximately 30 stores that are designated as Xpress locations.
Due to the small number of stores in transition relative to our total store
population, Xpress stores represent a small portion of our sales and gross
profit. Xpress sales, as a percentage of totals sales, for 2009, 2008 and 2007
were 3.0%, 2.3% and 2.7%, respectively, and gross profit, as a percentage of
total gross profit for the same time period was 2.8%, 2.1% and 2.4%,
respectively.
Merchandising and
Marketing
The
business in which the Company is engaged is highly competitive. The principal
competitive factors include location of stores, price and quality of
merchandise, in-stock consistency, merchandise assortment and presentation, and
customer service. The Company competes for sales and store locations in varying
degrees with national, regional and local retailing establishments, including
department stores, discount stores, variety stores, dollar stores, discount
clothing stores, drug stores, grocery stores, outlet stores, convenience stores,
warehouse stores and other stores. Many of the largest retail companies in the
nation have stores in areas in which the Company operates. Management
believes that its knowledge of regional and local consumer preferences,
developed over its 63 year history, enables the Company to compete very
effectively within its region.
Management
believes that FRED’S has a distinctive niche in that it offers a wider variety
of merchandise with a more attractive price-to-value relationship than either a
drug store or smaller variety/dollar store and is more shopper-convenient than a
larger discount store. The variety and depth of merchandise offered in our
high-traffic departments, such as health and beauty aids and paper and cleaning
supplies, are comparable to those of larger discount retailers. The
depth and variety in these departments is a promise of our “We Got It” program,
which ensures that we have our highest demand consumable items (700 – 800 items)
on our shelves and available to our customers.
Purchasing
The
Company’s primary buying activities (other than prescription drug buying) are
directed from the corporate office by the Executive Vice President and General
Merchandise Manager through five Divisional Senior Vice Presidents of
Merchandising. The Merchandising Department is supported by a staff
of 27 merchants and assistants. The merchants are participants in an incentive
compensation program, which is based upon various factors primarily relating to
gross margin return on inventory, all of which are intended to drive shareholder
value. The Company purchases its merchandise from a wide variety of domestic and
import suppliers. Many of the import suppliers generally require long lead times
and orders are placed four to six months in advance of delivery. These products
are either imported directly by us or acquired from distributors based in the
United States and their purchase prices are denominated in United States
dollars. The Merchandising Department manages all replenishment and forecasting
functions with the Company’s open-to-buy reports generated by proprietary
software. The Merchandising Department develops vendor line reviews, assortment
planning and the testing of new products and programs to continually improve
overall inventory productivity and in-stock positions.
The
Company purchased approximately 13% in 2009, 14% in 2008 and 13% in 2007 of the
Company’s warehouse purchases from Procter and Gamble. The Company believes that
adequate alternative sources of products are available for these categories of
merchandise.
During
2009, all of the Company’s prescription drugs were ordered by its pharmacies
individually and shipped direct from the Company’s primary pharmaceutical
wholesaler, AmerisourceBergen Corporation (“Bergen”). Bergen provides
substantially all of the Company’s prescription drugs. During 2009, 2008 and
2007 approximately 38%, 37% and 36%, respectively, of the Company’s total
purchases were made from Bergen. Although there are alternative wholesalers that
supply pharmaceutical products, the Company operates under a purchase and supply
contract with Bergen as its primary wholesaler, which continues through 2012.
Accordingly, the unplanned loss of this particular supplier could have a
short-term gross margin impact on the Company’s business until an alternative
wholesaler arrangement could be implemented.
Excluding
the purchases made from our pharmaceutical supplier and those made from Procter
and Gamble mentioned previously, no other supplier accounted for more than 5% of
the Company’s total purchases for the years 2009, 2008 and 2007.
Sales
Mix
The
Company’s sales, which occur through Company owned stores and to franchised
FRED’S stores, constitute a single reportable operating segment.
The
Company’s sales mix by major category for the preceding three years was as
follows:
|
|
For the Year Ended
|
|
|
|
January 30,
2010
|
|
|
January 31,
2009
|
|
|
February 2,
2008
|
|
Pharmaceuticals
|
|
|
33.5 |
% |
|
|
31.7 |
% |
|
|
32.2 |
% |
Household
Goods
|
|
|
23.4 |
% |
|
|
24.8 |
% |
|
|
24.8 |
% |
Food
and Tobacco Products
|
|
|
16.2 |
% |
|
|
15.5 |
% |
|
|
14.2 |
% |
Paper
and Cleaning Supplies
|
|
|
9.2 |
% |
|
|
9.2 |
% |
|
|
8.8 |
% |
Apparel
and Linens
|
|
|
7.9 |
% |
|
|
8.6 |
% |
|
|
9.9 |
% |
Health
and Beauty Aids
|
|
|
7.6 |
% |
|
|
8.0 |
% |
|
|
8.0 |
% |
Sales
to Franchised Fred's Stores
|
|
|
2.2 |
% |
|
|
2.2 |
% |
|
|
2.1 |
% |
Total
Sales Mix
|
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
The sales
mix varies from store to store depending upon local consumer preferences and
whether the stores include pharmacies and/or a full-line of
apparel. In 2009, the average customer transaction size for
comparable stores was approximately $19.29, and the number of customer
transactions totaled approximately 89 million. The average transaction size
was approximately $19.05 in 2008 and $18.75 in 2007.
Our
FRED’S Brand products include household cleaning supplies, health and beauty
aids, disposable diapers, pet foods, paper products and a variety of food and
beverage products. Private label products sold constituted approximately 8.2% of
total store sales in 2009 compared to 5.9% in 2008 and 3.0% in 2007. Private
label products afford the Company higher than average gross margins while
providing the customer with lower priced products that are of a quality
comparable to that of competing branded products. An independent
laboratory-testing program is used for substantially all of the Company’s
private label products. As part of our 2009 strategic plan, we expanded our
private label program and plan to continue that expansion in 2010. For a
complete discussion, reference Item 7, Management’s Discussion and Analysis
of Financial Condition and Results of Operation.
The
Company sells merchandise to its 24 franchised “FRED’S” stores. These sales
during the last three years totaled approximately $38.4 million in 2009,
$39.6 million in 2008 and $37.3 million in 2007. Franchise and other
fees earned totaled approximately $2.1 million in 2009, $2.1 million in
2008 and $2.0 million in 2007. These fees represent a reimbursement for use
of the FRED’S name and administrative costs incurred on behalf of the franchised
stores. The Company does not intend to expand its franchise
network.
Advertising
and Promotions
Net
advertising and promotion costs represented approximately 1.2% of net sales in
2009 and 2008 and 1.5% of net sales in 2007. The Company uses direct
mail, television, radio and select newspaper advertising to deliver the FRED’S
value message. The Company utilizes full-color circulars coordinated by our
internal advertising staff to promote its merchandise, special promotional
events and a discount retail image. Additionally, the Company retains an outside
advertising agency to assist with radio and television promotions, and to
develop and implement the Company’s branding strategy.
The
Company’s merchants have discretion to mark down slow moving items. The Company
offers regular clearance of seasonal merchandise and conducts sales and
promotions of particular items. The Company also encourages its store managers
to create in-store advertising displays and signage in order to increase
customer traffic and impulse purchases.
Store Operations
All
FRED’S stores are open six days a week (Monday through Saturday), and most
stores are open seven days a week (excluding the pharmacy). Store
hours are generally from 9:00 a.m. to 9:00 p.m.; however, certain stores are
only open until 6:00 p.m. Each FRED’S store is managed by a full-time
store manager and those stores with a pharmacy employ a full-time
pharmacist. The Company’s 38 district managers and 5 Regional Vice
Presidents supervise the management and operation of FRED’S stores.
FRED’S
operates 307 pharmacies (as of January 30, 2010), which offer brand name and
generic pharmaceuticals and are staffed by licensed pharmacists and are managed
by 11 healthcare managers. The addition of acquired pharmacies in the
Company’s stores has resulted in increased store sales and sales per selling
square foot. Management believes that the Pharmacy Department, in
addition to the 45 other merchandise departments, increases customer traffic and
repeat visits and is an integral part of the store’s operation.
The
Company has an incentive compensation plan for store managers, pharmacists and
district managers based on meeting or exceeding targeted profit percentage
contributions. Various factors included in determining profit
percentage contribution are gross profits and controllable expenses at the store
level. These factors of operating performance are reviewed regularly
by executive management to pinpoint developments in key performance
areas. Management believes that this incentive compensation plan,
together with the Company’s store management training program, are instrumental
in maximizing store performance. The Company’s training program
covers all aspects of the Company’s operation from product knowledge to handling
customers with courtesy.
Inventory Control
The
Company’s centralized management information system maintains a daily
stock-keeping unit (“SKU”) level inventory and current and historical sales
information for each store and the distribution centers. This system
is supported by our in-store point-of-sale (“POS”) system, which captures SKU
and other data at the time of sale. The Merchandising arm of the
system uses the data received from the stores to provide integrated inventory
management, automated replenishment, promotional planning, space management, and
merchandise planning. Additionally, the company uses NEX/DEX
technology for in-store receiving and inventory control for all items delivered
directly to our stores. The Company conducts annual physical
inventory counts at all FRED’S stores and has implemented the use of radio
frequency devices (RF guns) to conduct cycle counts to ensure replenishment
accuracy.
Distribution
The
Company has an 850,000 square foot distribution center in Memphis, Tennessee
that services 359 stores and a 600,000 square foot distribution center in
Dublin, Georgia that services 286 stores (see “Properties” below). Approximately
46% of the merchandise received by FRED’S stores in 2009 was shipped through
these distribution centers, with the remainder (primarily pharmaceuticals,
certain snack food items, greeting cards, beverages and tobacco products) being
shipped directly to the stores by suppliers. For distribution, the Company uses
owned and leased trailers and tractors, as well as common carriers. The
Company’s Warehouse Management System is completely automated and provides
conveyor control and pick, pack and ship processes by using portable
radio-frequency terminals. This system is integrated with the Company’s
centralized management information system to provide up-to-date perpetual
records as well as facilitating merchandise allocation and distribution
decisions. The Company uses cycle counts throughout the year to ensure accuracy
within the Warehouse Management System.
Seasonality
Our
business is somewhat seasonal in that the Company’s sales volume is heavier
around the first of the calendar month. Many of the customers who shop at FRED’S
stores rely on government aid, social security, and other means that are
typically paid at the first of the month. These governmental payment cycles
coupled with the distribution of our newspaper-advertising circular are major
factors in concentrating sales earlier in the calendar month.
The
following table reflects the seasonality of net sales, gross profit, operating
income, and net income by quarter.
For the year ended:
|
|
1st
Quarter
|
|
|
2nd
Quarter
|
|
|
3rd
Quarter
|
|
|
4th
Quarter
|
|
January
30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Sales
|
|
|
25.6 |
% |
|
|
24.3 |
% |
|
|
23.6 |
% |
|
|
26.5 |
% |
Gross
Profit
|
|
|
25.8 |
% |
|
|
24.2 |
% |
|
|
24.6 |
% |
|
|
25.4 |
% |
Operating
Profit
|
|
|
35.5 |
% |
|
|
21.2 |
% |
|
|
19.9 |
% |
|
|
23.4 |
% |
Net
Income
|
|
|
36.2 |
% |
|
|
18.0 |
% |
|
|
21.3 |
% |
|
|
24.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January
31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Sales
|
|
|
25.8 |
% |
|
|
24.9 |
% |
|
|
23.2 |
% |
|
|
26.1 |
% |
Gross
Profit
|
|
|
26.3 |
% |
|
|
24.6 |
% |
|
|
24.7 |
% |
|
|
24.4 |
% |
Operating
Profit *
|
|
|
44.6 |
% |
|
|
7.4 |
% |
|
|
35.7 |
% |
|
|
12.3 |
% |
Net
Income *
|
|
|
43.6 |
% |
|
|
6.2 |
% |
|
|
36.6 |
% |
|
|
13.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February
2, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Sales
|
|
|
24.8 |
% |
|
|
23.8 |
% |
|
|
23.6 |
% |
|
|
27.8 |
% |
Gross
Profit
|
|
|
25.9 |
% |
|
|
24.8 |
% |
|
|
25.5 |
% |
|
|
23.8 |
% |
Operating
Profit (Loss)*
|
|
|
67.8 |
% |
|
|
34.6 |
% |
|
|
43.7 |
% |
|
|
-46.1 |
% |
Net
Income (Loss) *
|
|
|
69.4 |
% |
|
|
28.5 |
% |
|
|
43.0 |
% |
|
|
-40.9 |
% |
* Results include certain charges for the non-routine closings
of 75 stores in 2008 and 17 stores in 2007 (see Item 7 "Exit and Disposal
Activities" section) and implementation of ASC 740, primarily in the fourth
quarter of 2007 and the second quarter of 2008.
Employees
At
January 30, 2010, the Company had approximately 4,774 full-time and 4,530
part-time employees, the majority of which are store employees. The number of
employees varies during the year, reaching a peak during the Christmas selling
season, which typically begins after the Thanksgiving holiday. Only the Memphis,
Tennessee distribution center employees are represented by the UNITE-HERE union
pursuant to a three (3) year collective bargaining agreement which went
into effect on July 1, 2008. The Company believes that it continues to have
good relations with all of its employees.
Competition
The
discount retail merchandise business is highly competitive. We compete in
respect to price, store location, in-stock consistency, merchandise quality,
assortment and presentation, and customer service with many national, regional
and local retailing establishments, including department stores, discount
stores, variety stores, dollar stores, discount clothing stores, drug stores,
grocery stores, outlet stores, convenience stores, warehouse stores and other
stores. Our competitors range from smaller, growing companies to considerably
larger retail businesses that have greater financial, distribution, marketing
and other resources than we do. There is no assurance that we will be able to
compete successfully with them in the future. See “Statement Regarding
Forward-Looking Disclosures” and “Item 1A - Risk Factors”.
Government
Regulation
As a
publicly traded Company, we are subject to numerous federal securities laws and
regulations, including the Securities Act of 1933 and the Securities Exchange
Act of 1934, and related rules and regulations promulgated by the SEC, as well
as the Sarbanes-Oxley Act of 2002. These laws and regulations impose significant
requirements in the areas of accounting and financial reporting, corporate
governance and insider trading, among others.
Each of
our locations must comply with regulations adopted by federal and state agencies
regarding licensing, health, sanitation, safety, fire and other regulations. In
addition, we must comply with the Fair Labor Standards Act and various state
laws governing various matters such as minimum wage, overtime and other working
conditions. We must also comply with provisions of the Americans with
Disabilities Act of 1990, as amended, which requires generally that employers
provide reasonable accommodation for employees with disabilities and that our
stores be accessible to customers with disabilities. The Company’s pharmacy
department, in particular, is subject to extensive federal and state laws and
regulations.
Licensure and Regulation of
Retail Pharmacies
There are
extensive federal and state regulations applicable to the practice of pharmacy
at the retail level. We are subject to numerous federal and state laws and
regulations concerning the protection of confidential patient medical records
and information, including the federal Health Insurance Portability and
Accountability Act (“HIPAA”). Most states have laws and regulations governing
the operation and licensing of pharmacies, and regulate standards of
professional practice by pharmacy providers. These regulations are issued by an
administrative body in each state, typically a pharmacy board, which is
empowered to impose sanctions for non-compliance. Additionally, the
Drug Enforcement Agency (“DEA”) requires that controlled substances be monitored
and controlled at all times.
As a
provider of Medicare prescription drug plan benefits, we are subject to various
federal regulations promulgated by the Center for Medicare and Medicaid Services
under the Medicare Prescription Drug, Improvement and Modernization Act of 2003.
In the future we may also be subject to changes to various state and federal
insurance laws and regulations in connection with the Company’s pharmacy
operations.
Healthcare
Initiatives
Legislative
and regulatory initiatives pertaining to such healthcare related issues as
reimbursement policies, payment practices, therapeutic substitution programs,
and other healthcare cost containment issues are frequently introduced at both
the state and federal level. The recently enacted Patient Protection and
Affordable Care Act of 2010 may affect our pharmacy business, but it is too
early to judge what that impact might be. The Company is unable to
predict accurately whether or when additional legislation may be enacted or
regulations may be adopted relating to the Company’s pharmacy operations or what
the effect of such legislation or regulations may be.
Substantial
Compliance
The
Company’s management believes the Company is in substantial compliance with all
existing statutes and regulations material to the operation of the Company’s
businesses and is unaware of any material non-compliance action against the
Company.
Environmental
Matters
We are
not aware of any federal, state or local environmental laws or regulations that
will materially affect our earnings or competitive position, or result in
material capital expenditures. However, we cannot predict the effect on
our operations of possible future environmental legislation or
regulations. During fiscal year 2009, we did not incur any material
capital expenditures for environmental control facilities and no such material
expenditures are anticipated.
Available
Information
Our
website address is http://www.fredsinc.com.
We make available through this website, without charge, our annual report on
Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
amendments to these reports as soon as reasonably practicable after these
materials are electronically filed with or furnished to the
SEC.
Investors
are encouraged to carefully consider the risks described below and other
information contained in this document when considering an investment decision
with respect to FRED’S securities. Additional risks and uncertainties not
presently known to management, or that management currently deems immaterial,
may also impair the Company’s business operations. Any of the events discussed
in the risk factors below may occur. If one or more of these events do occur,
business, results of operations or financial condition could be materially
adversely affected. In that instance, the trading price of FRED’S securities
could decline, and investors might lose all or part of their
investment.
Our business is somewhat
seasonal.
We
typically realize a significant portion of our net sales during the Christmas
selling season in the fourth quarter. Our inventories and short-term
borrowings, if required, increase in anticipation of this holiday season. A
seasonal merchandise inventory imbalance could result if for any reason our net
sales during the Christmas selling season were to fall below seasonal norms.
If for any reason our fourth quarter results were substantially below
expectations, our profitability and operating results could be adversely
affected by unanticipated markdowns, especially in seasonal
merchandise.
We operate in a competitive
industry.
We are in
a highly competitive sector of the discount retail industry. This
competitive environment subjects us to the risk of reduced profitability because
of lower prices, and lower margins, required to maintain our competitive
position. We compete with discount stores and with many other retailers,
including department stores, variety stores, dollar stores, discount clothing
stores, drug stores, grocery stores, outlet stores, convenience stores,
warehouse stores and other stores, some of whom may have greater resources than
we do. This competitive environment subjects us to various risks, including the
ability to continue to provide competitively priced merchandise to our customers
that will allow us to maintain profitability and continue store growth. Some of
our competitors utilize aggressive promotional activities, advertising programs,
and pricing discounts and our results of operations could be adversely affected
if we do not respond effectively to these efforts.
Changes in third-party
reimbursements, including government programs, could adversely affect our
business.
A
significant portion of our sales are funded by federal and state governments and
private insurance plans. For the years ended January 30, 2010 and January 31,
2009, pharmaceutical sales were 33.5% and 31.7% of total sales, respectively.
The health care industry is experiencing a trend toward cost-containment with
governments and private insurance plans seeking to impose lower reimbursements
and utilization restrictions. Payments made under such programs may not remain
at levels comparable to the present levels or be sufficient to cover our cost.
Private insurance plans may base their reimbursement rates on the government
rates. Accordingly, reimbursements may be limited or reduced, thereby adversely
affecting our revenues and cash flows. Additionally, and in light of a worsening
economy and recent healthcare legislation, government or private insurance plans
may adjust scheduled reimbursement payments to us in amounts that could have a
material adverse effect on our cash flows and financial condition.
Changes in consumer demand
and product mix and changes in overall economic conditions could adversely
affect our business.
Our
success depends on our ability to anticipate and respond in a timely manner to
changing customer demands and preferences for product mix. A general slowdown in
the United States economy, rising personal debt levels, rising foreclosure
rates, rising fuel prices, or changes in government aid, social security, and
other means that many of our customers rely upon may adversely affect the
spending of our consumers, which would likely result in lower net sales than
expected on a quarterly or annual basis. In addition, changes in the types of
products available for sale and the selection of products by our customers
affect sales, product mix and margins. Future economic conditions affecting
disposable consumer income, such as employment levels, business conditions, fuel
and energy costs, inflation, interest rates, and tax rates, could also adversely
affect our business by reducing consumer spending or causing consumers to shift
their spending to other products. We might be unable to anticipate these buying
patterns and implement appropriate inventory strategies, which would adversely
affect our sales and gross profit performance. In addition, increases in fuel
and energy costs would increase our transportation costs and overall cost of
doing business and could adversely affect our financial statements as a
whole.
Natural disasters or
unusually adverse weather conditions could affect our
business.
Unusually
adverse weather conditions, natural disasters or similar disruptions, could
significantly reduce our net sales. In addition, these disruptions could
also adversely affect our supply chain efficiency and make it more difficult for
us to obtain sufficient quantities of merchandise from suppliers. A number of
our stores are located in areas that are susceptible to hurricanes and
tornadoes.
Merchandise supply and
pricing and the interruption of and dependence on imports could adversely affect
our business.
We have
maintained good relations with our vendors and believe that we are generally
able to obtain attractive pricing and other terms from vendors. We purchase a
significant portion of our inventory from foreign suppliers, principally in the
Far East. As a result, political instability or other events resulting in the
disruption of trade from other countries or the imposition of additional
regulations relating to duties on imports could cause significant delays or
interruptions in the supply of our merchandise or increase our costs. Also, our
cost of goods is affected by the fluctuation of local currencies against the
dollar in countries where these goods are produced. Accordingly, changes in the
value of the dollar relative to foreign currencies may increase our cost of
goods sold and, if we are unable to pass such cost increases on to our
customers, decrease our gross margins and ultimately our earnings. We purchase a
significant amount of goods from Procter and Gamble and several large import
vendors and any disruption in that supply and or pricing of such merchandise
could negatively impact our operations and results.
Delays and costs of
operating new stores and distribution facilities could have an adverse impact on
our business.
We
maintain two distribution facilities in our geographic territory, and plan on
constructing new facilities as needed to support our growth. One of our key
business strategies is to expand our base of retail stores. We plan on expanding
and refreshing our network of stores through new store openings and remodeling
existing stores each year. Delays in opening, refreshing or remodeling
stores or delays in opening distribution facilities to service those new stores
could adversely affect our future operations by slowing growth, which may in
turn reduce revenue and margin growth. Adverse changes in the cost to
operate distribution facilities and stores, such as changes in labor, utilities,
fuel and transportation, and other operating costs, could have an adverse impact
on us.
Operational difficulties
could disrupt our business.
Our
stores are managed through a network of geographically dispersed management
personnel. Our inability to effectively and efficiently operate our
stores, including the ability to control losses resulting from inventory
shrinkage, may negatively impact our sales and/or margin. In addition, we
rely upon our distribution and logistics network to provide goods to stores in a
timely and cost-effective manner; any disruption, unanticipated expense or
operational failure related to this process could negatively impact store
operations. Our operation depends on a variety of information technology
systems for the efficient functioning of its business. We rely on certain
software vendors to maintain and upgrade these systems as needed. We rely on
telecommunications carriers to gather and disseminate our operations
information. The disruption or failure of these systems or carriers could
negatively impact our operations.
Use of a single supplier of
pharmaceutical products and our ability to negotiate satisfactory terms could
adversely affect our business.
We have a
long-term supply contract from a single supplier, AmerisourceBergen, for our
pharmaceutical operations. Any significant disruption in our relationship with
this supplier, deterioration in their financial condition, changes in terms, or
an industry-wide change in wholesale business practices, including those of our
supplier, could have a material adverse effect on our operations.
Higher than expected costs
and not achieving our targeted results associated with the implementation of new
programs, systems and technology could adversely affect our
business.
We are
undertaking a variety of operating initiatives as well as store upgrades and
infrastructure initiatives. The failure to properly execute any of these
initiatives could have an adverse impact on our future operating
results.
Changes in state or federal
legislation or regulations, including the effects of legislation and regulations
on wage levels and entitlement programs; trade restrictions, tariffs, quotas and
freight rates could adversely affect our business.
Unanticipated
changes in federal or state wage requirements or other changes in workplace
regulation could adversely impact our ability to achieve our financial
targets. Changes in trade restrictions, new tariffs and quotas, and higher
shipping costs for goods could also adversely impact our ability to achieve
anticipated operating results.
We depend on the success of
our new store opening program for a portion of our growth.
Our
growth is dependent on both increases in sales in existing stores and the
ability to open new stores. Unavailability of store locations that we deem
attractive, delays in the acquisition or opening of new stores, difficulties in
staffing and operating new store locations and lack of customer acceptance of
stores in expanded market areas all may negatively impact our new store growth,
the costs associated with new stores and/or the profitability of new
stores. Our ability to renew or enter into new leases on favorable
terms could affect costs of operations or slow store
expansions.
Changes in our ability to
attract and retain employees, and changes in health care and other insurance
costs could adversely affect our business.
Our
growth could be adversely impacted by our inability to attract and retain
employees at the store operations level, in distribution facilities, and at the
corporate level, including our senior management team. Adverse changes in
health care costs could also adversely impact our ability to achieve our
operational and financial goals and to offer attractive benefit programs to our
employees.
Adverse impacts associated
with legal proceedings and claims could affect our business.
We are a
party to a variety of legal proceedings and claims, including those described
elsewhere in this Annual Report. Operating results could be adversely
impacted if legal proceedings and claims against us are made, requiring the
payment of cash in connection with those proceedings or changes to the operation
of the business.
Our ability to achieve the
results of our strategic plan initiatives could adversely affect our
business.
As part
of our continuing operations, we perform research and analysis to discover
potential underperforming stores. We use such research and analysis
to identify potential store closures. The estimated costs and charges associated
with these initiatives may vary materially and adversely based upon various
factors, including the timing of execution, the outcome of negotiations with
landlords and other third parties, or unexpected costs, any of which could
result in our not realizing the anticipated benefits from the strategic
plan.
Increases in our
insurance-related costs could significantly affect our
business.
The costs
of many types of insurance and self-insurance, especially workers’ compensation,
employee health care and others, have been increasing in recent years due to
rising health care costs, legislative changes, economic conditions, terrorism
and heightened scrutiny of insurance brokers and insurance providers. Our
pharmacy departments are also exposed to risks inherent in the packaging and
distribution of pharmaceuticals and other healthcare products, including with
respect to improper filling of prescriptions, labeling of prescriptions and
adequacy of warnings, and are significantly dependent upon suppliers to provide
safe, government-approved and non-counterfeit products. We also sell a variety
of products that we purchase from a large number of suppliers, including some
who operate in foreign countries, which could become subject to contamination,
product tampering, mislabeling or other damage. While we maintain reasonable
quality assurance practices, no program can provide complete assurance that a
product liability issue will not arise. Should a product liability issue arise,
the coverage limits under our insurance programs may not be adequate to protect
us against future claims. In addition, we may not be able to maintain this
insurance on acceptable terms in the future. Damage to our reputation in the
event of a product liability issue could have an adverse affect on our business.
If our insurance-related costs increase significantly, or we are unable to renew
our insurance policies or protect against all the business risks facing us, our
financial position and results of operations could be adversely
affected.
Adverse impacts associated
with the current economic and financial crisis could affect our
business.
The
lingering economic downturn could have an adverse impact of our business and
profitability. Many consumers have fallen prey to the current crisis
either as a result of job losses, foreclosures, or their inability to obtain
short-term financing, all of which could negatively affect their ability to shop
in our stores and buy our products. Additionally, decreased consumer
demand resulting from a pronounced negative consumer sentiment and an increasing
personal savings rate could also negatively affect our sales and
profits. Also, our ability to obtain financing, should the need arise
outside of our current contractual credit facility, could be at risk due to
restrictive lending practices in the wake of the liquidity crisis in the United
States financial system.
None.
As of
January 30, 2010, the geographical distribution of the Company’s 645 retail
store locations in 15 states was as follows:
State
|
|
Number of Stores
|
|
Georgia
|
|
|
110 |
|
Mississippi
|
|
|
108 |
|
Alabama
|
|
|
88 |
|
Tennessee
|
|
|
88 |
|
Arkansas
|
|
|
71 |
|
South
Carolina
|
|
|
53 |
|
Louisiana
|
|
|
47 |
|
North
Carolina
|
|
|
22 |
|
Texas
|
|
|
18 |
|
Florida
|
|
|
13 |
|
Kentucky
|
|
|
13 |
|
Illinois
|
|
|
6 |
|
Missouri
|
|
|
6 |
|
Indiana
|
|
|
1 |
|
Oklahoma
|
|
|
1 |
|
|
|
|
645 |
|
The
Company owns the real estate and the buildings for 63 locations, 6 of which are
closed and 5
locations which are subject to ground leases. Seven of these locations are
encumbered by mortgages (see Note 3 – Indebtedness). The Company
leases the remaining 582 locations from third parties pursuant to leases that
provide for monthly rental payments primarily at fixed rates (although a number
of leases provide for additional rent based on sales). Store locations range in
size from 1,000 square feet to 25,000 square feet. Three hundred and sixty-eight
of the locations are in strip centers or adjacent to a downtown-shopping
district, with the remainder being freestanding.
It is
anticipated that existing buildings and buildings to be developed by others will
be available for lease to satisfy the Company’s expansion program in the near
term. It is management’s intention to enter into leases of relatively moderate
length with renewal options, rather than entering into long-term leases. The
Company will thus have maximum relocation flexibility in the future, since
continued availability of existing buildings is anticipated in the Company’s
market areas.
The
Company owns its distribution center and corporate headquarters situated on
approximately 60 acres in Memphis, Tennessee. The site contains the distribution
center with approximately 850,000 square feet of space, and 250,000 square feet
of office and retail space. Presently, the Company utilizes 90,000 square feet
of office space and 22,000 square feet of retail space at the site. The retail
space is operated as a FRED’S store and is used to test new products,
merchandising ideas and technology. The Company financed the construction of its
600,000 square foot distribution center in Dublin, Georgia with taxable
industrial development revenue bonds issued by the City of Dublin and County of
Laurens Development Authority. Presently, both distribution centers are able to
serve a total of approximately 750 to 800 stores.
In July
2008, a lawsuit styled Jessica Chapman, on behalf of herself and others
similarly situated, v. FRED’S Stores of Tennessee, Inc. was filed in the United
States District Court for the Northern District of Alabama, Southern Division,
in which the plaintiff alleges that she and other female assistant store
managers are paid less than comparable males and seeks compensable damages,
liquidated damages, attorney fees and court costs. The plaintiff
filed a motion seeking collective action. Briefs have been filed, but
the court has not ruled. The Company believes that all assistant
managers have been properly paid and that the matter is not appropriate for
collective action treatment. Discovery has not yet
begun. The Company is and will continue to vigorously defend this
matter. In accordance with FASB ASC 450, “Contingencies”, the Company
does not feel that a loss in this matter is probable or can be reasonably
estimated. Therefore, we have not recorded a liability for this
case.
In August
2007, a lawsuit entitled Julia Atchinson, et al. v. FRED’S Stores of Tennessee,
Inc., et al, was filed in the United States District Court for the Northern
District of Alabama, Southern Division in which the plaintiff alleges that she
and other current and former FRED’S Discount assistant store managers were
improperly classified as exempt executive employees under the Fair Labor
Standards Act (FLSA) and seeks to recover overtime pay, liquidated damages,
attorney’s fees and court costs. The plaintiffs filed a motion
seeking a collective action which the Judge has not ruled on. The
Company believes that its assistant store managers are and have been properly
classified as exempt employees under FLSA and that the matter is not appropriate
for collective action treatment. The parties also agreed to mediate this case in
January 2009 and did so successfully, reaching a settlement of $1.5 million
(including attorneys’ fees and costs). Again, based on the
substantial costs of continuing litigation, unfavorably high jury verdicts
against other retailers and the constant distraction to management of a possible
protracted jury trial, this is a favorable settlement for
FRED’S. FRED’S has admitted no liability or wrongdoing, and no
liability has been found against the Company. The parties are
finalizing settlement documents and will jointly present the settlement to the
court, which must approve the settlement.
In June
2006, a lawsuit entitled Sarah Ziegler, et al. v. FRED’S Discount Store was
filed in the United States District Court for the Northern District of Alabama
in which the plaintiff alleges that she and other current and former FRED’S
Discount assistant store managers were improperly classified as exempt executive
employees under the Fair Labor Standards Act (“FLSA”) and sought to recover
overtime pay, liquidated damages, and attorneys’ fees and court
cost. In July 2006, the plaintiffs filed an emergency motion to
facilitate notice pursuant to the FLSA that would give current and former
assistant managers information about their rights to opt-in to the
lawsuit. After initially denying the motion, in October 2006, the
judge granted plaintiffs motion to facilitate notice pursuant to the
FLSA. Notice was sent to some 2,055 current and former assistant
store managers and approximately 450 persons opted into the case. The
cutoff date for individuals to advise of their interest in becoming part of this
lawsuit was February 2, 2007.
The
Company believes that its assistant store managers are and have been properly
classified as exempt employees under the FLSA and that the actions described
above are not appropriate for collective action treatment. The
parties agreed to mediate this case and did so successfully in January
2009. The total settlement amount, (including attorneys’ fees and
costs) was $5.0 million. FRED’S believes this was a favorable
settlement in consideration of the substantial costs of continuing litigation,
high jury verdicts against other retailers who were sued for practices similar
to the claims alleged in this case as well as the constant distraction to
management of a possible protracted jury trial. FRED’S has admitted
no liability or wrongdoing and no liability was found against
FRED’S. The parties finalized settlement documents, which the court
approved and the Company paid in 2009.
In
addition to the matters disclosed above, the Company is party to several pending
legal proceedings and claims arising in the normal course of
business. Although the outcome of the proceedings and claims cannot
be determined with certainty, management of the Company is of the opinion that
it is unlikely that these proceedings and claims will have a material adverse
effect on the financial statements as a whole. However, litigation
involves an element of uncertainty. There can be no assurance that
pending lawsuits will not consume the time and energy of our management or that
future developments will not cause these actions or claims, individually or in
aggregate, to have a material adverse effect on the financial statements as a
whole. We intend to vigorously defend or prosecute each pending
lawsuit.
ITEM
4: Reserved
The
Company’s common stock is traded on the NASDAQ Global Select Market under the
symbol “FRED.” The following table sets forth the high and low sales prices, as
reported in the regular quotation system of NASDAQ, together with cash dividends
paid per share on the Company’s common stock during each quarter in fiscal 2009
and fiscal 2008.
|
|
1st
Quarter
|
|
|
2nd
Quarter
|
|
|
3rd
Quarter
|
|
|
4th
Quarter
|
|
Fiscal
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
$ |
14.17 |
|
|
$ |
14.85 |
|
|
$ |
14.00 |
|
|
$ |
12.18 |
|
Low
|
|
$ |
8.52 |
|
|
$ |
11.91 |
|
|
$ |
11.68 |
|
|
$ |
9.01 |
|
Dividends
|
|
$ |
0.02 |
|
|
$ |
0.03 |
|
|
$ |
0.03 |
|
|
$ |
0.03 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
$ |
11.79 |
|
|
$ |
13.64 |
|
|
$ |
15.91 |
|
|
$ |
12.90 |
|
Low
|
|
$ |
8.20 |
|
|
$ |
10.33 |
|
|
$ |
9.17 |
|
|
$ |
8.22 |
|
Dividends
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
The
Company’s stock price at the close of the market on April 14, 2010 was
$12.55. There were approximately 12,200 shareholders of record of the
Company’s common stock as of April 15, 2010. The Board of Directors regularly
reviews the Company’s dividend plans to ensure that they are consistent with the
Company’s earnings performance, financial condition, need for capital and other
relevant factors. As part of that review and in light of the Company’s current
financial position, the Board of Directors raised the dividend from $.02 per
share to $.03 per share in the second quarter of 2009. The Company
has paid cash dividends on its common stock since 1993.
Securities Authorized for Issuance
under Equity Compensation Plans
Information
for our equity compensation plans in effect as of January 30, 2010, is as
follows:
Plan Category
|
|
Number of Securities
to be Issued upon
Exercise of
Outstanding Options,
Warrants and Rights
(a)
|
|
|
Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
(b)
|
|
|
Number of Securities
Remaining Available for
Issuance Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column (a))
(c)
|
|
Equity
Compensation plans approved by security holders
|
|
|
1,261,330 |
|
|
$ |
13.91 |
|
|
|
1,631,758 |
|
Equity
Compensation plans not approved by security holders
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
Total
|
|
|
1,261,330 |
|
|
$ |
13.91 |
|
|
|
1,631,758 |
|
Purchases of Equity Securities by the
Issuer and Affiliated Purchasers.
On
August 27, 2007, the Board of Directors approved a plan that authorized
stock repurchases of up to 4.0 million shares of the Company’s common
stock. Under the plan, the Company may repurchase its common stock in open
market or privately negotiated transactions at such times and at such prices as
determined to be in the Company’s best interest. These purchases may be
commenced or suspended without prior notice depending on then-existing business
or market conditions and other factors. The following table sets forth the
amounts of our common stock purchased by the Company at January 30, 2010
(amounts in thousands, except price data). The repurchased shares have been
cancelled and returned to authorized but unissued shares.
|
|
Total Number of
Shares Purchased
|
|
|
Average Price Paid
Per Share
|
|
|
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Program
|
|
|
Maximum Number of
Shares That May Yet
Be Purchased Under
the Plans or Program
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February
1, 2009 - January 30, 2010
|
|
|
742.7 |
|
|
$ |
9.61 |
|
|
|
742.7 |
|
|
|
2,830.8 |
|
Our
selected financial data set forth below should be read in connection with
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (ITEM 7), Consolidated Financial Statements and Notes (ITEM 8), and
the Forward-Looking Statement/Risk Factors disclosures
(Item 1).
(dollars in thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
|
2008 5 |
|
|
|
2007 5 |
|
|
2006 2 &
4
|
|
|
|
2005
|
|
Statement
of Income Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
1,788,136 |
|
|
$ |
1,798,840 |
|
|
$ |
1,780,923 |
|
|
$ |
1,767,239 |
|
|
|
$ |
1,589,342 |
|
Operating
income
|
|
|
38,494 |
|
|
|
26,318 |
|
|
|
16,457 |
|
|
|
40,949 |
|
|
|
|
40,081 |
|
Income
before income taxes
|
|
|
38,201 |
|
|
|
25,910 |
|
|
|
15,664 |
|
|
|
40,213 |
|
|
|
|
39,255 |
|
Provision
for income taxes
|
|
|
14,586 |
|
|
|
9,268 |
|
|
|
4,946 |
|
|
|
13,467 |
|
|
|
|
13,161 |
|
Net
income
|
|
|
23,615 |
|
|
|
16,642 |
|
|
|
10,718 |
|
|
|
26,746 |
|
|
|
|
26,094 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
0.59 |
|
|
|
0.42 |
|
|
|
0.27 |
|
|
|
0.67 |
|
|
|
|
0.66 |
|
Diluted
|
|
|
0.59 |
|
|
|
0.42 |
|
|
|
0.27 |
|
|
|
0.67 |
|
|
|
|
0.66 |
|
Cash
dividends declared per share
|
|
|
0.11 |
|
|
|
0.08 |
|
|
|
0.08 |
|
|
|
0.08 |
|
|
|
|
0.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selected
Operating Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income as a percentage of sales
|
|
|
2.2 |
% |
|
|
1.5 |
% |
|
|
0.9 |
% |
|
|
2.3 |
% |
|
|
|
2.5 |
% |
Increase
in comparable store sales 1
|
|
|
0.4 |
% |
|
|
1.8 |
% |
|
|
0.3 |
% |
|
|
2.4 |
% |
3
|
|
|
1.2 |
% |
Stores
open at end of period
|
|
|
645 |
|
|
|
639 |
|
|
|
692 |
|
|
|
677 |
|
|
|
|
621 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
Sheet Data (at period end):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
|
$ |
571,441 |
|
|
$ |
544,775 |
|
|
$ |
550,572 |
|
|
$ |
515,709 |
|
|
|
$ |
498,141 |
|
Short-term
debt (including capital leases)
|
|
|
718 |
|
|
|
243 |
|
|
|
285 |
|
|
|
737 |
|
|
|
|
1,053 |
|
Long-term
debt (including capital leases)
|
|
|
4,179 |
|
|
|
4,866 |
|
|
|
35,653 |
|
|
|
2,331 |
|
|
|
|
6,815 |
|
Shareholders'
equity
|
|
|
400,940 |
|
|
|
387,081 |
|
|
|
372,059 |
|
|
|
369,268 |
|
|
|
|
339,595 |
|
1 A
store is first included in the comparable store sales calculation after the end
of the 12th month following the store's grand opening month (see
additional information regarding calculation of comparable store sales in
"Results of Operations" section).
2
Results for 2006 include 53 weeks.
3 The
increase in comparable store sales for 2006 is computed on the same 53-week
period for 2005.
4
Results for 2006 include the implementation of ASC
718.
5
Results include certain charges for the non-routine closing of 75
stores in 2008 and 17 in 2007, (see "Exit and Disposal Activities" section) and
implementation of ASC 740.
ITEM
7: Management’s Discussion and Analysis of Financial Condition and Results of
Operations
General Accounting
Periods
The
following information contains references to years 2009, 2008, and 2007, which
represent fiscal years ended January 30, 2010, January 31, 2009 and
February 2, 2008 (which were 52-week accounting
periods). Amounts are in thousands unless otherwise
noted. This discussion and analysis should be read with, and is
qualified in its entirety by, the Consolidated Financial Statements and the
notes thereto. Additionally, our discussion and analysis should be
read in conjunction with the Forward-Looking Statements/Risk Factors disclosures
included herein.
Executive Summary
Recognizing
our pharmacy department as a key factor differentiating us from other small-box
discount retailers, we have accelerated our growth strategy in this area and are
aggressively pursuing opportunities to acquire independent pharmacies within our
targeted markets. Our emphasis will continue to be on
acquisitions and buying prescription files, but cold starts will be employed
where it makes sense to do so. As we have mentioned previously, we
began offering our Prescription Plus $4 generic program in all pharmacies in the
chain. We piloted this program on a limited basis last year and found
it to be a traffic driver, and thus rolled it out to all pharmacies in the first
quarter. We are pleased with this deployment and its effect on our
prescription count.
Our Own
Brand initiative continues to be a key strategy for the Company in terms of
building customer loyalty and increasing gross margin. We have
reached an Own Brand penetration rate of approximately 8.2% of total sales, and
that number will continue to grow in the future as new Own Brand products are
introduced. Our commitment to quality in our Own Brand products is
resonating with our customers and they continue to make the switch to our
“Fred’s Brand”. We are continuing to add new products to our Own
Brand line on an ongoing basis, with new items in paper and chemicals, food and
hardware introduced during 2009.
Expense
reduction and containment continues to be a key focus of the Company, especially
in light of current economic conditions. We are aggressively pursuing
cost reductions in all functional areas and are also continuously reviewing
internal processes to find efficiencies and/or redundancies and drive
unnecessary costs and expenses out of the business. These efforts are
being coordinated at the Executive Level and close attention is being paid not
to sacrifice service to our customers. These efforts resulted in a 70
basis point reduction in expenses as a percentage of sales or $16.0 million in
2009 compared to the same period last year.
Improving
inventory productivity has been a key focus throughout 2009. Initiatives
set in motion in 2008, such as reducing the store fixture profile to remove
inventory displayed above eye level, improvement in seasonal buying to reduce
pack away inventory and continuous improvement in the line review process, have
resulted in a 2.5% reduction in total company inventory from the same
period last year. This reduction in inventory was
accomplished without jeopardizing our in-stock positions or the merchandise
selection available to our customers.
During
2009, we continued refining our real estate site selection and store layout
programs. We continue to improve the interior layout of our stores so
that our customers experience more open customer spaces, more logical product
flow and a more consistent and meaningful price message, all of which are
intended to provide a more pleasurable shopping trip. We also
continue to hone our real estate strategy so that the proper site is selected to
support our targeted demographics, thus driving traffic and
sales. Many of these efforts culminated in the third quarter with the
grand opening of our “Pilot Store of the Future”.
Throughout
2009, we have continued with capital improvements in infrastructure, including
new stores as well as existing store expansion and remodels, distribution center
upgrades and further development of our information technology
capabilities. Technology upgrades have been made in the areas of
direct store delivery systems, in-store systems, and pharmacy
systems.
During
2010, the Company will continue to implement its strategic plan to improve
profitability and operating margin. A significant number of stores
will be refreshed in 2010 to highlight our Core 5 program, which spotlights
differentiated, traffic driving departments within our
store. Additionally, a number of these departments have higher than
average margin and increased focus and sales will affect our overall product mix
and margin. Also, a number of our stores will be remodeled to reflect
our new “Pilot Store” format, which delivers higher sales per square foot and
higher contribution margin per square foot.
While our
private label or FRED’S Brand products will continue to be a focus in 2010, we
will implement several national brands in our stores. National brands
that resonate with our customers will be implemented to provide our customers
with a more complete shopping trip. Throughout the year, we will be
evaluating which name brands are the most popular with our customers and will be
adding those that complement our current product mix.
Key
factors that will be critical to the Company’s future success include managing
the strategy for opening new stores and pharmacies, including the ability to
open and operate efficiently, maintaining high standards of customer service,
maximizing efficiencies in the supply chain, controlling working capital needs
through improved inventory turnover, managing the effects of inflation or
deflation, controlling product mix, increasing operating margin through improved
gross margin and leveraging operating costs, and generating adequate cash flow
to fund the Company’s future needs.
Other
factors that will affect Company performance in 2010 include the continuing
management of the impacts of the changing regulatory environment in which our
pharmacy department operates, especially in regards to the health care
legislation recently passed by the United States Congress and related
regulations currently being developed. Additionally, we believe that
the prolonged recession and elevated unemployment rate continue to place
tremendous economic pressure on the consumer. However, we also
continue to believe that our affordable pricing and value proposition make us an
attractive destination to wary consumers.
Critical 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 are
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. Our most critical accounting policies are as
follows:
Revenue
Recognition. The
Company markets goods and services through Company owned stores and 24
franchised stores as of January 30, 2010. Net sales include sales of merchandise
from Company owned stores, net of returns and exclusive of sales taxes. Sales to
franchised stores are recorded when the merchandise is shipped from the
Company’s warehouse. Revenues resulting from layaway sales are recorded upon
delivery of the merchandise to the customer.
The
Company also sells gift cards for which the revenue is recognized at time of
redemption. The Company records a gift card liability on the date the gift card
is issued to the customer. Revenue is recognized and the gift card liability is
reduced as the customer redeems the gift card. The Company will recognize aged
liabilities as revenue when the likelihood of the gift card being redeemed is
remote (gift card breakage). The Company has not recognized any revenue from
gift card breakage since the inception of the program in May 2004 and does
not expect to record any gift card breakage revenue until there is more
certainty regarding our ability to retain such amounts in light of current
consumer protection and state escheatment laws.
In
addition, the Company charges the franchised stores a fee based on a percentage
of their purchases from the Company. These fees represent a reimbursement for
use of the FRED’S name and other administrative costs incurred on behalf of the
franchised stores and are therefore netted against selling, general and
administrative expenses. Total franchise income for 2009, 2008, and 2007 was
$2,087 $2,145 and $2,008, respectively.
Inventories. Merchandise inventories are
valued at the lower of cost or market using the retail first-in, first-out
(FIFO) method for goods in our stores and the cost first-in, first-out
(FIFO) method for goods in our distribution centers. The retail inventory
method is a reverse mark-up, averaging method which has been widely used in the
retail industry for many years. This method calculates a cost-to-retail ratio
that is applied to the retail value of inventory to determine the cost value of
inventory and the resulting cost of goods sold and gross margin. The assumption
that the retail inventory method provides for valuation at lower of cost or
market and the inherent uncertainties therein are discussed in the following
paragraphs.
In order
to assure valuation at the lower of cost or market, the retail value of our
inventory is adjusted on a consistent basis to reflect current market
conditions. These adjustments include increases to the retail value of inventory
for initial markups to set the selling price of goods or additional markups to
adjust pricing for inflation and decreases to the retail value of inventory for
markdowns associated with promotional, seasonal or other declines in the market
value. Because these adjustments are made on a consistent basis and are based on
current prevailing market conditions, they approximate the carrying value of the
inventory at net realizable value (market value). Therefore, after applying the
cost to retail ratio, the cost value of our inventory is stated at the lower of
cost or market as is prescribed by Generally Accepted Accounting Principles in
the U.S. (GAAP).
Because
the approximation of net realizable value (market value) under the retail
inventory method is based on estimates such as markups, markdowns and inventory
losses (shrink), there exists an inherent uncertainty in the final determination
of inventory cost and gross margin. In order to mitigate that uncertainty, the
Company has a formal review by product class which considers such variables as
current market trends, seasonality, weather patterns and age of merchandise to
ensure that markdowns are taken currently, or a markdown reserve is established
to cover future anticipated markdowns. This review also considers current
pricing trends and inflation to ensure that markups are taken if necessary. The
estimation of inventory losses (shrink) is a significant element in
approximating the carrying value of inventory at net realizable value, and as
such the following paragraph describes our estimation method as well as the
steps we take to mitigate the risk of this estimate in the determination of the
cost value of inventory.
The
Company calculates inventory losses (shrink) based on actual inventory
losses occurring as a result of physical inventory counts during each fiscal
period and estimated inventory losses occurring between yearly physical
inventory counts. The estimate for shrink occurring in the interim period
between physical counts is calculated on a store-specific basis and is based on
history, as well as performance on the most recent physical count. It is
calculated by multiplying each store’s shrink rate, which is based on the
previously mentioned factors, by the interim period’s sales for each store.
Additionally, the overall estimate for shrink is adjusted at the corporate level
to a three-year historical average to ensure that the overall shrink estimate is
the most accurate approximation of shrink based on the Company’s overall history
of shrink. The three-year historical estimate is calculated by dividing the
“book to physical” inventory adjustments for the trailing 36 months by the
related sales for the same period. In order to reduce the uncertainty inherent
in the shrink calculation, the Company first performs the calculation at the
lowest practical level (by store) using the most current performance indicators.
This ensures a more reliable number, as opposed to using a higher level
aggregation or percentage method. The second portion of the calculation ensures
that the extreme negative or positive performance of any particular store or
group of stores does not skew the overall estimation of shrink. This portion of
the calculation removes additional uncertainty by eliminating short-term peaks
and valleys that could otherwise cause the underlying carrying cost of inventory
to fluctuate unnecessarily. The Company has not experienced any significant
change in shrink as a percentage of sales from year to year during the subject
reporting periods.
Management
believes that the Company’s Retail Inventory Method provides an inventory
valuation which reasonably approximates cost and results in carrying inventory
at the lower of cost or market. For pharmacy inventories, which were
approximately $30.2 million, and $30.8 million at January 30, 2010 and
January 31, 2009, respectively, cost was determined using the retail LIFO
(last-in, first-out) method in which inventory cost is maintained using the
Retail Inventory 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
approximately $21.5 million at January 30, 2010 and $19.1 million at
January 31, 2009. The LIFO reserve increased by approximately
$2.4 million and $3.7 million during 2009 and 2008,
respectively.
The
Company has historically included an estimate of inbound freight and certain
general and administrative costs in merchandise inventory as prescribed by GAAP.
These costs include activities surrounding the procurement and storage of
merchandise inventory such as merchandise planning and buying, warehousing,
accounting, information technology and human resources, as well as inbound
freight. The total amount of procurement and storage costs and inbound freight
included in merchandise inventory at January 30, 2010 is $17.4 million,
with the corresponding amount of $19.0 million at January 31,
2009.
Impairment.
The Company’s policy is to review the carrying value of all long-lived assets
for impairment whenever events or changes in circumstances indicate that the
carrying value of an asset may not be recoverable. In accordance with FASB ASC
360, “Impairment or Disposal of Long-Lived Assets,” we review for impairment all
stores open at least 3 years or remodeled more than 2 years. Impairment results
when the carrying value of the assets exceeds the undiscounted future cash flows
over the life of the lease or 10 years for owned stores. Our estimate of
undiscounted future cash flows over the lease term is based upon historical
operations of the stores and estimates of future store profitability which
encompasses many factors that are subject to management’s judgment and are
difficult to predict. If a long-lived asset is found to be impaired, the amount
recognized for impairment is equal to the difference between the carrying value
and the asset’s fair value. The fair value is based on estimated market values
for similar assets or other reasonable estimates of fair market value based upon
management’s judgment.
Exit and
Disposal Activities. During fiscal 2007,
the Company closed 17 underperforming stores.
During
fiscal 2008, the Company closed 74 underperforming stores and 23 underperforming
pharmacies. The closures took place during the first three quarters
of 2008 pursuant to our restructuring plan announced February 6, 2008 and were
the result of an in-depth study conducted by the Company of its operations over
the previous 10 quarters. The study revealed that FRED’S has a strong
and healthy store base, and that by closing these underperforming stores the
Company would improve its cash flow and operating margin, both of which are core
goals of the Company’s overall strategic plan. As a result of the successful
execution of this plan, the Company is stronger and is in a better position to
respond to fluctuations in the economy and to take advantage of opportunities to
further improve our business.
During
fiscal 2009, the Company closed 9 underperforming stores, which is consistent
with our anticipated amount of annual store closures.
Inventory
Impairment
During
fiscal 2007, we recorded a below-cost inventory adjustment of approximately
$10.0 million to reduce the value of inventory to lower of cost or market in
stores that were planned for closure as part of the Company’s strategic plan to
improve profitability and operating margin. The adjustment was
recorded in cost of goods sold in the consolidated statement of income for the
year ended February 2, 2008.
In fiscal
2008, we recorded an additional below-cost inventory adjustment of
$0.3 million to reduce the value of inventory to lower of cost or market
associated with stores closed in the third quarter and utilized the entire
$10.3 million impairment.
Lease
Termination
For store
closures where a lease obligation still exists, we record the estimated future
liability associated with the rental obligation on the cease use date (when the
store is closed) in accordance with FASB ASC 420, “Exit or Disposal Cost
Obligations.” Liabilities are established at the cease use date for the present
value of any remaining operating lease obligations, net of estimated sublease
income, and at the communication date for severance and other exit costs, as
prescribed by FASB ASC 420. Key assumptions in calculating the liability include
the timeframe expected to terminate lease agreements, estimates related to the
sublease potential of closed locations, and estimation of other related exit
costs. If actual timing and potential termination costs or realization of
sublease income differ from our estimates, the resulting liabilities could vary
from recorded amounts. These liabilities are reviewed periodically and adjusted
when necessary.
During
fiscal 2007, we closed 17 under performing stores and recorded lease contract
termination costs of $1.6 million in rent expense in conjunction with those
closings, of which $1.0 million was utilized during fiscal 2007, leaving $.6
million in the reserve at the beginning of fiscal year 2008.
During
fiscal 2008, we closed 74 under performing stores and recorded lease contract
termination costs of $10.5 million, of which $9.6 million was charged to rent
expense and $.9 million reduced the liability for deferred rent. We
utilized $7.7 million during the period, leaving $3.4 million in the reserve at
January 31, 2009.
During
fiscal 2009, we utilized $2.4 million, leaving $1.0 million in the reserve at
January 30, 2010.
The
following table illustrates the exit and disposal activity related to the store
closures discussed in the previous paragraphs (in millions):
|
|
Beginning
Balance
January 31,
2009
|
|
|
Additions
FY09
|
|
|
Utilized
FY09
|
|
|
Ending
Balance
January 30,
2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease
contract termination liability
|
|
$ |
3.4 |
|
|
$ |
- |
|
|
$ |
(2.4 |
) |
|
$ |
1.0 |
|
Fixed Asset
Impairment
During
the fourth quarter of 2007, the Company recorded a charge of $4.6 million in
selling, general and administrative expense for the impairment of fixed assets
and leasehold improvements associated with the planned closure of 75 stores in
2008. During the second quarter of fiscal 2008, the Company recorded
an additional charge of $.1 million associated with store closures that
occurred in the third quarter. Impairment of $0.2 million for the planned store
closures was recorded in fiscal 2009.
Property
and Equipment and Intangibles. Property and equipment are carried at
cost. Depreciation is calculated using the straight-line method over the
estimated useful lives of the assets and recorded in selling, general and
administrative expenses. Improvements to leased premises are depreciated using
the straight-line method over the shorter of the initial term of the lease or
the useful life of the improvement. Leasehold improvements added late in the
lease term are depreciated 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. Gains or losses on the
sale of assets are recorded at disposal as a component of operating income. The
following average estimated useful lives are generally applied:
|
Estimated Useful Lives
|
Building
and building improvements
|
8 -
31.5 years
|
Furniture,
fixtures and equipment
|
3 -
10 years
|
Leasehold
improvements
|
3 -
10 years or term of lease, if shorter
|
Automobiles
and vehicles
|
3 -
6 years
|
Airplane
|
9
years
|
Assets
under capital lease are depreciated 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.
Other
identifiable intangible assets, which are included in other noncurrent assets,
primarily represent customer lists associated with acquired pharmacies and are
being amortized on a straight-line basis over five years.
Vendor
Rebates and Allowances. The Company receives rebates for a variety of
merchandising activities, such as volume commitment rebates, relief for
temporary and permanent price reductions, cooperative advertising programs, and
for the introduction of new products in our stores. In accordance with FASB ASC
605-50 “Customer Payments and Incentives”, rebates received from a vendor are
recorded as a reduction of cost of sales when the product is sold or a reduction
to selling, general and administrative expenses if the reimbursement represents
a specific incremental and identifiable cost. Should the allowance received
exceed the incremental cost, then the excess is recorded as a reduction of cost
of sales when the product is sold. Any excess amounts for the periods reported
are immaterial. Any rebates received subsequent to merchandise being sold are
recorded as a reduction to cost of goods sold when received.
As of
January 30, 2010, the Company had approximately 750 vendors who participate in
vendor rebate programs and the terms of the agreements with those vendors vary
in length from short-term arrangements to be completed within a month to
longer-term arrangements that could last up to three years.
In
accordance with FASB ASC 720-35 “Advertising Costs”, the Company charges
advertising, including production costs, to selling, general and administrative
expense on the first day of the advertising period. Gross advertising expenses
for 2009, 2008 and 2007, were $24.0 million, $24.1 million and $27.6
million, respectively. Gross advertising expenses were reduced by vendor
cooperative advertising allowances of $2.6 million, $2.3 million and
$1.5 million, for 2009, 2008 and 2007, respectively. It would be the
Company’s intention to incur a similar amount of advertising expense as in prior
years and in support of our stores even if we did not receive support from our
vendors in the form of cooperative adverting programs.
Insurance
Reserves. The Company is largely self-insured for workers compensation,
general liability and employee medical insurance. The Company’s liability for
self-insurance is determined based on claims known at the time of determination
of the reserve and estimates for future payments against incurred losses and
claims that have been incurred but not reported. Estimates for future claims
costs include uncertainty because of the variability of the factors involved,
such as the type of injury or claim, required services by the providers, healing
time, age of claimant, case management costs, location of the claimant, and
governmental regulations. These uncertainties or a deviation in future claims
trends from recent historical patterns could result in the Company recording
additional expenses or expense reductions that might be material to the
Company’s results of operations. The Company carries additional coverage for
excessive or catastrophic claims with stop loss limits of $500,000 for property
and general liability and $200,000 for employee medical. The Company’s insurance
reserve was $9.0 million and $8.6 million on January 30, 2010 and January 31,
2009, respectively. Changes in the reserve over that time period were
attributable to additional reserve requirements of $44.6 million netted
with reserve utilization of $44.2 million.
Income
Taxes. The Company reports income taxes in accordance with FASB ASC 740,
“Income Taxes.” Under FASB ASC 740, the asset and liability method is used for
computing future income tax consequences of events, which have been recognized
in the Company’s Consolidated Financial Statements or income tax returns.
Deferred income tax expense or benefit is the net change during the year in the
Company’s deferred income tax assets and liabilities (see Note 4 – Income
Taxes).
In
June 2006, the Financial Accounting Standards Board issued FASB
Interpretation No. 48 (“FASB ASC 740”), Accounting for Uncertainty in
Income Taxes — an Interpretation of FASB Statement No.109 that is codified in
FASB ASC 740. We adopted FASB ASC 740 as of February 4, 2007, the first day
of fiscal 2007. This interpretation clarifies the accounting for uncertainty in
income taxes recognized in an enterprise’s financial statements in accordance
with FASB ASC 740 and prescribes a minimum recognition threshold of
more-likely-than-not to be sustained upon examination that a tax position must
meet before being recognized in the financial statements. Under FASB ASC 740,
the impact of an uncertain income tax position on the income tax return must be
recognized at the largest amount that is more-likely-than-not to be sustained
upon audit by the relevant taxing authority. An uncertain income tax position
will not be recognized if it has less than a 50% likelihood of being sustained.
Additionally, FASB ASC 740 provides guidance on de-recognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure and transition (see Note 4 – Income Taxes).
FASB ASC
740 further requires that interest and penalties required to be paid by the tax
law on the underpayment of taxes should be accrued on the difference between the
amount claimed or expected to be claimed on the tax return and the tax benefit
recognized in the financial statements. The Company includes potential interest
and penalties recognized in accordance with FASB ASC 740 in the financial
statements as a component of income tax expense. As of January 30, 2010, accrued
interest and penalties related to our unrecognized tax benefits totaled
$1.4 million and $0.3 million, respectively, and are both recorded in the
consolidated balance sheet within “Other non-current
liabilities.”
Stock-Based
Compensation. Effective January 29, 2006, the Company adopted the
fair value recognition provisions of FASB ASC 718, “Compensation – Stock
Compensation”, using the modified prospective transition method. Under this
method, compensation expense recognized post adoption includes:
(1) compensation expense for all share-based payments granted prior to, but
not yet vested as of January 29, 2006, based on the grant date fair value
estimated in accordance with the FASB ASC 718, and (2) compensation cost
for all share-based payments granted subsequent to January 29, 2006, based
on the grant date fair value estimated in accordance with the provisions of FASB
ASC 718. Results for prior periods have not been restated.
Effective
January 29, 2006, the Company elected to adopt the alternative transition
method provided in FASB ASC 718 for calculating the income tax effects of
stock-based compensation. The alternative transition method includes simplified
methods to establish the beginning balance of the additional paid-in-capital
pool (“APIC Pool”) related to the income tax effects of stock based
compensation, and for determining the subsequent impact on the APIC pool and
consolidated statements of cash flows of the income tax effects of stock-based
compensation awards that are outstanding upon adoption of FASB ASC
718.
FASB ASC
718 also requires the benefits of income tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow. The impact of adopting FASB ASC 718 on future results will
depend on, among other things, levels of share-based payments granted in the
future, actual forfeiture rates and the timing of option exercises.
Stock-based
compensation expense, post adoption of FASB ASC 718, is based on awards
ultimately expected to vest, and therefore has been reduced for estimated
forfeitures. Forfeitures are estimated at the time of grant based on the
Company’s historical forfeiture experience and will be revised in subsequent
periods if actual forfeitures differ from those estimates.
Equity
Incentive Plans. See Note 7 to
the Consolidated Financial Statements for additional information regarding
equity incentive plans.
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.
|
For
the Year Ended
|
|
|
January
30, 2010
|
|
|
January 31, 2009 3
|
|
|
|
February 2, 2008 3
|
|
Net
sales
|
100.0 |
%
|
|
100.0 |
%
|
|
|
|
100.0
|
% |
Cost
of good sold 1
|
72.1 |
|
|
72.0 |
|
|
|
|
72.5 |
|
Gross
profit
|
27.9 |
|
|
28.0 |
|
|
|
|
27.5 |
|
Selling,
general and administrative expenses 2
|
25.8 |
|
|
26.5 |
|
|
|
|
26.6 |
|
Operating
income
|
2.1 |
|
|
1.5 |
|
|
|
|
0.9 |
|
Interest
expense, net
|
- |
|
|
0.1 |
|
|
|
|
- |
|
Income
before taxes
|
2.1 |
|
|
1.4 |
|
|
|
|
0.9 |
|
Income
taxes
|
0.8 |
|
|
0.5 |
|
|
|
|
0.3 |
|
Net
income
|
1.3
|
% |
|
0.9
|
% |
|
|
|
0.6
|
% |
1 Cost of
goods sold includes the cost of product sold, along with all costs associated
with inbound freight.
2 Selling,
general and administrative expenses include the costs associated with
purchasing, receiving, handling, securing and storing product. These
costs are associated with products that have been sold and no longer remain in
ending inventory.
3 Results
include certain charges for the non-routine closing of 75 stores in
2008 and the 17 stores closed in 2007 (see Item 7, "Exit and Disposal
Activities" section).
Comparable
Sales. Our policy
regarding the calculation of comparable store sales represents the increase or
decrease in net sales for stores that have been opened after the end of the
12th
month following the store’s grand opening month, including stores that have been
remodeled or relocated during the reporting period. The majority of our remodels
and relocations do not include expansion. The purpose of the remodel or the
relocation is to change the store’s layout, refresh the store with new fixtures,
interiors or signage or to locate the store in a more desirable area. This type
of change to the store does not necessarily change the product mix or product
departments; therefore, on a comparable store sales basis, the store is the same
before and after the remodel or relocation. In relation to remodels and
relocations, expansions have been much more infrequent and consequently, any
increase in the selling square footage is immaterial to the overall calculation
of comparable store sales.
Additionally,
we do not exclude newly added hardline, softline or pharmacy departments from
our comparable store sales calculation because we believe that all departments
within a FRED’S store create a synergy supporting our overall goals for managing
the store, servicing our customer and promoting traffic and sales growth.
Therefore, the introduction of all new departments is included in same store
sales in the year in which the department is introduced. Likewise, our same
store sales calculation is not adjusted for the removal of a department from a
location.
Fiscal
2009 Compared to Fiscal 2008
Sales
Net sales
for 2009 decreased to $1,788.1 million from $1,798.8 million in 2008, a
year-over-year decrease of $10.7 million or .6%. Excluding sales from
stores closed in 2008 ($40.3 million), total sales were up $29.6 million or 1.7%
over the prior year. On a comparable store basis, sales for 2009
increased .4% ($6.2 million) compared with a 1.8% ($29.1 million) increase in
the same period last year.
The
Company’s 2009 front store (non-pharmacy) sales decreased 3.2% over 2008 front
store sales. Excluding the front store sales from stores closed in
2008 ($40.3 million), sales increased .2% over prior year. We
experienced sales increases in categories such as tobacco, food and small
appliances partially offset by decreases in home furnishings, health and beauty
aids and housewares.
The
Company’s pharmacy sales were 33.5% of total sales in 2009 compared to 31.5% of
total sales in the prior year and continue to rank as the largest sales category
within the Company. The total sales in this department, including the Company’s
mail order operation which we closed during the first quarter of 2009, increased
5.0% over 2008, with third party prescription sales representing approximately
93% of total pharmacy sales, the same as in the prior year. The Company’s
pharmacy department continues to benefit from an ongoing program of purchasing
prescription files from independent pharmacies as well as the addition of
pharmacy departments in existing store locations.
Sales to
FRED’S 24 franchised locations during 2009 decreased to $38.4 million (2.2% of
sales) from $39.6 million (2.2% of sales) in 2008. The decrease in
year-over-year franchise sales continues to be impacted by the ongoing economic
challenges affecting our customers’ disposable income. The Company
does not intend to expand its franchise network.
The sales
mix for the period, unadjusted for deferred layaway sales, was 33.5%
Pharmaceuticals, 23.4% Household Goods, 16.2% Food and Tobacco, 9.2% Paper and
Cleaning Supplies, 7.9% Apparel and Linens, 7.6% Health and Beauty Aids, and
2.2% Franchise. The sales mix for the same period last year was 31.7%
Pharmaceuticals, 24.8% Household Goods, 15.5% Food and Tobacco, 9.2% Paper and
Cleaning Supplies, 8.6% Apparel and Linens, 8.0% Health and Beauty Aids, and
2.2% Franchise.
For the
year, comparable store customer traffic decreased .1% over last year while the
average customer ticket increased 1.0% to $19.29.
Gross Profit
Gross
profit for the year decreased to $499.2 million in 2009 from $503.0 million in
2008, a year-over-year decline of $3.8 million or .8%. Gross margin,
measured as a percentage of sales, declined to 27.9% in 2009 from 28.0% in 2008.
Gross margin was unfavorably impacted by continued competitive pressures, higher
promotional markdowns, and an unfavorable shift in the product mix toward lower
margin basic and consumable products. Gross profit was also favorably
impacted, primarily in the third and fourth quarter, by purchase price variances
related to those and previous quarters. These purchase price
variances resulted from reduced product costs obtained from
vendors. The impact on prior quarters was immaterial. This
unfavorability was partially offset by an increase in vendor dollar
consideration and higher general merchandise department markup and improved
shrink experience.
Selling, General and Administrative
Expenses
Selling,
general and administrative expenses, including depreciation and amortization,
decreased to $460.7 million in 2009 (25.8% of sales)
from $476.7 million in 2008 (26.5% of sales). This 70 basis point
expense leverage resulted primarily from the effect of our store closures in
fiscal 2008 ($9.6 million), a reduction in professional fees primarily due to
the legal costs related to the settlement of the Atchinson and Ziegler cases
recorded in fiscal 2008 ($6.6 million) (see Item 3. Legal Proceedings from our
10-K filed April 16, 2009). In addition, we continued to manage costs
in our stores by reducing labor expense ($2.8 million) and lowering utilities
expense ($2.2 million) with the installation of Energy Management
Systems. This favorability was partially offset by deleveraging in
our pharmacy labor and depreciation expense related to new pharmacy openings
during the fiscal year.
Operating Income
Operating
income increased to $38.5 million in 2009 (2.1% of sales) from $26.3 million in
2008 (1.5% of sales) due primarily to a decrease in selling, general and
administrative expenses as the Company did not incur expenses related to store
closures in 2009 and did not experience the one-time legal costs as in 2008,
referenced in the Selling, General and Administrative Expenses section
above. This favorability was partially offset by a decrease in gross
profit of $3.8 million, a year-over-year decline of .8%, as described in the
Gross Profit section above.
Interest Expense,
Net
Net
interest expense for 2009 totaled $.3 million or less than .1% of sales
compared to $.4 million which was also less than .1% of sales in
2008.
Income
Taxes
The
effective income tax rate was 38.2% in 2009 compared to 35.8% in 2008. The
increase in the effective tax rate was primarily due to an increase in the
valuation allowance associated with deferred state tax benefits which management
has determined are more likely than not to expire unused.
The
Company’s estimates of income taxes and the significant items resulting in the
recognition of deferred tax assets and liabilities are described in Note 4 to
the Consolidated Financial Statements and reflect the Company’s assessment of
future tax consequences of transactions that have been reflected in the
Company’s financial statements or tax returns for each taxing authority in which
it operates. Actual income taxes to be paid could vary from these estimates due
to future changes in income tax law or the outcome of audits completed by
federal and state taxing authorities. The reserves are determined based upon the
Company’s judgment of the probable outcome of the tax contingencies and are
adjusted, from time to time, based upon changing facts and
circumstances.
State net
operating loss carry-forwards are available to reduce state income taxes in
future years. These carry-forwards total approximately $135.7 million for
state income tax purposes and expire at various times during 2010 through 2029.
If certain substantial changes in the Company’s ownership should occur, there
would be an annual limitation on the amount of carry-forwards that can be
utilized. We have provided a reserve for the portion believed to be more likely
than not to expire unused.
We expect
our effective tax rate to decrease in fiscal 2010 to 35% — 36% from fiscal 2009
due mainly to the settlement of the Internal Revenue Service Examination ($8.6
million) during 2009.
Net Income
Net
income increased to $23.6 million ($.59 per diluted share) in 2009 from $16.6
million ($.42 per diluted share) in 2008. The increase in net income
is primarily attributable to the decrease in selling, general and administrative
expenses of 3.3% resulting from the effect of our store closures in fiscal 2008
($9.6 million) and the legal costs related to the settlement of the Atchinson
case also in 2008 ($5.0 million) (see Item 3. Legal Proceedings from our 10-K
filed April 16, 2009). This favorability was partially offset by the
$3.8 million reduction in gross profit as described within the caption Gross
Profit above, as well as increased income taxes due to a $12.3 million increase
in pretax income and an increased tax rate resulting from the final settlement
of the IRS audit.
Fiscal
2008 Compared to Fiscal 2007
Sales
Net sales
increased 1.0% ($17.9 million) in 2008. Approximately
$24.9 million of the increase was attributable to a net addition of 21 new
stores, and a net addition of 6 pharmacies during 2008, together with the sales
of 15 store locations and 7 pharmacies that were opened or upgraded during 2007
and contributed a full year of sales in 2008. Comparable store sales,
consisting of sales from stores that have been open for more than one year,
increased 1.8% in 2008, which accounted for $32.9 million in
sales. This increase was partially offset by the closure of 74 stores
and 22 pharmacy locations during 2008. Those stores represent a
reduction in year-over-year sales of $39.9 million.
The
Company’s 2008 front store (non-pharmacy) sales increased approximately 1.7%
over 2007 front store sales. Front store sales growth benefited from the above
mentioned store additions and improvements, and sales increases in certain
categories such as pets, tobacco, paper and chemical, food, prepaid products,
beverage and lawn and garden.
FRED’S
pharmacy sales were 31.7% of total sales in 2008 and 32.2% of total sales in
2007 and continue to rank as the largest sales category within the Company. The
total sales in this department, including the Company’s mail order operation,
decreased 0.4% over 2007, with third party prescription sales representing
approximately 92% of total pharmacy sales, the same as in the prior year. The
Company’s pharmacy department continued to benefit from an ongoing program of
purchasing prescription files from independent pharmacies and the addition of
pharmacy departments in existing store locations, however overall pharmacy
department sales declined due to the closing of 23 pharmacies in 2008, the sales
mix shift from branded to generic and a significant decline in the Company’s
mail order operation caused by a lack of competitive sourcing for its primary
product, contraceptives.
Sales to
FRED’S 24 franchised locations increased approximately $2.3 million in 2008 and
represented 2.2% of the Company’s total sales, compared to 2.1% of the Company’s
total sales in 2007. The increase in sales to franchised locations results
primarily from the sales volume increases experienced by the franchise locations
during the year. The Company does not intend to expand its franchise network in
the future.
Gross Margin
Gross
margin as a percentage of sales increased to 28.0% in 2008 compared to 27.5% in
2007. Excluding the costs associated with closing underperforming
stores in both years ($0.3 million in 2008 and $10.0 million in 2007, see Note
11 Exit and Disposal Activities), gross margin was 28.0% in 2008 compared with
28.1% in 2007. This decline resulted from continued pricing
pressures, an unfavorable shift in the product mix toward lower margin, basic
and consumable products, and higher inbound freight costs. These
negative factors were partially offset by the favorable margin effect of a
positive mix shift in the pharmacy department from branded to generic
drugs.
Selling, General and Administrative
Expenses
Selling,
general and administrative expenses were $450.2 million (25.0% of net
sales) in 2008 compared to $445.2 million (25.0% of net sales) in
2007. The increase in selling, general and administrative expenses
was due primarily to an increase in insurance costs of $2.5 million (0.1%)
related to increasing medical costs and higher claims, additional legal costs of
$5.9 million (0.3%) related to the settlement of the Ziegler and Atchinson cases
(see Item 3. Legal Proceedings) as well as an additional $4.3 million (0.2%) in
impairment charges from lease write-offs and liquidation fees for stores closed
in 2008. These increases were partially offset by decreases in labor
costs of $2.1 million (0.1%), occupancy costs of $3.5 million (0.2%) and
advertising costs of $4.2 million (0.2%) all resulting from the store closures
completed in the current year.
Operating Income
Operating
income increased to $26.3 million in 2008 (1.5% of sales) from $16.5 million in
2007 (0.9% of sales) due to increased sales primarily from comparable stores and
new stores in 2008 and a gross margin increase which was driven by a reduction
in year-over-year costs associated with closing underperforming stores ($0.3
million in 2008 versus $10.0 million in 2007). These increases were
reduced by an increase in selling, general and administrative expenses due
primarily to higher insurance costs of $2.5 million (0.1%) related to increasing
medical costs and higher claims, additional legal costs of $5.9 million (0.3%)
related to the settlement of the Ziegler and Atchinson cases (see Item 3. Legal
Proceedings) as well as an additional $4.3 million (0.2%) in impairment charges
from lease write-offs and liquidations fees for stores closed in
2008. These increases were partially offset by decreases in labor
costs of $2.1 million (0.1%), occupancy costs of $3.5 million (0.2%) and
advertising costs of $4.2 million (0.2%) all resulting from the store closures
completed in the current year.
Interest Expense,
Net
Net
interest expense for 2008 totaled $.4 million or less than .1% of sales
compared to $.8 million which was also less than .1% of sales in
2007.
Income Taxes
The
effective income tax rate was 35.8% in 2008 compared to 31.6% in 2007, primarily
as a result of various jobs tax credits available in 2007.
The
Company’s estimates of income taxes and the significant items resulting in the
recognition of deferred tax assets and liabilities are described in Note 4 to
the Consolidated Financial Statements and reflect the Company’s assessment of
future tax consequences of transactions that have been reflected in the
Company’s financial statements or tax returns for each taxing authority in which
it operates. Actual income taxes to be paid could vary from these estimates due
to future changes in income tax law or the outcome of audits completed by
federal and state taxing authorities. The reserves are determined based upon the
Company’s judgment of the probable outcome of the tax contingencies and are
adjusted, from time to time, based upon changing facts and
circumstances.
State net
operating loss carry-forwards are available to reduce state income taxes in
future years. These carry-forwards total approximately $118.5 million for
state income tax purposes and expire at various times during 2009 through 2028.
If certain substantial changes in the Company’s ownership should occur, there
would be an annual limitation on the amount of carry-forwards that can be
utilized. We have provided a reserve for the portion believed to be more likely
than not to expire unused.
We expect
our effective tax rate to increase in fiscal 2009 to 36% — 37% from fiscal 2008
and fiscal 2007 levels due to the expiration of federal credits for jobs in the
2005 hurricane impact zone and the mid year end expiration of state tax
incentives offered by Georgia.
Net Income
Net
income increased to $16.6 million ($.42 per diluted share) in 2008 from $10.7
million ($.27 per diluted share) in 2007. The increase in net income
is attributable to sales increases of 1.0% and gross margin increases of 0.5%
driven by a reduction in year-over year costs associated with closing
underperforming stores ($0.3 million in 2008 versus $10.0 million in
2007). The gross margin increase was partially offset by increased
selling, general and administrative costs of $5.0 million as described within
the caption Selling, General and Administrative Expenses above, as well as
increased income taxes of 0.5% due to a $10.2 million increase in pretax income
and an increased tax rate resulting from less tax credits being available in
2008 when compared to 2007.
Liquidity and Capital
Resources
The
Company’s principal capital requirements include funding new stores and
pharmacies, remodeling existing stores and pharmacies, maintenance of stores and
distribution centers, and the ongoing investment in information systems. FRED’S
primary sources of working capital have traditionally been cash flow from
operations and borrowings under its credit facility. The Company had working
capital of $266.7 million, $255.5 million and $270.5 million at
year-end 2009, 2008 and 2007, respectively. Working capital fluctuates in
relation to profitability, seasonal inventory levels, and the level of store
openings and closings. Working capital at year-end 2009 increased by
approximately $11.1 million from 2008. The increase was primarily due to
increased cash and cash equivalents of $19.6 million due to improved cash
management and a $7.7 million reduction in accrued expenses related to the
settlement of two legal cases (see Item 3. Legal Proceedings in our 10-K filed
April 16, 2009). The increase described above was offset by a
year-over-year increase in account payable of $17.4 million, a result of our
focus on improving our terms with vendors. In 2010, the Company intends to open
approximately 20 - 25 stores and pharmacies and close an estimated 10 stores and
5 pharmacies.
During
2005, 2006, 2007 and 2009, we incurred losses caused by fire, tornado and flood
damage, which consisted primarily of losses of inventory and fixed assets. We
reached settlements on some of our insurance claims related to inventory and
fixed assets in 2006, 2007 and 2008. Insurance proceeds related to fixed assets
are included in cash flows from investing activities and proceeds related to
inventory losses and business interruption are included in cash flows from
operating activities.
Net cash
flow provided by operating activities totaled $64.2 million in 2009,
$78.3 million in 2008 and $19.3 million in 2007.
In fiscal
2009, inventory, net of the LIFO reserve, decreased by approximately
$7.5 million due to higher inventory turn rates in our stores, the average
of which has increased to 4.1 in fiscal 2009 from 3.8 in fiscal
2008. Accounts receivable increased by approximately $1.6 million due
primarily to an increase in vendor related allowances. Accounts
payable and accrued expenses increased by approximately $11.4 million primarily
as a result of the focus on improving our terms with our
vendors. Income taxes payable decreased by $8.0 million while
deferred income tax expense increased by $5.9 million. Other non-current
liabilities decreased by $3.4 million due to a reduction in the Company FASB ASC
740 reserves.
In fiscal
2008, inventory, net of the LIFO reserve, decreased by approximately
$18.5 million due to the store and pharmacy closing throughout the year, as
well as reductions in discretionary product classes where sales decreased in
2008. Accounts receivable decreased by approximately $5.4 million due
primarily to a decrease of an income tax receivable that was created in the
prior year. Accrued expenses increased by approximately $5.5 million
primarily as a result of the $6.6 million legal accrual related to the
settlement of the Ziegler and Atchinson cases in the fourth quarter of
2008. Other non-current liabilities increased by $8.7 million due to
an increase in the Company FASB ASC 740 reserves.
In fiscal
2007, inventory, net of the LIFO reserve, increased by approximately
$25.3 million due to improving in-stock positions in the basic and
consumable product categories as well as slower sales than projected during the
2007 Holiday season. This increase was offset by a $10.0 million non-cash
reduction in inventory resulting from the below-cost inventory adjustment
related to the planned store closures in the upcoming year. Accounts receivable
increased by approximately $8.1 million due an increase in income tax receivable
which reflects overpayment of estimated taxes due to lower than anticipated
sales.
Capital
expenditures in 2009 totaled $22.7 million compared to $17.0 million
in 2008 and $31.4 million in 2007. The capital expenditures during 2009
consisted primarily of the store and pharmacy expansion program
($15.7 million), technology enhancements ($3.3 million), transportation and
distribution center expenditures ($2.1 million) and other corporate expenditures
($1.6 million). Capital expenditures during 2008 consisted primarily of the
store and pharmacy expansion program ($13.7 million), technology and other
corporate expenditures ($2.2 million) and improvements at our two
distribution centers ($1.1 million). The capital expenditures during 2007
consisted primarily of the store and pharmacy expansion program
($15.3 million), acquisition of previously leased land and buildings ($11.7
million), expenditures related to the Store Refresher Program
($7.5 million) and technology and other corporate expenditures
($4.2 million). Also during fiscal 2007, the Company assumed
debt of $6.1 million and issued $1.2 million in common stock for the
acquisition of store real estate. Cash used for investing activities
also includes $10.7 million in 2009, $5.7 million in 2008 and $1.7 million
in 2007 for the acquisition of prescription lists and other pharmacy related
items and $0.6 million in 2008 and $1.1 million in 2007 from insurance
proceeds related to fixed assets reimbursements.
In 2010,
the Company is planning capital expenditures totaling approximately $26.6
million. Expenditures are planned totaling $19.3 million for new and
existing stores and pharmacies. Planned expenditures also include approximately
$4.3 million for technology upgrades and approximately $2.4 million
for distribution center equipment and other capital maintenance. Technology
upgrades in 2010 will be made in the areas of business intelligence software and
POS systems and equipment for the stores. In addition, the Company plans
expenditures of approximately $10.0 million in 2010 for the acquisition of
prescription lists and other pharmacy related items.
Cash and
cash equivalents were $54.7 million at the end of 2009 compared to
$35.1 million at the end of 2008 and $10.3 million at the end of 2007.
Short-term investment objectives are to maximize yields while minimizing company
risk and maintaining liquidity. Accordingly, limitations are placed on the
amounts and types of investments the Company can select.
On
August 27, 2007, the Board of Directors approved a plan that authorized
stock repurchases of up to 4.0 million shares of the Company’s common
stock. Under the plan, the Company may repurchase its common stock in open
market or privately negotiated transactions at such times and at such prices as
determined to be in the Company’s best interest. These purchases may be
commenced or suspended without prior notice depending on then-existing business
or market conditions and other factors. In fiscal 2009, the Company repurchased
742,663 shares for $7.2 million. There were no share repurchases in
fiscal 2008.
On
September 16, 2008, the Company and Regions Bank entered into a Ninth Loan
Modification of the Revolving Loan and Credit Agreement which decreased the
credit line from $75 million to $60 million and extended the term until July 31,
2011. All other terms, conditions and covenants remained in place
after the amendment, with only a slight modification to one of the financial
covenants required by the Agreement. Under the most restrictive
covenants of the Agreement, the Company is required to maintain specified
shareholders’ equity (which was $300.6 million at January 31, 2009) and net
income levels. Borrowings and the unused fees under the agreement
bear interest at a tiered rate based on the Company’s previous four quarter
average of the Fixed Charge Coverage Ratio. Currently the Company is
at 125 basis points over LIBOR for borrowings and 25 basis points over LIBOR for
the unused fee. There were no borrowings outstanding under the
Agreement at January 31, 2009 and $30.6 million outstanding at February 2,
2008. The weighted-average interest rate on borrowings under the
Agreement was 3.67% and 5.76% at January 31, 2009 and February 2, 2008,
respectively.
On
October 30, 2007, the Company and Regions Bank entered into an Eighth
Modification Agreement of the Revolving Loan and Credit Agreement (“Agreement”)
to provide an increase in the credit line from $50 million to
$75 million and to extend the term until July 31, 2009. All other
terms, conditions and covenants remained in place after the amendment.
Borrowings under the Agreement bore interest at 1.5% below the prime rate or a
LIBOR-based rate. Under the most restrictive covenants of the Agreement, the
Company was required to maintain specified shareholders’ equity (which was
$292.3 million at February 2, 2008) and net income levels. The Company was
required to pay a commitment fee to the bank at a rate per annum equal to 0.15%
on the unutilized portion of the revolving line commitment over the term of the
Agreement. There were $30.6 million and $2.2 million of borrowings
outstanding under the Agreement at February 2, 2008 and February 3,
2007, respectively. The increase in debt was due to an increase in inventory to
improve in-stock positions and capital expenditures to acquire the land and
building occupied by thirteen FRED’S stores that we had previously leased. The
weighted average interest rate on borrowings under Agreement was 5.76% and 5.93%
at February 2, 2008 and February 3, 2007, respectively.
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.
Off-Balance Sheet
Arrangements
The
Company has no off-balance sheet financing arrangements.
Effects of Inflation and Changing
Prices. The Company believes that inflation and/or deflation had a
minimal impact on its overall operations during fiscal years 2009, 2008 and
2007.
Contractual Obligations and
Commercial Commitments
As
discussed in Note 5 to the Consolidated Financial Statements, the Company leases
certain of its store locations under noncancelable operating leases expiring at
various dates through 2029. Many of these leases contain renewal options and
require the Company to pay contingent rent based upon a percentage of sales,
taxes, maintenance, insurance and certain other operating expenses applicable to
the leased properties. In addition, the Company leases various equipment under
noncancelable operating leases.
The
following table summarizes the Company’s significant contractual obligations as
of January 30, 2010, which excludes the effect of imputed interest:
(dollars in thousands)
|
|
2010
|
|
|
2011
|
|
|
2012
|
|
|
2013
|
|
|
2014
|
|
|
Thereafter
|
|
|
Total
|
|
Operating
leases 1
|
|
$ |
45,274 |
|
|
$ |
40,440 |
|
|
$ |
33,851 |
|
|
$ |
23,558 |
|
|
$ |
15,148 |
|
|
$ |
26,724 |
|
|
$ |
184,995 |
|
Inventory
purchase obligations 2
|
|
|
154,241 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
154,241 |
|
Equipment
leases 3
|
|
|
1,808 |
|
|
|
1,438 |
|
|
|
457 |
|
|
|
58 |
|
|
|
6 |
|
|
|
|
|
|
|
3,767 |
|
Mortgage
loans on land & buildings and other 4
|
|
|
718 |
|
|
|
161 |
|
|
|
170 |
|
|
|
1,109 |
|
|
|
525 |
|
|
|
2,214 |
|
|
|
4,897 |
|
Postretirement
benefits 5
|
|
|
29 |
|
|
|
33 |
|
|
|
36 |
|
|
|
40 |
|
|
|
46 |
|
|
|
271 |
|
|
|
455 |
|
Total
contractual obligations
|
|
$ |
202,070 |
|
|
$ |
42,072 |
|
|
$ |
34,514 |
|
|
$ |
24,765 |
|
|
$ |
15,725 |
|
|
$ |
29,209 |
|
|
$ |
348,355 |
|
1
Operating leases are described in Note 5 to the Consolidated Financial
Statements.
2
Inventory purchase obligations represent open purchase orders and any
outstanding purchase commitments as of January 30, 2010.
3
Equipment leases represent the cooler program and other equipment operating
leases.
4 Mortgage
loans for purchased land and buildings and other debt.
5
Postretirement benefits are described in Note 9 to the Consolidated Financial
Statements.
The
Company had commitments approximating $8.8 million at January 30, 2010 and
$9.7 million at January 31, 2009 on issued letters of credit, which support
purchase orders for merchandise. Additionally, the Company had outstanding
letters of credit aggregating approximately $11.1 million at January 30, 2010
and $12.0 million at January 31, 2009 utilized as collateral for its risk
management programs.
The
Company financed the construction of its Dublin, Georgia distribution center
with taxable industrial development revenue bonds issued by the City of Dublin
and County of Laurens development authority. The Company purchased 100% of the
bonds and intends to hold them to maturity, effectively financing the
construction with internal cash flow. The Company has offset the investment in
the bonds ($34.6 million) against the related liability and neither is
reflected in the consolidated balance sheet.
Related Party
Transactions
During
the year ended February 2, 2008, Atlantic Retail Investors, LLC, which is
partially owned by Michael J. Hayes, Chairman of the Board of Directors,
purchased the land and buildings occupied by thirteen FRED’S stores. The stores
were purchased by Atlantic Retail Investors, LLC from an independent
landlord/developer. Prior to the purchase by Atlantic Retail Investors, LLC the
Company was offered the right to purchase the same stores and declined the
offer. The terms and conditions regarding the leases on these locations are
consistent in all material respects with other stores leases of the Company. The
total rental payments related to these leases was $1.3 million for the year
ended January 30, 2010. Total future commitments under related party leases are
$9.7 million.
Recent Accounting
Pronouncements
In June
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards (“SFAS”) No. 168, “The FASB Accounting Standards
Codification and the Hierarchy of Generally Accepted Accounting Principles – a
replacement of SFAS No. 162” (“FASB ASC 105”). FASB ASC 105 modifies the GAAP
hierarchy by establishing only two levels of GAAP, authoritative and
nonauthoritative accounting literature. Effective July 2009, the FASB Accounting
Standards Codification (“ASC”), also known collectively as the “Codification”,
is considered the single source of authoritative U.S. accounting and reporting
standards, except for additional authoritative rules and interpretive releases
issued by the SEC. The Codification was developed to organize GAAP
pronouncements by topic so that users can more easily access authoritative
accounting guidance. FASB ASC 105 became effective for the third quarter of
fiscal year 2009. All other accounting standards references have been updated in
this report with ASC references.
In May
2009, the FASB issued FASB ASC 855, “Subsequent Events”, which establishes
general standards of accounting for and disclosure of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. FASB ASC 855 requires issuers to reflect in
their financial statements and disclosures the effects of subsequent events that
provide additional evidence about conditions at the balance sheet
date. Disclosures should include the nature of the event and either
an estimate of its financial effect or a statement that an estimate cannot be
made. This standard also requires issuers to disclose the date
through which they have evaluated subsequent events and whether the date
corresponds with the release of their financial statements. The
Company adopted FASB ASC 855 as of the interim period ended August 1,
2009. As the requirements under FASB ASC 855 are consistent with its
current practice, the implementation of this standard did not have an impact on
the Company’s consolidated financial statements.
In
December 2008, the FASB issued FASB ASC 715, “Compensation-Retirement Benefits”,
which is effective for fiscal years ending after December 15,
2009. FASB ASC 715 provides additional guidance on required
disclosures about postretirement benefit plan assets of a defined benefit
pension or other postretirement benefit plan. The Company adopted
FASB ASC 715 as of the year ending January 30, 2010 and concluded the
implementation of this standard did not have an impact on the Company’s
consolidated financial statements or disclosures.
In June
2008, the FASB issued FASB ASC 260, which addresses whether instruments granted
in share-based payment transactions are participating securities prior to
vesting and therefore need to be included in the earnings allocation in
computing earnings per share (EPS) under the two-class method described in FASB
ASC 260, “Earnings Per Share”. This FASB ASC is effective for fiscal
periods beginning after December 15, 2008. The Company adopted FASB
ASC 260 in the quarter ended May 2, 2009 and determined that it had no
significant impact on its results of operations or financial
position.
In
September 2006, the FASB issued FASB ASC 820, “Fair Value Measurements and
Disclosures”. FASB ASC 820 provides a single definition of fair
value, together with a framework for measuring it, and requires additional
disclosure about the use of fair value to measure assets and
liabilities. FASB ASC 820 also emphasizes that fair value is a
market-based measurement, not an entity-specific measurement, and sets out a
fair value hierarchy with the highest priority being quoted prices in active
markets. Under FASB ASC 820, fair value measurements are required to
be disclosed by level within that hierarchy. FASB ASC 820 is
effective for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. However, FASB ASC 820-10-65-1,
issued in February 2008, delays the effective date of FASB ASC 820 for all
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis, to fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years. The Company adopted FASB ASC 820 effective
February 3, 2008, and its adoption did not have a material effect on its results
of operations or financial position. The Company has also evaluated
FASB ASC 820-10-65-1 and determined that it will have no impact on its results
of operations or financial position. In October 2008, the FASB issued
ASC 820-10-65-2, “Determining the Fair Value of a Financial Asset When the
Market for That Asset Is Not Active”. FASB ASC 820-10-65-2 clarifies the
application of FASB ASC 820 when the market for a financial asset is inactive.
The guidance in FASB ASC 820-10-65-2 is effective immediately and has no effect
on our financial statements. In April 2009, the FASB issued ASC
820-10-65-4, “Determining Fair Value When the Level and Volume of Activity for
the Asset or Liability have Significantly Decreased and Identifying Transactions
That Are Not Orderly” which further clarifies the principles established by FASB
ASC 820. The guidance is effective for the periods ending after June
15, 2009 with early adoption permitted for the periods ending after March 15,
2009. The Company has evaluated FASB ASC 820-10-65-4 and determined
that it had no impact on its results of operations or financial
position.
The
Company has no holdings of derivative financial or commodity instruments as of
January 30, 2010. The Company is exposed to financial market risks, including
changes in interest rates. All borrowings under the Company’s 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
the Company’s income. All of the Company’s business is transacted in U.S.
dollars and, accordingly, foreign exchange rate fluctuations have never had a
significant impact on the Company, and they are not expected to in the
foreseeable future.
Report
of Independent Registered Public Accounting Firm
Board of
Directors and Shareholders
FRED’S,
Inc.
Memphis,
Tennessee
We have
audited the accompanying consolidated balance sheets of FRED’S, Inc. (the
“Company”) as of January 30, 2010 and January 31, 2009 and the related
consolidated statements of income and comprehensive income, changes in
shareholders’ equity, and cash flows for each of the three years in the period
ended January 30, 2010. These financial statements are the
responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of FRED’S, Inc. at January 30,
2010 and January 31, 2009, and the results of its operations and its cash flows
for each of the three years in the period ended January 30, 2010, in conformity
with accounting principles generally accepted in the United States of
America.
As
discussed in Note 1 to the Consolidated Financial Statements, the Company has
changed its method for accounting for uncertainty in income taxes in the year
ended February 2, 2008 due to the adoption of revised accounting standards FASB
ASC 740.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), FRED’S, Inc.’s internal control over financial
reporting as of January 30, 2010, based on criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) and our report dated April 15, 2010 expressed an
unqualified opinion thereon.
/s/ BDO
Seidman, LLP
Memphis,
Tennessee
April 15,
2010
FRED’S,
INC.
CONSOLIDATED
BALANCE SHEETS
(in
thousands, except for number of shares)
|
|
January 30,
|
|
|
January 31,
|
|
|
|
2010
|
|
|
2009
|
|
ASSETS
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
54,742 |
|
|
$ |
35,128 |
|
Receivables,
less allowance for doubtful accounts of $764 and $885,
respectively
|
|
|
28,893 |
|
|
|
28,857 |
|
Inventories
|
|
|
294,024 |
|
|
|
301,537 |
|
Other
non-trade receivables
|
|
|
25,193 |
|
|
|
15,782 |
|
Prepaid
expenses and other current assets
|
|
|
10,945 |
|
|
|
11,912 |
|
Total
current assets
|
|
|
413,797 |
|
|
|
393,216 |
|
Property
and equipment, at depreciated cost
|
|
|
137,569 |
|
|
|
138,036 |
|
Equipment
under capital leases, less accumulated amortization of $4,967 and
$4,928,
|
|
|
|
|
|
|
|
|
respectively
|
|
|
- |
|
|
|
39 |
|
Intangibles |
|
|
16,035 |
|
|
|
9,042 |
|
Other
noncurrent assets, net
|
|
|
4,040 |
|
|
|
4,442 |
|
Total
assets
|
|
$ |
571,441 |
|
|
$ |
544,775 |
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS’
EQUITY
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
87,393 |
|
|
$ |
69,955 |
|
Current
portion of indebtedness
|
|
|
718 |
|
|
|
243 |
|
Accrued
expenses and other
|
|
|
39,621 |
|
|
|
46,659 |
|
Deferred
income taxes
|
|
|
19,373 |
|
|
|
13,061 |
|
Other
current liabilities
|
|
|
- |
|
|
|
7,749 |
|
Total
current liabilities
|
|
|
147,105 |
|
|
|
137,667 |
|
Long-term
portion of indebtedness
|
|
|
4,179 |
|
|
|
4,866 |
|
Deferred
income taxes
|
|
|
2,009 |
|
|
|
1,328 |
|
Other
noncurrent liabilities
|
|
|
17,209 |
|
|
|
13,833 |
|
Total
liabilities
|
|
|
170,502 |
|
|
|
157,694 |
|
|
|
|
|
|
|
|
|
|
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,
|
|
|
|
|
|
|
|
|
39,363,462
and 40,028,484 shares issued and outstanding, respectively
|
|
|
131,685 |
|
|
|
136,877 |
|
Common
stock, Class B nonvoting, no par value, 11,500,000 shares
authorized,
|
|
|
|
|
|
|
|
|
none
outstanding
|
|
|
- |
|
|
|
- |
|
Retained
earnings
|
|
|
268,350 |
|
|
|
249,141 |
|
Accumulated
other comprehensive income
|
|
|
904 |
|
|
|
1,063 |
|
Total
shareholders’ equity
|
|
|
400,939 |
|
|
|
387,081 |
|
Total
liabilities and shareholders’ equity
|
|
$ |
571,441 |
|
|
$ |
544,775 |
|
See
accompanying notes to condensed consolidated financial
statements.
FRED’S,
INC.
CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
(in
thousands, except per share amounts)
|
|
For the Years Ended
|
|
|
|
January 30,
|
|
|
January 31,
|
|
|
February 2,
|
|
|
|
2010
|
|
|
2009
|
|
|
2008
|
|
Net
sales
|
|
$ |
1,788,136 |
|
|
$ |
1,798,840 |
|
|
$ |
1,780,923 |
|
Cost
of goods sold
|
|
|
1,288,899 |
|
|
|
1,295,822 |
|
|
|
1,290,680 |
|
Gross
profit
|
|
|
499,237 |
|
|
|
503,018 |
|
|
|
490,243 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
26,387 |
|
|
|
26,425 |
|
|
|
28,614 |
|
Selling,
general and administrative expenses
|
|
|
434,356 |
|
|
|
450,275 |
|
|
|
445,172 |
|
Operating
income
|
|
|
38,494 |
|
|
|
26,318 |
|
|
|
16,457 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
|
(189 |
) |
|
|
(308 |
) |
|
|
(567 |
) |
Interest
expense
|
|
|
482 |
|
|
|
716 |
|
|
|
1,360 |
|
Income
before income taxes
|
|
|
38,201 |
|
|
|
25,910 |
|
|
|
15,664 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for income taxes
|
|
|
14,586 |
|
|
|
9,268 |
|
|
|
4,946 |
|
Net
income
|
|
$ |
23,615 |
|
|
$ |
16,642 |
|
|
$ |
10,718 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.59 |
|
|
$ |
0.42 |
|
|
$ |
0.27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$ |
0.59 |
|
|
$ |
0.42 |
|
|
$ |
0.27 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average shares outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
39,822 |
|
|
|
39,282 |
|
|
|
39,771 |
|
Effect
of dilutive stock options
|
|
|
67 |
|
|
|
569 |
|
|
|
111 |
|
Diluted
|
|
|
39,889 |
|
|
|
39,851 |
|
|
|
39,882 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
23,615 |
|
|
$ |
16,642 |
|
|
$ |
10,718 |
|
Other
comprehensive income (expense), net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
postretirement
plan adjustment
|
|
|
(159 |
) |
|
|
23 |
|
|
|
(43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
income
|
|
$ |
23,456 |
|
|
$ |
16,665 |
|
|
$ |
10,675 |
|
See
accompanying notes to condensed consolidated financial
statements.
FRED’S,
INC.
CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in
thousands, except share and per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
Common Stock
|
|
|
Retained
|
|
|
Unearned
|
|
|
Comprehensive
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Earnings
|
|
|
Compensation
|
|
|
Income
|
|
|
Total
|
|
Balance,
February 3, 2007
|
|
|
40,068,953 |
|
|
$ |
135,803 |
|
|
$ |
232,382 |
|
|
$ |
- |
|
|
$ |
1,083 |
|
|
$ |
369,268 |
|
Adjustment
to initially apply FASB ASC 740 as of February
4, 2007
|
|
|
|
|
|
|
|
|
|
|
(4,212 |
) |
|
|
|
|
|
|
|
|
|
|
(4,212 |
) |
Cash
dividends paid ($.08 per share)
|
|
|
|
|
|
|
|
|
|
|
(3,204 |
) |
|
|
|
|
|
|
|
|
|
|
(3,204 |
) |
Restricted
stock grants, cancellations and withholdings,
net
|
|
|
64,036 |
|
|
|
(43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(43 |
) |
Issuance
of shares under employee
stock purchase plan
|
|
|
71,294 |
|
|
|
667 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
667 |
|
Repurchased
and cancelled shares
|
|
|
(426,500 |
) |
|
|
(4,371 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,371 |
) |
Stock-based
compensation
|
|
|
|
|
|
|
2,116 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,116 |
|
Issuance
of shares for real estate purchase
|
|
|
103,053 |
|
|
|
1,173 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,173 |
|
Income
tax benefit on exercise of stock options
|
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10 |
) |
Adjustment
for postretirement benefits (net of tax)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(43 |
) |
|
|
(43 |
) |
Net
income
|
|
|
|
|
|
|
|
|
|
|
10,718 |
|
|
|
|
|
|
|
|
|
|
|
10,718 |
|
Balance,
February 2, 2008
|
|
|
39,880,836 |
|
|
|
135,335 |
|
|
|
235,684 |
|
|
|
- |
|
|
|
1,040 |
|
|
|
372,059 |
|
Cash
dividends paid ($.08 per share)
|
|
|
|
|
|
|
|
|
|
|
(3,196 |
) |
|
|
|
|
|
|
|
|
|
|
(3,196 |
) |
Restricted
stock grants, cancellations and withholdings,
net
|
|
|
73,364 |
|
|
|
(35 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(35 |
) |
Issuance
of shares under employee stock purchase
plan
|
|
|
73,084 |
|
|
|
584 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
584 |
|
Stock-based
compensation
|
|
|
|
|
|
|
990 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
990 |
|
Exercises
of stock options
|
|
|
1,200 |
|
|
|
17 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
17 |
|
Income
tax benefit on exercise of stock options
|
|
|
|
|
|
|
(14 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(14 |
) |
Adjustment
for postretirement benefits (net of tax)
|
|
|
|
|
|
|
|
|
|
|
11 |
|
|
|
|
|
|
|
23 |
|
|
|
34 |
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
16,642 |
|
|
|
|
|
|
|
|
|
|
|
16,642 |
|
Balance,
January 31, 2009
|
|
|
40,028,484 |
|
|
|
136,877 |
|
|
|
249,141 |
|
|
|
- |
|
|
|
1,063 |
|
|
|
387,081 |
|
Cash
dividends paid ($.11per share)
|
|
|
|
|
|
|
|
|
|
|
(4,406 |
) |
|
|
|
|
|
|
|
|
|
|
(4,406 |
) |
Restricted
stock grants, cancellations and withholdings,
net
|
|
|
16,691 |
|
|
|
(142 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(142 |
) |
Issuance
of shares under employee stock purchase
plan
|
|
|
60,350 |
|
|
|
542 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
542 |
|
Repurchased
and cancelled shares
|
|
|
(742,663 |
) |
|
|
(7,152 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7,152 |
) |
Stock-based
compensation
|
|
|
|
|
|
|
1,595 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,595 |
|
Exercises
of stock options
|
|
|
600 |
|
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8 |
|
Income
tax benefit on exercise of stock options
|
|
|
|
|
|
|
(43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(43 |
) |
Adjustment
for postretirement benefits (net of tax)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(159 |
) |
|
|
(159 |
) |
Net
income
|
|
|
|
|
|
|
|
|
|
|
23,615 |
|
|
|
|
|
|
|
|
|
|
|
23,615 |
|
Balance,
January 30, 2010
|
|
|
39,363,462 |
|
|
$ |
131,685 |
|
|
$ |
268,350 |
|
|
$ |
- |
|
|
$ |
904 |
|
|
$ |
400,939 |
|
See
accompanying notes to condensed consolidated financial
statements.
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in
thousands)
|
|
For the Years Ended
|
|
|
|
January 30, 2010
|
|
|
January 31, 2009
|
|
|
February 2, 2008
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$ |
23,615 |
|
|
$ |
16,642 |
|
|
$ |
10,718 |
|
Adjustments
to reconcile net income to net cash flows from operating
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
26,387 |
|
|
|
26,425 |
|
|
|
28,614 |
|
Net
(gain) loss on asset disposition
|
|
|
356 |
|
|
|
(831 |
) |
|
|
(335 |
) |
Provision
for store closures and asset impairment
|
|
|
- |
|
|
|
419 |
|
|
|
14,559 |
|
Stock-based
compensation
|
|
|
1,595 |
|
|
|
990 |
|
|
|
2,116 |
|
(Recovery)
provision for uncollectible receivables
|
|
|
636 |
|
|
|
486 |
|
|
|
255 |
|
LIFO
reserve increase
|
|
|
2,411 |
|
|
|
3,700 |
|
|
|
1,657 |
|
Deferred
income tax expense (benefit)
|
|
|
5,932 |
|
|
|
(4,080 |
) |
|
|
(6,604 |
) |
Income
tax benefit (charge) upon exercise of stock options
|
|
|
43 |
|
|
|
14 |
|
|
|
10 |
|
Provision
for postretirement medical
|
|
|
(74 |
) |
|
|
34 |
|
|
|
(43 |
) |
(Increase)
decrease in operating assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Trade
receivables
|
|
|
(2,569 |
) |
|
|
4,925 |
|
|
|
(8,162 |
) |
Insurance
receivables
|
|
|
(780 |
) |
|
|
902 |
|
|
|
1,537 |
|
Inventories
|
|
|
5,101 |
|
|
|
14,751 |
|
|
|
(26,981 |
) |
Other
assets
|
|
|
1,369 |
|
|
|
(169 |
) |
|
|
432 |
|
Increase
(decrease) in operating liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts
payable and accrued expenses
|
|
|
11,593 |
|
|
|
5,537 |
|
|
|
3,377 |
|
Income
taxes payable
|
|
|
(7,925 |
) |
|
|
1,178 |
|
|
|
(3,508 |
) |
Other
noncurrent liabilities
|
|
|
(3,441 |
) |
|
|
7,362 |
|
|
|
1,699 |
|
Net
cash provided by operating activities
|
|
|
64,249 |
|
|
|
78,285 |
|
|
|
19,341 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(22,692 |
) |
|
|
(16,727 |
) |
|
|
(31,289 |
) |
Proceeds
from asset dispositions
|
|
|
125 |
|
|
|
2,182 |
|
|
|
463 |
|
Insurance
recoveries for replacement assets
|
|
|
- |
|
|
|
556 |
|
|
|
1,094 |
|
Asset
acquisition, net (primarily intangibles)
|
|
|
(10,663 |
) |
|
|
(5,686 |
) |
|
|
(1,663 |
) |
Net
cash used in investing activities
|
|
|
(33,230 |
) |
|
|
(19,675 |
) |
|
|
(31,395 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments
of indebtedness and capital lease obligations
|
|
|
(212 |
) |
|
|
(469 |
) |
|
|
(1,656 |
) |
Proceeds
from revolving line of credit
|
|
|
- |
|
|
|
205,996 |
|
|
|
344,755 |
|
Payments
on revolving line of credit
|
|
|
- |
|
|
|
(236,631 |
) |
|
|
(316,293 |
) |
Excess
tax benefits (charges) from stock-based compensation
|
|
|
(43 |
) |
|
|
(14 |
) |
|
|
(10 |
) |
Proceeds
from exercise of stock options and employee stock purchase
plan
|
|
|
408 |
|
|
|
566 |
|
|
|
624 |
|
Repurchase
of shares
|
|
|
(7,152 |
) |
|
|
- |
|
|
|
(4,371 |
) |
Cash
dividends paid
|
|
|
(4,406 |
) |
|
|
(3,196 |
) |
|
|
(3,204 |
) |
Net
cash provided by (used in) financing activities
|
|
|
(11,405 |
) |
|
|
(33,748 |
) |
|
|
19,845 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase
in cash and cash equivalents
|
|
|
19,614 |
|
|
|
24,862 |
|
|
|
7,791 |
|
Cash
and cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning
of year
|
|
|
35,128 |
|
|
|
10,266 |
|
|
|
2,475 |
|
End
of year
|
|
$ |
54,742 |
|
|
$ |
35,128 |
|
|
$ |
10,266 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosures of cash flow information:
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
paid
|
|
$ |
293 |
|
|
$ |
408 |
|
|
$ |
1,269 |
|
Income
taxes paid
|
|
$ |
22,999 |
|
|
$ |
2,559 |
|
|
$ |
18,200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash
investing and financial activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets
acquired through term loan
|
|
$ |
- |
|
|
$ |
274 |
|
|
$ |
6,065 |
|
Common
stock issued for purchase of capital assets
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
1,173 |
|
See
accompanying notes to condensed consolidated financial
statements.
Notes
to Consolidated Financial Statements
NOTE 1 — DESCRIPTION OF BUSINESS AND
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of
business. The primary business of FRED’S, Inc. and
subsidiaries (the “Company”) is the sale of general merchandise through its
retail discount stores and full service pharmacies. In addition, the
Company sells general merchandise to its 24 franchisees. As of January 30, 2010,
the Company had 645 retail stores and 307 pharmacies located in 15 states mainly
in the Southeastern United States.
Consolidated Financial
Statements. The Consolidated Financial Statements include the
accounts of the Company and its subsidiaries. All significant
intercompany accounts and transactions are eliminated. Amounts are in
thousands unless otherwise noted.
Fiscal year. The
Company utilizes a 52 — 53 week accounting period which ends on the
Saturday closest to January 31. Fiscal years 2009, 2008 and
2007, as used herein, refer to the years ended January 30, 2010, January 31,
2009 and February 2, 2008, respectively. The fiscal years 2009,
2008 and 2007 each had 52 weeks.
Use of
estimates. The preparation of financial statements in
accordance with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reported period. Actual results
could differ from those estimates and such differences could be material to the
financial statements.
Cash and cash equivalents.
Cash on hand and in banks, together with other highly liquid investments
which are subject to market fluctuations and having original maturities of three
months or less, are classified as cash and cash equivalents.
Allowance for doubtful
accounts. The Company is reimbursed for drugs sold by its pharmacies by
many different payors including insurance companies, Medicare and various state
Medicaid programs. The Company estimates the allowance for doubtful accounts on
a payor-specific basis, given its interpretation of the contract terms or
applicable regulations. However, the reimbursement rates are often subject to
interpretations that could result in payments that differ from the Company’s
estimates. Additionally, updated regulations and contract negotiations occur
frequently, necessitating the Company’s continual review and assessment of the
estimation process. Senior management reviews accounts receivable on a quarterly
basis to determine if any receivables are potentially uncollectible. The Company
includes any accounts receivable balances that are determined to be
uncollectible in our overall allowance for doubtful accounts. After all attempts
to collect a receivable have failed, the receivable is written off against the
allowance account.
Inventories. Merchandise
inventories are valued at the lower of cost or market using the retail first-in,
first-out (FIFO) method for goods in our stores and the cost first-in,
first-out (FIFO) method for goods in our distribution centers. The retail
inventory method is a reverse mark-up, averaging method which has been widely
used in the retail industry for many years. This method calculates a
cost-to-retail ratio that is applied to the retail value of inventory to
determine the cost value of inventory and the resulting cost of goods sold and
gross margin. The assumption that the retail inventory method provides for
valuation at lower of cost or market and the inherent uncertainties therein are
discussed in the following paragraphs. In order to assure valuation at the lower
of cost or market, the retail value of our inventory is adjusted on a consistent
basis to reflect current market conditions. These adjustments include increases
to the retail value of inventory for initial markups to set the selling price of
goods or additional markups to adjust pricing for inflation and decreases to the
retail value of inventory for markdowns associated with promotional, seasonal or
other declines in the market value. Because these adjustments are made on a
consistent basis and are based on current prevailing market conditions, they
approximate the carrying value of the inventory at net realizable value (market
value). Therefore, after applying the cost to retail ratio, the cost value of
our inventory is stated at the lower of cost or market as is prescribed by U.S.
GAAP.
Because
the approximation of net realizable value (market value) under the retail
inventory method is based on estimates such as markups, markdowns and inventory
losses (shrink), there exists an inherent uncertainty in the final determination
of inventory cost and gross margin. In order to mitigate that uncertainty, the
Company has a formal review by product class which considers such variables as
current market trends, seasonality, weather patterns and age of merchandise to
ensure that markdowns are taken currently, or a markdown reserve is established
to cover future anticipated markdowns. This review also considers current
pricing trends and inflation to ensure that markups are taken if necessary. The
estimation of inventory losses (shrink) is a significant element in
approximating the carrying value of inventory at net realizable value, and as
such the following paragraph describes our estimation method as well as the
steps we take to mitigate the risk that this estimate in the determination of
the cost value of inventory.
The
Company calculates inventory losses (shrink) based on actual inventory
losses occurring as a result of physical inventory counts during each fiscal
period and estimated inventory losses occurring between yearly physical
inventory counts. The estimate for shrink occurring in the interim period
between physical counts is calculated on a store-specific basis and is based on
history, as well as performance on the most recent physical count. It is
calculated by multiplying each store’s shrink rate, which is based on the
previously mentioned factors, by the interim period’s sales for each store.
Additionally, the overall estimate for shrink is adjusted at the corporate level
to a three-year historical average to ensure that the overall shrink estimate is
the most accurate approximation of shrink based on the Company’s overall history
of shrink. The three-year historical estimate is calculated by dividing the
“book to physical” inventory adjustments for the trailing 36 months by the
related sales for the same period. In order to reduce the uncertainty inherent
in the shrink calculation, the Company first performs the calculation at the
lowest practical level (by store) using the most current performance indicators.
This ensures a more reliable number, as opposed to using a higher level
aggregation or percentage method. The second portion of the calculation ensures
that the extreme negative or positive performance of any particular store or
group of stores does not skew the overall estimation of shrink. This portion of
the calculation removes additional uncertainty by eliminating short-term peaks
and valleys that could otherwise cause the underlying carrying cost of inventory
to fluctuate unnecessarily. The Company has not experienced any significant
change in shrink as a percentage of sales from year to year during the subject
reporting periods.
Management
believes that the Company’s Retail Inventory Method provides an inventory
valuation which reasonably approximates cost and results in carrying inventory
at the lower of cost or market. For pharmacy inventories, which were
approximately $30.2 million and $30.8 million at January 30, 2010 and
January 31, 2009, respectively, cost was determined using the retail LIFO
(last-in, first-out) method in which inventory cost is maintained using the
Retail Inventory 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 approximately
$21.5 million at January 30, 2010 and $19.1 million at January 31,
2009. The LIFO reserve increased by approximately $2.4 million during 2009, $3.7
million during 2008 and $1.6 million during 2007.
The
Company has historically included an estimate of inbound freight and certain
general and administrative costs in merchandise inventory as prescribed by GAAP.
These costs include activities surrounding the procurement and storage of
merchandise inventory such as merchandise planning and buying, warehousing,
accounting, information technology and human resources, as well as inbound
freight. The total amount of procurement and storage costs and inbound freight
included in merchandise inventory at January 30, 2010 is $17.4 million,
with the corresponding amount of $19.0 million at January 31,
2009.
The
Company recorded a year end below-cost inventory adjustment of approximately
$10.0 million in cost of goods sold in the consolidated statements of
income for the year ended February 2, 2008 to value inventory at the lower
of cost or market in the stores impacted by the Company’s plan to close
approximately 75 stores in fiscal 2008. During the year ended January 31, 2009,
we recorded an additional below-cost inventory adjustment of $0.3 million to
reduce the value of inventory to lower of cost or market associated with stores
that closed in the third quarter and utilized the entire $10.3 million. No
below-cost inventory adjustment was recorded during the year ended January 30,
2010 (see Note 11 Exit and Disposal Activity).
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 depreciated using the straight-line method
over the shorter of the initial term of the lease or the useful life of the
improvement. Leasehold improvements added late in the lease term are depreciated
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. Gains or losses on the sale of assets are
recorded at disposal. The following average estimated useful lives are generally
applied:
|
Estimated Useful Lives
|
Building
and building improvements
|
8 -
31.5 years
|
Furniture,
fixtures and equipment
|
3 -
10 years
|
Leasehold
improvements
|
3 -
10 years or term of lease, if shorter
|
Automobiles
and vehicles
|
3 -
6 years
|
Airplane
|
9
years
|
Assets
under capital lease are depreciated 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.
Leases. Certain operating
leases include rent increases during the initial lease term. For these leases,
the Company recognizes the related rental expense on a straight-line basis over
the term of the lease (which includes the pre-opening period of construction,
renovation, fixturing and merchandise placement) and records the difference
between the amounts charged to operations and amounts paid as a rent liability.
Rent is recognized on a straight-line basis over the lease term, which includes
any rent holiday period.
The
Company recognizes contingent rental expense when the achievement of specified
sales targets are considered probable in accordance with FASB ASC 840 “Leases”.
The amount expensed but not paid was $1.1 million at both January 30, 2010 and
January 31, 2009, and is included in “Accrued expenses and other” in the
consolidated balance sheet (See Note 2).
The
Company occasionally receives reimbursements from landlords to be used towards
construction of the store the Company intends to lease. The reimbursement is
primarily for the purpose of performing work required to divide a much larger
location into smaller segments, one of which the Company will use for its store.
This work could include the addition or demolition of walls, separation of
plumbing, utilities, electrical work, entrances (front and back) and other work
as required. Leasehold improvements are recorded at their gross costs including
items reimbursed by landlords. The reimbursements are initially recorded as a
deferred credit and then amortized as a reduction of rent expense over the
initial lease term.
Based
upon an overall analysis of store performance and expected trends, we
periodically evaluate the need to close underperforming stores. When we
determine that an underperforming store should be closed and a lease obligation
still exists, we record the estimated future liability associated with the
rental obligation on the date the store is closed in accordance with FASB ASC
420, “Exit or Disposal Cost Obligations.” Liabilities are computed based at the
point of closure for the present value of any remaining operating lease
obligations, net of estimated sublease income, and at the communication date for
severance and other exit costs, as prescribed by FASB ASC 420. The assumptions
in calculating the liability include the timeframe expected to terminate the
lease agreement, estimates related to the sublease of potential closed
locations, and estimation of other related exit costs. If the actual timing and
the potential termination costs or realization of sublease income differ from
our estimates, the resulting liabilities could vary from recorded amounts. We
periodically review the liability for closed stores and make adjustments when
necessary.
Impairment of Long-lived assets.
The Company’s policy is to review the carrying value of all long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying value of an asset may not be recoverable. In accordance with FASB
ASC 360, “Impairment or Disposal of Long-Lived Assets,” we review for impairment
all stores open at least 3 years or remodeled for more than two years.
Impairment results when the carrying value of the assets exceeds the
undiscounted future cash flows over the life of the lease. Our estimate of
undiscounted future cash flows over the lease term is based upon historical
operations of the stores and estimates of future store profitability which
encompasses many factors that are subject to management’s judgment and are
difficult to predict. If a long-lived asset is found to be impaired, the amount
recognized for impairment is equal to the difference between the carrying value
and the asset’s fair value. The fair value is based on estimated market values
for similar assets or other reasonable estimates of fair market value based upon
management’s judgment.
In the
fourth quarter of 2007, the Company recorded approximately $4.6 million in
selling, general and administrative expense in the consolidated statements of
income to reflect impairment charges for furniture and fixtures and leasehold
improvements relating to planned fiscal 2008 store closures. During 2008, the
Company recorded an additional charge of $0.1 million associated with stores
closures that occurred in the third quarter. Impairment of $0.2 million for the
planned store closures was recorded in fiscal 2009.
Vendor rebates and allowances.
The Company receives rebates for a variety of merchandising activities,
such as volume commitment rebates, relief for temporary and permanent price
reductions, cooperative advertising programs, and for the introduction of new
products in our stores. FASB ASC 605-50 “Customer Payments and
Incentives” addresses the accounting and income statement classification for
consideration given by a vendor to a retailer in connection with the sale of the
vendor’s products or for the promotion of sales of the vendor’s products. Such
consideration received from vendors is reflected as a decrease in prices paid
for inventory and recognized in cost of sales as the related inventory is sold,
unless specific criteria are met qualifying the consideration for treatment as
reimbursement of specific, identifiable incremental costs.
Selling, general and administrative
expenses. The Company includes buying, warehousing, distribution,
advertising, depreciation and amortization and occupancy costs in selling,
general and administrative expenses.
Advertising. In accordance
with FASB ASC 720-35 “Advertising Costs”, the Company charges advertising,
including production costs, to selling, general and administrative expense on
the first day of the advertising period. Gross advertising expenses for 2009,
2008 and 2007, were $24.0 million, $24.1 million and $27.6 million,
respectively. Gross advertising expenses were reduced by vendor cooperative
advertising allowances of $2.6 million, $2.3 million and $1.5 million
for 2009, 2008 and 2007, respectively. It would be the Company’s intention to
incur a similar amount of advertising expense as in prior years and in support
of our stores even if we did not receive support from our vendors in the form of
cooperative adverting allowances.
Preopening costs. The Company
charges to expense the preopening costs of new stores as incurred. These costs
are primarily labor to stock the store, rent, preopening advertising, store
supplies and other expendable items.
Revenue Recognition. The
Company markets goods and services through Company owned stores and 24
franchised stores as of January 30, 2010. Net sales includes sales of
merchandise from Company owned stores, net of returns and exclusive of sales
taxes. Sales to franchised stores are recorded when the merchandise is shipped
from the Company’s warehouse. Revenues resulting from layaway sales are recorded
upon delivery of the merchandise to the customer.
The
Company also sells gift cards for which the revenue is recognized at time of
redemption. The Company records a gift card liability on the date the gift card
is issued to the customer. Revenue is recognized and the gift card liability is
reduced as the customer redeems the gift card. The Company will recognize aged
liabilities as revenue when the likelihood of the gift card being redeemed is
remote (gift card breakage). The Company has not recognized any revenue from
gift card breakage since the inception of the program in May 2004 and does
not expect to record any gift card breakage revenue until there is more
certainty regarding our ability to retain such amounts in light of current
consumer protection and state escheatment laws.
In
addition, the Company charges the franchised stores a fee based on a percentage
of their purchases from the Company. These fees represent a reimbursement for
use of the FRED’S name and other administrative costs incurred on behalf of the
franchised stores and are therefore netted against selling, general and
administrative expenses. Total franchise income for 2009, 2008 and 2007 was $2.1
million, $2.1 million and $2.0 million, respectively.
Other intangible assets. Other
identifiable intangible assets, which are included in other noncurrent assets,
primarily represent customer lists associated with acquired pharmacies and are
being amortized on a straight-line basis over five years. Intangibles, net of
accumulated amortization, totaled $15.9 million at January 30, 2010, and $9.0
million at January 31, 2009. Accumulated amortization at January 30, 2010 and
January 31, 2009 totaled $19.3 million and $15.6 million, respectively.
Amortization expense for 2009, 2008 and 2007, was $3.7 million, $2.6 million and
$2.4 million, respectively. Estimated amortization expense in millions for each
of the next 5 years is as follows: 2010 - $4.2, 2011 - $3.6, 2012 - $3.2,
2013 - $2.7 and 2014 - $1.2.
Financial instruments. At
January 30, 2010, the Company did not have any outstanding derivative
instruments. The recorded value of the Company’s financial instruments, which
include cash and cash equivalents, receivables, accounts payable and
indebtedness, approximates fair value. The following methods and assumptions
were used to estimate fair value of each class of financial instrument:
(1) the carrying amounts of current assets and liabilities approximate fair
value because of the short maturity of those instruments and (2) the fair
value of the Company’s indebtedness is estimated based on the current borrowing
rates available to the Company for bank loans with similar terms and average
maturities. Most of our indebtedness is under variable interest
rates.
Insurance reserves. The
Company is largely self-insured for workers compensation, general liability and
employee medical insurance. The Company’s liability for self-insurance is
determined based on claims known at the time of determination of the reserve and
estimates for future payments against incurred losses and claims that have been
incurred but not reported. Estimates for future claims costs include uncertainty
because of the variability of the factors involved, such as the type of injury
or claim, required services by the providers, healing time, age of claimant,
case management costs, location of the claimant, and governmental regulations.
These uncertainties or a deviation in future claims trends from recent
historical patterns could result in the Company recording additional expenses or
expense reductions that might be material to the Company’s results of
operations. The Company carries additional coverage for excessive or
catastrophic claims with stop loss limits of $250,000 to $500,000 for property
and general liability and $200,000 for employee medical. The Company’s insurance
reserve was $9.0 million and $8.6 million on January 30, 2010 and
January 31, 2009, respectively. Changes in the reserve during fiscal 2009 were
attributable to additional reserve requirements of $44.6 million netted
with reserve utilization of $44.2 million.
Stock-based compensation.
Effective January 29, 2006, the Company adopted the fair value
recognition provisions of FASB ASC 718, “Compensation – Stock Compensation”,
using the modified prospective transition method. Under this method,
compensation expense recognized post adoption includes: (1) compensation
expense for all share-based payments granted prior to, but not yet vested as of
January 29, 2006, based on the grant date fair value estimated in
accordance with the original provisions of FASB ASC 718, and
(2) compensation cost for all share-based payments granted subsequent to
January 29, 2006, based on the grant date fair value estimated in
accordance with the provisions of FASB ASC 718. Results for prior periods have
not been restated.
Effective
January 29, 2006, the Company elected to adopt the alternative transition
method provided in FASB ASC 718 for calculating the income tax effects of
stock-based compensation. The alternative transition method includes simplified
methods to establish the beginning balance of the additional paid-in-capital
pool (“APIC Pool”) related to the income tax effects of stock based
compensation, and for determining the subsequent impact on the APIC pool and
consolidated statements of cash flows of the income tax effects of stock-based
compensation awards that are outstanding upon adoption of FASB ASC
718.
FASB ASC
718 also requires the benefits of income tax deductions in excess of recognized
compensation cost to be reported as a financing cash flow, rather than as an
operating cash flow. The impact of adopting FASB ASC 718 on future results will
depend on, among other things, levels of share-based payments granted in the
future, actual forfeiture rates and the timing of option exercises.
Stock-based
compensation expense, post adoption of FASB ASC 718, is based on awards
ultimately expected to vest, and therefore has been reduced for estimated
forfeitures. Forfeitures are estimated at the time of grant based on the
Company’s historical forfeiture experience and will be revised in subsequent
periods if actual forfeitures differ from those estimates.
Income taxes. The Company
reports income taxes in accordance with FASB ASC 740, “Income Taxes.” Under FASB
ASC 740, the asset and liability method is used for computing future income tax
consequences of events, which have been recognized in the Company’s Consolidated
Financial Statements or income tax returns. Deferred income tax expense or
benefit is the net change during the year in the Company’s deferred income tax
assets and liabilities (see Note 4 – Income Taxes).
In
June 2006, the Financial Accounting Standards Board issued FASB
Interpretation No. 48 (“FASB ASC 740”), Accounting for Uncertainty in
Income Taxes – An Interpretation of FASB Statement 109. Effective
February 4, 2007, we adopted FASB ASC 740, which clarifies the accounting
for uncertainties in income taxes recognized in the Company’s financial
statements in accordance with FASB ASC 740 by defining the criterion that an
individual tax position must meet in order to be recognized in the financial
statements. FASB ASC 740 requires that the tax effects of a position be
recognized only if it is “more-likely-than-not” to be sustained based solely on
the technical merits as of the reporting date (see Note 4 – Income
Taxes).
Business segments. The Company
operates in a single reportable operating segment.
Comprehensive income.
Comprehensive income consists of two components, net income and other
comprehensive income (loss). Other comprehensive income (loss) refers to
gains and losses that under generally accepted accounting principles are
recorded as an element of stockholders’ equity but are excluded from net income.
The Company’s accumulated other comprehensive income includes the effect of
adopting SFAS No. 158, Employers’ Accounting for Defined Benefit Pension
and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88,
106, and 132(R)(“SFAS No. 158”) codified in FASB ASC 715 “Compensation –
Retirement Benefits”. See Note 9, Commitments and Contingencies, in the Notes to
Consolidated Financial Statements for further discussion.
Reclassifications. Certain
prior year amounts have been reclassified to conform to the 2009
presentation.
Recent Accounting Pronouncements.
In June 2009, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 168, “The FASB
Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles – a replacement of SFAS No. 162” (“FASB ASC 105”). FASB
ASC 105 modifies the GAAP hierarchy by establishing only two levels of GAAP,
authoritative and nonauthoritative accounting literature. Effective July 2009,
the FASB Accounting Standards Codification (“ASC”), also known collectively as
the “Codification”, is considered the single source of authoritative U.S.
accounting and reporting standards, except for additional authoritative rules
and interpretive releases issued by the SEC. The Codification was developed to
organize GAAP pronouncements by topic so that users can more easily access
authoritative accounting guidance. FASB ASC 105 became effective for the third
quarter of fiscal year 2009. All other accounting standards references have been
updated in this report with ASC references.
In May
2009, the FASB issued FASB ASC 855, “Subsequent Events”, which establishes
general standards of accounting for and disclosure of events that occur after
the balance sheet date but before financial statements are issued or are
available to be issued. FASB ASC 855 requires issuers to reflect in
their financial statements and disclosures the effects of subsequent events that
provide additional evidence about conditions at the balance sheet
date. Disclosures should include the nature of the event and either
an estimate of its financial effect or a statement that an estimate cannot be
made. This standard also requires issuers to disclose the date
through which they have evaluated subsequent events and whether the date
corresponds with the release of their financial statements. The
Company adopted FASB ASC 855 as of the interim period ended August 1,
2009. As the requirements under FASB ASC 855 are consistent with its
current practice, the implementation of this standard did not have an impact on
the Company’s consolidated financial statements.
In June
2008, the FASB issued FASB ASC 260, which addresses whether instruments granted
in share-based payment transactions are participating securities prior to
vesting and therefore need to be included in the earnings allocation in
computing earnings per share (EPS) under the two-class method described in FASB
ASC 260, “Earnings Per Share”. This FASB ASC is effective for fiscal
periods beginning after December 15, 2008. The Company adopted FASB
ASC 260 in the quarter ended May 2, 2009 and determined that it had no
significant impact on its results of operations or financial
position.
In
September 2006, the FASB issued FASB ASC 820, “Fair Value Measurements and
Disclosures”. FASB ASC 820 provides a single definition of fair
value, together with a framework for measuring it, and requires additional
disclosure about the use of fair value to measure assets and
liabilities. FASB ASC 820 also emphasizes that fair value is a
market-based measurement, not an entity-specific measurement, and sets out a
fair value hierarchy with the highest priority being quoted prices in active
markets. Under FASB ASC 820, fair value measurements are required to
be disclosed by level within that hierarchy. FASB ASC 820 is
effective for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. However, FASB ASC 820-10-65-1,
issued in February 2008, delays the effective date of FASB ASC 820 for all
nonfinancial assets and nonfinancial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis, to fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years. The Company adopted FASB ASC 820 effective
February 3, 2008, and its adoption did not have a material effect on its results
of operations or financial position. The Company has also evaluated
FASB ASC 820-10-65-1 and determined that it had no impact on its results of
operations or financial position. In October 2008, the FASB issued
ASC 820-10-65-2, “Determining the Fair Value of a Financial Asset When the
Market for That Asset Is Not Active”. FASB ASC 820-10-65-2 clarifies the
application of FASB ASC 820 when the market for a financial asset is inactive.
The guidance in FASB ASC 820-10-65-2 is effective immediately and has no effect
on our financial statements. In April 2009, the FASB issued ASC
820-10-65-4, “Determining Fair Value When the Level and Volume of Activity for
the Asset or Liability have Significantly Decreased and Identifying Transactions
That Are Not Orderly” which further clarifies the principles established by FASB
ASC 820. The guidance is effective for the periods ending after June
15, 2009 with early adoption permitted for the periods ending after March 15,
2009. The Company has evaluated FASB ASC 820-10-65-4 and determined
that it had no impact on its results of operations or financial
position.
NOTE
2 – DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
|
|
(in thousands)
|
|
|
|
2009
|
|
|
2008
|
|
Property
and equipment, at cost:
|
|
|
|
|
|
|
Buildings
and building improvements
|
|
$ |
95,844 |
|
|
$ |
91,826 |
|
Leasehold
improvements
|
|
|
55,078 |
|
|
|
49,775 |
|
Automobiles
and vehicles
|
|
|
5,273 |
|
|
|
5,223 |
|
Airplane
|
|
|
4,697 |
|
|
|
4,697 |
|
Furniture,
fixtures and equipment
|
|
|
240,883 |
|
|
|
230,272 |
|
|
|
|
401,775 |
|
|
|
381,793 |
|
Less:
Accumulated depreciation and amortization
|
|
|
(271,185 |
) |
|
|
(251,002 |
) |
|
|
|
130,590 |
|
|
|
130,791 |
|
Construction
in progress
|
|
|
446 |
|
|
|
912 |
|
Land
|
|
|
6,533 |
|
|
|
6,333 |
|
Total
Property and equipment, at depreciated cost
|
|
$ |
137,569 |
|
|
$ |
138,036 |
|
Depreciation
expense totaled $22.7 million, $23.9 million and $26.2 million for 2009, 2008
and 2007, respectively.
|
|
(in thousands)
|
|
|
|
2009
|
|
|
2008
|
|
Other non trade receivables:
|
|
|
|
|
|
|
|
|
Vendor
receivables
|
|
$ |
14,814 |
|
|
$ |
12,381 |
|
Income
tax receivable
|
|
|
6,762 |
|
|
|
220 |
|
Franchise
stores receivable
|
|
|
1,334 |
|
|
|
1,026 |
|
Insurance
claims receivable
|
|
|
892 |
|
|
|
112 |
|
Landlord
receivables
|
|
|
- |
|
|
|
109 |
|
Other
|
|
|
1,391 |
|
|
|
1,934 |
|
Total
non trade receivable
|
|
$ |
25,193 |
|
|
$ |
15,782 |
|
|
|
2009
|
|
|
2008
|
|
Prepaid expenses and other current assets:
|
|
|
|
|
|
|
|
|
Prepaid
rent
|
|
$ |
4,059 |
|
|
$ |
4,045 |
|
Supplies
|
|
|
3,904 |
|
|
|
5,002 |
|
Prepaid
insurance
|
|
|
1,447 |
|
|
|
1,351 |
|
Prepaid
advertising
|
|
|
590 |
|
|
|
434 |
|
Other
|
|
|
945 |
|
|
|
1,080 |
|
Total
prepaid expenses and other current assets
|
|
$ |
10,945 |
|
|
$ |
11,912 |
|
|
|
2009
|
|
|
2008
|
|
Accrued expenses and other:
|
|
|
|
|
|
|
Payroll
and benefits
|
|
$ |
10,454 |
|
|
$ |
9,738 |
|
Insurance
reserves
|
|
|
8,994 |
|
|
|
8,633 |
|
Sales
and use tax
|
|
|
5,627 |
|
|
|
5,090 |
|
Deferred
/ contingent rent
|
|
|
2,507 |
|
|
|
3,150 |
|
Legal
settlement and related fees
|
|
|
1,521 |
|
|
|
6,600 |
|
Lease
liability
|
|
|
1,421 |
|
|
|
4,341 |
|
Other
|
|
|
9,097 |
|
|
|
9,107 |
|
Total
accrued expenses and other
|
|
$ |
39,621 |
|
|
$ |
46,659 |
|
|
|
2009
|
|
|
2008
|
|
Other current liabilities:
|
|
|
|
|
|
|
|
|
Unrecognized
tax benefit related to IRS exam (see Note 4 - Income Taxes in our Form
10-K filed on April 16, 2009)
|
|
$ |
- |
|
|
$ |
7,749 |
|
|
|
(in thousands)
|
|
|
|
2009
|
|
|
2008
|
|
Other noncurrent liabilities:
|
|
|
|
|
|
|
|
|
ASC
740 liability
|
|
$ |
9,193 |
|
|
$ |
8,760 |
|
Deferred
income (see Note 1 - Vendor Rebates and Allowances)
|
|
|
7,474 |
|
|
|
4,677 |
|
Other
|
|
|
542 |
|
|
|
396 |
|
|
|
$ |
17,209 |
|
|
$ |
13,833 |
|
NOTE 3 —
INDEBTEDNESS
On
September 16, 2008, the Company and Regions Bank entered into a Ninth Loan
Modification of the Revolving Loan and Credit Agreement which decreased the
credit line from $75 million to $60 million and extended the term until July 31,
2011. All other terms, conditions and covenants remained in place
after the amendment, with only a slight modification to one of the financial
covenants required by the Agreement. Under the most restrictive
covenants of the Agreement, the Company is required to maintain specified
shareholders’ equity (which was $312.4 million at January 30, 2010) and net
income levels. Borrowings and the unused fees under the agreement
bear interest at a tiered rate based on the Company’s previous four quarter
average of the Fixed Charge Coverage Ratio. Currently the Company is
at 125 basis points over LIBOR for borrowings and 25 basis points over LIBOR for
the unused fee. There were no borrowings outstanding under the
Agreement at January 30, 2010 and January 31, 2009.
During
the second and third quarter of fiscal 2007, the Company acquired the land and
buildings, occupied by 7 FRED’S stores which we had previously leased. In
consideration for the 7 properties, the Company assumed debt that has fixed
interest rates from 6.31% to 7.40%. The debt is collateralized by the land and
building. The table below shows the long term debt related to these properties
due for the next five years as of January 30, 2010:
(dollars in thousands)
|
|
2010
|
|
|
2011
|
|
|
2012
|
|
|
2013
|
|
|
2014
|
|
|
Thereafter
|
|
|
Total
|
|
Mortgage
loans on land & buildings
|
|
$ |
718 |
|
|
$ |
161 |
|
|
$ |
170 |
|
|
$ |
1,109 |
|
|
$ |
525 |
|
|
$ |
2,214 |
|
|
$ |
4,897 |
|
The
Company financed the construction of its Dublin, Georgia distribution center
with taxable industrial development revenue bonds issued by the City of Dublin
and County of Laurens Development Authority. The Company purchased 100% of the
issued bonds and intends to hold them to maturity, effectively financing the
construction with internal cash flow. Because a legal right of offset exists,
the Company has offset the investment in the bonds ($34.6 million) against
the related liability and neither is reflected on the consolidated balance
sheet.
NOTE 4 — INCOME TAXES
The
provision for income taxes consists of the following:
(dollars in thousands)
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Current
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$ |
7,782 |
|
|
$ |
12,677 |
|
|
$ |
10,886 |
|
State
|
|
|
872 |
|
|
|
671 |
|
|
|
664 |
|
|
|
|
8,654 |
|
|
|
13,348 |
|
|
|
11,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
4,985 |
|
|
|
(3,478 |
) |
|
|
(5,354 |
) |
State
|
|
|
947 |
|
|
|
(602 |
) |
|
|
(1,250 |
) |
|
|
|
5,932 |
|
|
|
(4,080 |
) |
|
|
(6,604 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
14,586 |
|
|
$ |
9,268 |
|
|
$ |
4,946 |
|
The
income tax effects of temporary differences that give rise to significant
portions of the deferred income tax assets and deferred income tax liabilities
are presented below:
(dollars in thousands)
|
|
2009
|
|
|
2008
|
|
Deferred
income tax assets:
|
|
|
|
|
|
|
Accrual
for incentive compensation
|
|
$ |
- |
|
|
$ |
614 |
|
Allowance
for doubtful accounts
|
|
|
392 |
|
|
|
479 |
|
Insurance
accruals
|
|
|
2,365 |
|
|
|
2,411 |
|
Other
accruals
|
|
|
496 |
|
|
|
133 |
|
Net
operating loss carryforwards
|
|
|
5,778 |
|
|
|
5,033 |
|
Postretirement
benefits other than pensions
|
|
|
279 |
|
|
|
238 |
|
Reserve
for below cost inventory adjustment
|
|
|
- |
|
|
|
110 |
|
Legal
reserve
|
|
|
- |
|
|
|
2,581 |
|
Deferred
revenue
|
|
|
994 |
|
|
|
730 |
|
Federal
benefit on state reserves
|
|
|
2,985 |
|
|
|
4,064 |
|
Amortization
of intangibles
|
|
|
5,608 |
|
|
|
4,969 |
|
Total
deferred income tax assets
|
|
|
18,897 |
|
|
|
21,362 |
|
Less:
Valuation allowance
|
|
|
2,123 |
|
|
|
1,609 |
|
Deferred
income tax assets, net of valuation allowance
|
|
|
16,774 |
|
|
|
19,753 |
|
|
|
|
|
|
|
|
|
|
Deferred
income tax liabilities:
|
|
|
|
|
|
|
|
|
Property,
plant and equipment
|
|
|
(15,056 |
) |
|
|
(14,446 |
) |
Inventory
valuation
|
|
|
(21,664 |
) |
|
|
(18,888 |
) |
Prepaid
expenses
|
|
|
(1,436 |
) |
|
|
(808 |
) |
Total
deferred income tax liabilities
|
|
|
(38,156 |
) |
|
|
(34,142 |
) |
|
|
|
|
|
|
|
|
|
Net
deferred income tax liabilities
|
|
$ |
(21,382 |
) |
|
$ |
(14,389 |
) |
The net
operating loss carryforwards are available to reduce state income taxes in
future years. These carryforwards total approximately $135.7 million for
state income tax purposes and expire at various times during the period 2010
through 2029.
During
2009, the valuation allowance increased $.5 million, and during 2008, the
valuation allowance decreased $.1 million. Based upon expected future
income, management believes that it is more likely than not that the results of
operations will generate sufficient taxable income to realize the deferred
income tax asset after giving consideration to the valuation
allowance.
A
reconciliation of the statutory federal income tax rate to the effective income
tax rate is as follows:
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Income
tax provision at statutory rate
|
|
|
35.0 |
% |
|
|
35.0 |
% |
|
|
35.0 |
% |
Tax
credits, principally jobs
|
|
|
(3.6 |
) |
|
|
(3.8 |
) |
|
|
(9.9 |
) |
State
income taxes, net of federal benefit
|
|
|
1.9 |
|
|
|
1.3 |
|
|
|
(0.7 |
) |
Permanent
differences
|
|
|
1.2 |
|
|
|
0.2 |
|
|
|
2.2 |
|
Uncertain
tax provisions
|
|
|
3.1 |
|
|
|
3.4 |
|
|
|
5.1 |
|
Change
in valuation allowance
|
|
|
1.4 |
|
|
|
(0.3 |
) |
|
|
(0.1 |
) |
Other
|
|
|
(0.8 |
) |
|
|
- |
|
|
|
- |
|
Effective
income tax rate
|
|
|
38.2 |
% |
|
|
35.8 |
% |
|
|
31.6 |
% |
In
June 2006, the Financial Accounting Standards Board issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an
Interpretation of FASB Statement No.109 which is codified in FASB ASC 740,
“Income Taxes”. We adopted FASB ASC 740 as of February 4, 2007, the first
day of fiscal 2007. This interpretation clarifies the accounting for uncertainty
in income taxes recognized in an enterprise’s financial statements and
prescribes a minimum recognition threshold of more-likely-than-not to be
sustained upon examination that a tax position must meet before being recognized
in the financial statements. Under FASB ASC 740, the impact of an uncertain
income tax position on the income tax return must be recognized at the largest
amount that is more-likely-than-not to be sustained upon audit by the relevant
taxing authority. An uncertain income tax position will not be recognized if it
has less than a 50% likelihood of being sustained. Additionally, FASB ASC 740
provides guidance on de-recognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and
transition.
As a
result of the adoption of FASB ASC 740, we recognized a cumulative effect
adjustment of a $4.2 million decrease to beginning retained earnings and a
reclassification of certain amounts between deferred income tax liabilities
($2.3 million decrease) and other non-current liabilities
($6.5 million increase, including $1.0 million of interest and
penalties) to conform to the balance sheet presentation requirements of FASB ASC
740. The Company increased the gross reserve for uncertain tax positions from
$6.5 million to $7.3 million, a change of $0.8 million to
disclose the gross liability rather than reflect the liability net of federal
income tax benefit.
A
reconciliation of the beginning and ending amount of the unrecognized tax
benefits is as follows:
(in millions)
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Beginning
balance
|
|
$ |
16.5 |
|
|
$ |
8.4 |
|
|
$ |
7.3 |
|
Additions
for tax position during the current year
|
|
|
1.0 |
|
|
|
1.1 |
|
|
|
1.5 |
|
Additions
for tax positions of prior years
|
|
|
1.0 |
|
|
|
7.7 |
|
|
|
0.4 |
|
Reductions
for tax positions of prior years from lapse of statue
|
|
|
(0.7 |
) |
|
|
(0.7 |
) |
|
|
(0.8 |
) |
Reductions
for settlements of prior year tax positions
|
|
|
(8.6 |
) |
|
|
- |
|
|
|
- |
|
Ending
balance
|
|
$ |
9.2 |
|
|
$ |
16.5 |
|
|
$ |
8.4 |
|
As of
January 31, 2009, our liability for unrecognized tax benefits totaled
$16.5 million, of which $0.6 million and $0.1 million were
recognized as income tax benefit during the quarterly periods ending
October 31, 2009 and January 31, 2010, respectively, as a result of a lapse
in applicable statute of limitations. We had additions of $2.0
million during fiscal 2009, $1.0 million of which resulted from state tax
positions during the current year and $1.0 million resulted from the Internal
Revenue Service finalizing an exam of the Company during 2009 covering fiscal
years 2004 through 2007. The Company recorded a reduction to
unrecognized tax benefits for settlement of the IRS exam which included tax and
interest in the amount of $8.6 million. The adjustments resulted from
the IRS exam related primarily to timing differences. As of January
30, 2010, our liability for unrecognized tax benefits totaled $9.2 million
and is recorded in our consolidated balance sheet within “Other noncurrent
liabilities,” all of which, if recognized, would affect our effective tax
rate. The Company is under examination by state jurisdictions which
are expected to be completed within the next 12 months.
FASB ASC
740 further requires that interest and penalties required to be paid by the tax
law on the underpayment of taxes should be accrued on the difference between the
amount claimed or expected to be claimed on the tax return and the tax benefit
recognized in the financial statements. The Company includes potential interest
and penalties recognized in accordance with FASB ASC 740 in the financial
statements as a component of income tax expense. As of January 30, 2010, accrued
interest and penalties related to our unrecognized tax benefits totaled
$1.4 million and $0.3 million, respectively. As of January 31,
2009, accrued interest and penalties related to our unrecognized tax benefits
totaled $2.4 million and $0.4 million, respectively. Both
accrued interest and penalties are recorded in the consolidated balance sheet
within “Other non-current liabilities.”
The
Company files numerous consolidated and separate company income tax returns in
the U.S. federal jurisdiction and in many U.S. state jurisdictions. With few
exceptions, we are subject to U.S. federal, state, and local income tax
examinations by tax authorities for years 2006-2008. However, tax authorities
have the ability to review years prior to these to the extent we utilized tax
attributes carried forward from those prior years.
NOTE
5 — LONG-TERM LEASES
The
Company leases certain of its store locations under noncancelable operating
leases that require monthly rental payments primarily at fixed rates (although a
number of the leases provide for additional rent based upon sales) expiring at
various dates through 2029. None of our operating leases contain residual value
guarantees. 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 and transportation equipment under noncancelable operating
leases and certain transportation equipment under capital leases. There were no
capital lease payments remaining as of January 30, 2010. Total rent
expense under operating leases was $53.2 million, $54.1 million and $54.5
million, for 2009, 2008 and 2007, respectively. Total contingent rentals
included in operating leases above was $1.1 million for 2009, 2008 and
2007.
Future
minimum rental payments under all operating leases as of January 30, 2010 are as
follows:
(in thousands)
|
|
Operating Leases
|
|
2010
|
|
$ |
45,273 |
|
2011
|
|
|
40,440 |
|
2012
|
|
|
33,851 |
|
2013
|
|
|
23,558 |
|
2014
|
|
|
15,148 |
|
Thereafter
|
|
|
26,724 |
|
Total
minimum lease payments
|
|
$ |
184,994 |
|
The gross
amount of property and equipment under capital leases was $5.0 million at
January 30, 2010 and January 31, 2009. Accumulated depreciation on property and
equipment under capital leases was $5.0 million and $4.9 million at January 30,
2010 and January 31, 2009, respectively. Depreciation expense on
assets under capital lease for 2009, 2008 and 2007, was $39 thousand, $92
thousand and $258 thousand, respectively.
Related Party
Transactions
During
the year ended February 2, 2008, Atlantic Retail Investors, LLC, which is
partially owned by Michael J. Hayes, Chairman of the Board of Directors,
purchased the land and buildings occupied by thirteen FRED’S stores. The stores
were purchased by Atlantic Retail Investors, LLC from an independent
landlord/developer. Prior to the purchase by Atlantic Retail Investors, LLC the
Company was offered the right to purchase the same stores and declined the
offer. The terms and conditions regarding the leases on these locations are
consistent in all material respects with other store leases of the Company. The
total rental payments related to these leases were $1.3 million and
$1.4 million for the years ended January 30, 2010 and January 31, 2009,
respectively. Total future commitments under related party leases are
$9.7 million.
NOTE 6 — SHAREHOLDERS’
EQUITY
In 1998,
the Company adopted a Shareholders Rights Plan which granted a dividend of one
preferred share purchase right (a “Right”) for each common share outstanding at
that date. Each Right represents the right to purchase one-hundredth of a
preferred share of stock at a preset price to be exercised when any one
individual, firm, corporation or other entity acquires 15% or more of the
Company’s common stock. The Rights become dilutive at the time of
exercise. The Shareholders Rights Plan was renewed in October 2008
and if unexercised, the Rights will expire in October 2018.
On
March 6, 2002, the Company filed a Registration Statement on Form S-3
registering 750,000 shares of Class A common stock. The common stock may be
used from time to time as consideration in the acquisition of assets, goods, or
services for use or sale in the conduct of our business. As of February 2, 2008,
the Company had 198,813 shares of Class A common stock available to be
issued from the March 6, 2002 Registration Statement. On December 31,
2008, the Registration Statement expired and the Company has not elected to
renew the statement.
Purchases of Equity Securities by the
Issuer and Affiliated Purchasers.
On
August 27, 2007, the Board of Directors approved a plan that authorized
stock repurchases of up to 4.0 million shares of the Company’s common
stock. Under the plan, the Company may repurchase its common stock in open
market or privately negotiated transactions at such times and at such prices as
determined to be in the Company’s best interest. These purchases may be
commenced or suspended without prior notice depending on then-existing business
or market conditions and other factors. The following table sets forth the
amounts of our common stock purchased by the Company during the fiscal year
ended January 30, 2010 (amounts in thousands, except price data). The
repurchased shares have been cancelled and returned to authorized but un-issued
shares.
|
|
Total Number of
Shares Purchased
|
|
|
Average Price Paid
Per Share
|
|
|
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Program
|
|
|
Maximum Number of
Shares That May Yet Be
Purchased Under the
Plans or Program
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February
3, 2008 - January 31, 2009
|
|
|
- |
|
|
$ |
- |
|
|
|
- |
|
|
|
3,573.5 |
|
February
1, 2009 - January 30, 2010
|
|
|
742.7 |
|
|
$ |
9.61 |
|
|
|
742.7 |
|
|
|
2,830.8 |
|
NOTE 7 – EQUITY INCENTIVE
PLANS
Incentive stock option plan.
The Company has a long-term incentive plan, which was approved by FRED’S
stockholders, under which an aggregate of 1,631,758 shares as of January 30,
2010 (2,023,079 shares as of January 31, 2009) are available to be granted.
These options expire five years to seven and one-half years from the date of
grant. Options outstanding at January 30, 2010 expire in fiscal 2010 through
fiscal 2016.
The
Company grants stock options to key employees including executive officers, as
well as other employees, as prescribed by the Compensation Committee (the
“Committee”) of the Board of Directors. The number of options granted is
directly linked to the employee’s job classification. Options, which include
non-qualified stock options and incentive stock options, are rights to purchase
a specified number of shares of FRED’S common stock at a price fixed by the
Committee. Stock options granted have an exercise price equal to the market
price of FRED’S common stock on the date of grant. The exercise price for stock
options issued under the plan that qualify as incentive stock options within the
meaning of Section 422(b) of the Code shall not be less than 100% of the fair
value as of the date of grant. The option exercise price may be satisfied in
cash or by exchanging shares of FRED’S common stock owned by the optionee for at
least six months, or a combination of cash and shares. Options have a maximum
term of five to seven and one-half years from the date of grant. Options granted
under the plan generally become exercisable ratably over five years or ten
percent during each of the first four years on the anniversary date and sixty
percent on the fifth anniversary date. The rest vest ratably over the requisite
service period. Stock option expense is generally recognized using the graded
vesting attribution method. The plan contains a non-compete provision and a
provision that if the Company meets or exceeds a specified operating income
margin during the most recently completed fiscal year that the annual vesting
percentage will accelerate from ten to twenty percent during that vesting
period. The plan also provides for annual stock grants at the fair value of the
stock on the grant date to non-employee directors according to a
non-discretionary formula. The number of shares granted is dependent upon
current director compensation levels.
Employee Stock Purchase Plan.
The 2004 Employee Stock Purchase Plan (the “2004 Plan”), which was
approved by FRED’S stockholders, permits eligible employees to purchase shares
of our common stock through payroll deductions at the lower of 85% of the fair
market value of the stock at the time of grant or 85% of the fair market value
at the time of exercise. There were 60,350, 73,084 and 71,294 shares issued
during fiscal years 2009, 2008 and 2007, respectively. There are 1,410,928
shares approved to be issued under the 2004 Plan and as of January 30, 2010
there were 1,090,513 shares available.
The
following represents total stock based compensation expense (a component of
selling, general and administrative expenses) recognized in the consolidated
financial statements (in
thousands):
(in thousands)
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Stock
option expense
|
|
$ |
789 |
|
|
$ |
526 |
|
|
$ |
1,312 |
|
Restricted
stock expense
|
|
|
573 |
|
|
|
282 |
|
|
|
591 |
|
ESPP
expense
|
|
|
233 |
|
|
|
182 |
|
|
|
213 |
|
Total
stock-based compensation
|
|
|
1,595 |
|
|
|
990 |
|
|
|
2,116 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit on stock-based compensation
|
|
$ |
364 |
|
|
$ |
228 |
|
|
$ |
340 |
|
The
Company uses the Modified Black-Scholes Option Valuation Model (“BSM”) to
measure the fair value of stock options granted to employees. The BSM option
valuation model was developed for use in estimating the fair value of traded
options, which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of highly subjective
assumptions including the expected stock volatility and option life. Because the
Company’s employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective assumptions
can materially affect the fair value estimate, in management’s opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
The fair
value of each option granted is estimated on the date of grant using the BSM
with the following weighted average assumptions:
Stock Options
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Expected
volatility
|
|
|
42.5 |
% |
|
|
40.1 |
% |
|
|
42.8 |
% |
Risk-free
interest rate
|
|
|
2.6 |
% |
|
|
3.3 |
% |
|
|
4.1 |
% |
Expected
option life (in years)
|
|
|
5.84 |
|
|
|
5.84 |
|
|
|
5.84 |
|
Expected
dividend yield
|
|
|
0.6 |
% |
|
|
0.5 |
% |
|
|
0.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average fair value at grant date
|
|
$ |
4.66 |
|
|
$ |
4.53 |
|
|
$ |
4.68 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
Stock Purchase Plan
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected
volatility
|
|
|
73.2 |
% |
|
|
36.8 |
% |
|
|
37.2 |
% |
Risk-free
interest rate
|
|
|
0.1 |
% |
|
|
3.1 |
% |
|
|
4.7 |
% |
Expected
option life (in years)
|
|
|
0.63 |
|
|
|
0.63 |
|
|
|
0.63 |
|
Expected
dividend yield
|
|
|
0.4 |
% |
|
|
0.4 |
% |
|
|
0.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average fair value at grant date
|
|
$ |
3.85 |
|
|
$ |
2.48 |
|
|
$ |
3.31 |
|
The
following is a summary of the methodology applied to develop each
assumption:
Expected Volatility —
This is a measure of the amount by which a price has fluctuated or is expected
to fluctuate. The Company uses actual historical changes in the market value of
our stock to calculate expected price volatility because management believes
that this is the best indicator of future volatility. The Company calculates
weekly market value changes from the date of grant over a past period
representative of the expected life of the options to determine volatility. An
increase in the expected volatility will increase compensation
expense.
Risk-free Interest
Rate — This is the yield of a U.S. Treasury zero-coupon bond issue
effective at the grant date with a remaining term equal to the expected life of
the option. An increase in the risk-free interest rate will increase
compensation expense.
Expected Lives — This
is the period of time over which the options granted are expected to remain
outstanding and is based on historical experience. Options granted have a
maximum term of seven and one-half years. An increase in the expected life will
increase compensation expense.
Dividend Yield — This
is based on the historical yield for a period equivalent to the expected life of
the option. An increase in the dividend yield will decrease compensation
expense.
Forfeiture Rate —
This is the estimated percentage of options granted that are expected to be
forfeited or cancelled before becoming fully vested. This estimate is based on
historical experience. An increase in the forfeiture rate will decrease
compensation expense.
Stock Options. The following
table summarizes stock option activity from February 3, 2007 through January 30,
2010:
|
|
Options
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Weighted-
Averaged
Contractual Life(years)
|
|
|
Aggregate
Intrinsic Value
(000s)
|
|
Outstanding
at February 3, 2007
|
|
|
1,103,064 |
|
|
$ |
16.74 |
|
|
|
4.2 |
|
|
$ |
298 |
|
Granted
|
|
|
270,552 |
|
|
|
10.97 |
|
|
|
|
|
|
|
|
|
Forfeited
/ Cancelled
|
|
|
(157,165 |
) |
|
|
17.19 |
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
Outstanding
at February 2, 2008
|
|
|
1,216,451 |
|
|
$ |
15.40 |
|
|
|
4.6 |
|
|
$ |
- |
|
Granted
|
|
|
37,500 |
|
|
|
10.97 |
|
|
|
|
|
|
|
|
|
Forfeited
/ Cancelled
|
|
|
(114,640 |
) |
|
|
16.57 |
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(1,200 |
) |
|
|
13.86 |
|
|
|
|
|
|
|
|
|
Outstanding
at January 31, 2009
|
|
|
1,138,111 |
|
|
$ |
15.13 |
|
|
|
3.9 |
|
|
$ |
11 |
|
Granted
|
|
|
404,891 |
|
|
|
11.26 |
|
|
|
|
|
|
|
|
|
Forfeited
/ Cancelled
|
|
|
(281,072 |
) |
|
|
15.06 |
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(600 |
) |
|
|
13.25 |
|
|
|
|
|
|
|
|
|
Outstanding
at January 30, 2010
|
|
|
1,261,330 |
|
|
$ |
13.91 |
|
|
|
3.1 |
|
|
$ |
73 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at January 30, 2010
|
|
|
793,003 |
|
|
$ |
15.57 |
|
|
|
1.9 |
|
|
$ |
4 |
|
The
aggregate intrinsic value in the table above represents the total pre-tax
intrinsic value (the excess of FRED’S closing stock price on the last trading
day of the fiscal year end and the exercise price of the option multiplied by
the number of in-the-money options) that would have been received by the option
holders had all option holders exercised their options on that date. This amount
changes based on changes in the market value of FRED’S stock. As of
January 30, 2010, total unrecognized stock-based compensation expense net of
estimated forfeitures related to non-vested stock options was approximately
$.88 million, which is expected to be recognized over a weighted average
period of approximately 3.5 years.
Other
information relative to option activity during 2009, 2008 and 2007 is as
follows:
(dollars in thousands)
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Total
fair value of stock options vested
|
|
$ |
1,249 |
|
|
$ |
2,240 |
|
|
$ |
1,008 |
|
Total
pretax intrinsic value of stock options exercised
|
|
$ |
- |
|
|
$ |
1 |
|
|
$ |
- |
|
The
following table summarizes information about stock options outstanding at
January 30, 2010:
|
|
Options Outstanding
|
|
|
Options Exercisable
|
|
Range of Exercise Prices
|
|
Shares
|
|
|
Weighted-Averaged
Contractual Life
(years)
|
|
|
Weighted-Average
Exercise Price
|
|
|
Shares
|
|
|
Weighted-Average
Exercise Price
|
|
$ 8.93
- $14.60
|
|
|
862,380 |
|
|
|
4.1 |
|
|
$ |
11.86 |
|
|
|
403,813 |
|
|
$ |
12.83 |
|
$14.68
- $18.40
|
|
|
304,880 |
|
|
|
0.8 |
|
|
$ |
17.38 |
|
|
|
295,120 |
|
|
$ |
17.43 |
|
$20.60
- $32.35
|
|
|
94,070 |
|
|
|
0.7 |
|
|
$ |
21.47 |
|
|
|
94,070 |
|
|
$ |
21.47 |
|
|
|
|
1,261,330 |
|
|
|
|
|
|
|
|
|
|
|
793,003 |
|
|
|
|
|
Restricted Stock. The
Company’s equity incentive plans also allow for granting of restricted stock
having a fixed number of shares at a purchase price that is set by the
Compensation Committee of the Company’s Board of Directors, which purchase price
may be set at zero, to certain executive officers, directors and key employees.
The Company calculates compensation expense as the difference between the market
price of the underlying stock on the date of grant and the purchase price if
any. Restricted shares granted under the plan have various vesting types, which
include cliff vesting and graded vesting with a requisite service period of
three to ten years. Restricted stock has a maximum term of five to ten years
from grant date. Compensation expense is recorded on a straight-line basis for
shares that cliff vest and under the graded vesting attribution method for those
that have graded vesting.
The
following table summarizes restricted stock from February 3, 2007 through
January 30, 2010:
|
|
Options
|
|
|
Weighted-
Average Grant
Date Fair Value
|
|
Non-vested
Restricted Stock at February 3, 2007
|
|
|
229,851 |
|
|
$ |
15.03 |
|
Granted
|
|
|
81,176 |
|
|
|
10.47 |
|
Forfeited
/ Cancelled
|
|
|
(15,713 |
) |
|
|
13.48 |
|
Exercised
|
|
|
(9,679 |
) |
|
|
16.59 |
|
Non-vested
Restricted Stock at February 2, 2008
|
|
|
285,635 |
|
|
$ |
13.83 |
|
Granted
|
|
|
124,653 |
|
|
|
9.84 |
|
Forfeited
/ Cancelled
|
|
|
(45,876 |
) |
|
|
14.15 |
|
Exercised
|
|
|
(11,628 |
) |
|
|
13.31 |
|
Non-vested
Restricted Stock at January 31, 2009
|
|
|
352,784 |
|
|
$ |
12.39 |
|
Granted
|
|
|
58,993 |
|
|
|
12.38 |
|
Forfeited
/ Cancelled
|
|
|
(29,909 |
) |
|
|
13.88 |
|
Exercised
|
|
|
(35,358 |
) |
|
|
14.90 |
|
Non-vested
Restricted Stock at January 30, 2010
|
|
|
346,510 |
|
|
$ |
12.01 |
|
The
aggregate pre-tax intrinsic value of restricted stock outstanding as of January
30, 2010 is $3.5 million with a weighted average remaining contractual life
of 5.6 years. The unrecognized compensation expense net of estimated
forfeitures, related to the outstanding restricted stock is approximately
$2.3 million, which is expected to be recognized over a weighted average
period of approximately 5.2 years. The total fair value of restricted stock
awards that vested for the years ended January 30, 2010, January 31, 2009 and
February 2, 2008 was $.5 million, $.2 million and $.2 million,
respectively.
There
were no significant modifications to the Company’s share-based compensation
plans during fiscal 2009.
NOTE 8 — NET INCOME PER
SHARE
Basic
earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if options to issue common stock were exercised into
common stock or resulted in the issuance of common stock that then shared in the
earnings of the entity. Restricted stock is a participating security and is
therefore included in the computation of basic earnings per share.
Options
to purchase shares of common stock that were outstanding at the end of the
respective fiscal year were not included in the computation of diluted earnings
per share when the options’ exercise prices were greater than the average market
price of the common shares. There were 1,396,549, 1,138,111, and 1,216,451 such
options outstanding at January 30, 2010, January 31, 2009 and February 2,
2008.
NOTE 9 — COMMITMENTS AND
CONTINGENCIES
Commitments. The Company had
commitments approximating $8.8 million at January 30, 2010 and $9.7 million
at January 31, 2009 on issued letters of credit, which support purchase orders
for merchandise. Additionally, the Company had outstanding letters of credit
aggregating approximately $11.1 million at January 30, 2010 and
$12.0 million at January 31, 2009 utilized as collateral for its risk
management programs.
Salary reduction profit sharing plan.
The Company has a defined contribution profit sharing plans for the
benefit of qualifying employees who have completed three months of service and
attained the age of 21. Participants may elect to make contributions to the plan
up to a maximum of 15% of their compensation. Company contributions are made at
the discretion of the Company’s Board of Directors. Participants are 100% vested
in their contributions and earnings thereon. Contributions by the Company and
earnings thereon are fully vested upon completion of six years of service. The
Company’s contributions for 2009, 2008, and 2007, were $.4 million, $.3 million,
and $.3 million, respectively.
Postretirement benefits. The
Company provides certain health care benefits to its full-time employees that
retire between the ages of 62 and 65 with certain specified levels of credited
service. Health care coverage options for retirees under the plan are the same
as those available to active employees.
Effective
February 3, 2007, the Company began recognizing the funded status of its
postretirement benefits plan in accordance with SFAS No. 158 codified in
FASB ASC 715. In accordance with FASB ASC 715 the Company is required to display
the net over-or–under funded position of a defined benefit postretirement plan
as an asset or liability, with any unrecognized prior service costs, transition
obligations or actuarial gains/losses reported as a component of accumulated
other comprehensive income in shareholders’ equity.
During
2008, the Company changed its measurement date from November 30 to January
31. In accordance with FASB ASC 715, we used the “14-month method” to
transition to the new measurement date and calculate the net periodic
postretirement benefit cost for the year ended January 31, 2009. As
part of the transition, an adjustment to retained earnings was recorded for the
two month period December 2, 2008 through January 31, 2009.
The
Company’s change in benefit obligation based upon an actuarial valuation is as
follows:
(in thousands)
|
|
January 30,
2010
|
|
|
January 31,
2009
|
|
|
February 2,
2008
|
|
Benefit
obligation at beginning of year
|
|
$ |
396 |
|
|
$ |
539 |
|
|
$ |
591 |
|
Service
cost
|
|
|
33 |
|
|
|
25 |
|
|
|
33 |
|
Interest
cost
|
|
|
30 |
|
|
|
24 |
|
|
|
30 |
|
Actuarial
loss (gain)
|
|
|
111 |
|
|
|
(172 |
) |
|
|
(82 |
) |
Benefits
paid
|
|
|
(28 |
) |
|
|
(28 |
) |
|
|
(33 |
) |
Adjustments
due to adoption of FASB ASC 715 measurement date
provisions
|
|
|
- |
|
|
|
8 |
|
|
|
- |
|
Benefit
obligation at end of year
|
|
$ |
542 |
|
|
$ |
396 |
|
|
$ |
539 |
|
The
medical care cost trend used in determining this obligation is 8.0% at January
30, 2010, decreasing annually throughout the actuarial projection period. The
below table illustrates a one-percentage-point increase or decrease in the
healthcare cost trend rate assumed for postretirement benefits:
|
|
For the Year Ended
|
|
(in thousands)
|
|
January 30,
2010
|
|
|
January 31,
2009
|
|
Effect
of health care trend rate
|
|
|
|
|
|
|
1%
increase effect of accumulated benefit obligations
|
|
$ |
52 |
|
|
$ |
34 |
|
1%
increase effect on periodic cost
|
|
|
7 |
|
|
|
6 |
|
1%
decrease effect on accumulated benefit obligations
|
|
|
(47 |
) |
|
|
(30 |
) |
1%
decrease effect on periodic cost
|
|
|
(6 |
) |
|
|
(5 |
) |
The
discount rate used in calculating the obligation was 5.6% in 2009 and 6.25% in
2008.
The
annual net postretirement cost is as follows:
|
|
For the Year Ended
|
|
(in thousands)
|
|
January 30,
2010
|
|
|
January 31,
2009
|
|
|
February 2,
2008
|
|
Service
cost
|
|
$ |
33 |
|
|
$ |
25 |
|
|
$ |
33 |
|
Interest
cost
|
|
|
30 |
|
|
|
24 |
|
|
|
30 |
|
Amorization
of prior service cost
|
|
|
(14 |
) |
|
|
(14 |
) |
|
|
(14 |
) |
Amorization
of unrecognized prior service costs
|
|
|
(94 |
) |
|
|
(102 |
) |
|
|
(97 |
) |
Net
periodic postretirement benefit cost
|
|
$ |
(45 |
) |
|
$ |
(67 |
) |
|
$ |
(48 |
) |
The
Company’s policy is to fund claims as incurred.
Information
about the expected cash flows for the postretirement medical plan
follows:
(in thousands)
|
|
Postretirement
Medical Plan
|
|
Expected
Benefit Payments, net of retiree contributions
|
|
|
|
2010
|
|
$ |
29 |
|
2011
|
|
|
33 |
|
2012
|
|
|
36 |
|
2013
|
|
|
40 |
|
2014
|
|
|
46 |
|
Next
5 years
|
|
|
271 |
|
Litigation. In July
2008, a lawsuit styled Jessica Chapman, on behalf of herself and others
similarly situated, v. FRED’S Stores of Tennessee, Inc. was filed in the United
States District Court for the Northern District of Alabama, Southern Division,
in which the plaintiff alleges that she and other female assistant store
managers are paid less than comparable males and seek compensable damages,
liquidated damages, attorney fees and court costs. The plaintiff
filed a motion seeking collective action. Briefs have been filed, but
the court has not ruled. The Company believes that all assistant
managers have been properly paid and that the matter is not appropriate for
collective action treatment. Discovery has not yet
begun. The Company is and will continue to vigorously defend this
matter. In accordance with FASB ASC 450, “Contingencies”, the Company
does not feel that a loss in this matter is probable or can be reasonably
estimated. Therefore, we have not recorded a liability for this
case.
In August
2007, a lawsuit entitled Julia Atchinson, et al. v. FRED’S Stores of Tennessee,
Inc., et al, was filed in the United States District Court for the Northern
District of Alabama, Southern Division in which the plaintiff alleges that she
and other current and former FRED’S Discount assistant store managers were
improperly classified as exempt executive employees under the Fair Labor
Standards Act (FLSA) and seeks to recover overtime pay, liquidated damages,
attorney’s fees and court costs. The plaintiffs filed a motion
seeking a collective action which the Judge has not ruled on. The
Company believes that its assistant store managers are and have been properly
classified as exempt employees under FLSA and that the matter is not appropriate
for collective action treatment. The parties also agreed to mediate
this case in January 2009 and did so successfully, reaching a settlement of $1.5
million (including attorneys’ fees and costs). Again, based on the
substantial costs of continuing litigation, unfavorably high jury verdicts
against other retailers and the constant distraction to management of a possible
protracted jury trial, this is a favorable settlement for
FRED’S. FRED’S has admitted no liability or wrongdoing, and no
liability has been found against the Company. The parties are
finalizing settlement documents and will jointly present the settlement to the
court, which must approve the settlement.
In June
2006, a lawsuit entitled Sarah Ziegler, et al. v. FRED’S Discount Store was
filed in the United States District Court for the Northern District of Alabama
in which the plaintiff alleges that she and other current and former FRED’S
Discount assistant store managers were improperly classified as exempt executive
employees under the Fair Labor Standards Act (“FLSA”) and sought to recover
overtime pay, liquidated damages, and attorneys’ fees and court
cost. In July 2006, the plaintiffs filed an emergency motion to
facilitate notice pursuant to the FLSA that would give current and former
assistant managers information about their rights to opt-in to the
lawsuit. After initially denying the motion, in October 2006, the
judge granted plaintiffs motion to facilitate notice pursuant to the
FLSA. Notice was sent to some 2,055 current and former assistant
store managers and approximately 450 persons opted into the case. The
cutoff date for individuals to advise of their interest in becoming part of this
lawsuit was February 2, 2007.
The
Company believes that its assistant store managers are and have been properly
classified as exempt employees under the FLSA and that the actions described
above are not appropriate for collective action treatment. The
parties agreed to mediate this case and did so successfully in January
2009. The total settlement amount, (including attorneys’ fees and
costs) was $5.0 million. FRED’S believes this was a favorable
settlement in consideration of the substantial costs of continuing litigation,
high jury verdicts against other retailers who were sued for practices similar
to the claims alleged in this case as well as the constant distraction to
management of a possible protracted jury trial. FRED’S has admitted
no liability or wrongdoing and no liability was found against
FRED’S. The parties finalized settlement documents, which the court
approved and the Company paid in 2009.
In
addition to the matters disclosed above, the Company is party to several pending
legal proceedings and claims arising in the normal course of
business. Although the outcome of the proceedings and claims cannot
be determined with certainty, management of the Company is of the opinion that
it is unlikely that these proceedings and claims will have a material adverse
effect on the financial statements as a whole. However, litigation
involves an element of uncertainty. There can be no assurance that
pending lawsuits will not consume the time and energy of our management or that
future developments will not cause these actions or claims, individually or in
aggregate, to have a material adverse effect on the financial statements as a
whole. We intend to vigorously defend or prosecute each pending
lawsuit.
NOTE
10 – SALES MIX
The
Company manages its business on the basis of one reportable segment. See Note 1
for a brief description of the Company’s business. As of January 30, 2010, all
of the Company’s operations were located within the United States. The following
data is presented in accordance with FASB ASC 280, “Segment
Reporting.”
The
Company’s sales mix by major category during the last 3 years was as
follows:
|
|
For the Year Ended
|
|
|
|
January 30,
2010
|
|
|
January 31,
2009
|
|
|
February 2,
2008
|
|
Pharmaceuticals
|
|
|
33.5 |
% |
|
|
31.7 |
% |
|
|
32.2 |
% |
Household
Goods
|
|
|
23.4 |
% |
|
|
24.8 |
% |
|
|
24.8 |
% |
Food
and Tobacco Products
|
|
|
16.2 |
% |
|
|
15.5 |
% |
|
|
14.2 |
% |
Paper
and Cleaning Supplies
|
|
|
9.2 |
% |
|
|
9.2 |
% |
|
|
8.8 |
% |
Apparel
and Linens
|
|
|
7.9 |
% |
|
|
8.6 |
% |
|
|
9.9 |
% |
Health
and Beauty Aids
|
|
|
7.6 |
% |
|
|
8.0 |
% |
|
|
8.0 |
% |
Sales
to Franchised Fred's Stores
|
|
|
2.2 |
% |
|
|
2.2 |
% |
|
|
2.1 |
% |
Total
Sales Mix
|
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
NOTE
11 – EXIT AND DISPOSAL ACTIVITY
During
fiscal 2007, the Company closed 17 underperforming stores.
During
fiscal 2008, the Company closed 74 underperforming stores and 23 underperforming
pharmacies. The closures took place during the first three quarters
of 2008 pursuant to our restructuring plan announced February 6, 2008 and were
the result of an in-depth study conducted by the Company of its operations over
the previous 10 quarters. The study revealed that FRED’S has a strong
and healthy store base, and that by closing these underperforming stores the
Company would improve its cash flow and operating margin, both of which are core
goals of the Company’s overall strategic plan. As a result of the successful
execution of this plan, the Company is stronger and is in a better position to
respond to fluctuations in the economy and to take advantage of opportunities to
further improve our business.
During
fiscal 2009, the Company closed 9 underperforming stores, which is consistent
with our anticipated amount of annual store closures.
Inventory
Impairment
During
fiscal 2007, we recorded a below-cost inventory adjustment of approximately
$10.0 million to reduce the value of inventory to lower of cost or market in
stores that were planned for closure as part of the Company’s strategic plan to
improve profitability and operating margin. The adjustment was
recorded in cost of goods sold in the consolidated statement of income for the
year ended February 2, 2008.
In fiscal
2008, we recorded an additional below-cost inventory adjustment of
$0.3 million to reduce the value of inventory to lower of cost or market
associated with stores closed in the third quarter and utilized the entire
$10.3 million impairment.
Lease
Termination
For store
closures where a lease obligation still exists, we record the estimated future
liability associated with the rental obligation on the cease use date (when the
store is closed) in accordance with FASB ASC 420, “Exit and Disposal Cost
Obligations.” Liabilities are established at the cease use date for the present
value of any remaining operating lease obligations, net of estimated sublease
income, and at the communication date for severance and other exit costs, as
prescribed by FASB ASC 420. Key assumptions in calculating the liability include
the timeframe expected to terminate lease agreements, estimates related to the
sublease potential of closed locations, and estimation of other related exit
costs. If actual timing and potential termination costs or realization of
sublease income differ from our estimates, the resulting liabilities could vary
from recorded amounts. These liabilities are reviewed periodically and adjusted
when necessary.
During
fiscal 2007, we closed 17 under performing stores and recorded lease contract
termination costs of $1.6 million in rent expense in conjunction with those
closings, of which $1.0 million was utilized during fiscal 2007, leaving $.6
million in the reserve at the beginning of fiscal year 2008.
During
fiscal 2008, we closed 74 under performing stores and recorded lease contract
termination costs of $10.5 million, of which $9.6 million was charged to rent
expense and $.9 million reduced the liability for deferred rent. We
utilized $7.7 million during the period, leaving $3.4 million in the reserve at
January 31, 2009.
During
fiscal 2009, we utilized $2.4 million, leaving $1.0 million in the reserve at
January 30, 2010.
The
following table illustrates the exit and disposal activity related to the store
closures discussed in the previous paragraphs (in millions):
|
|
Beginning
Balance
January 31,
2009
|
|
|
Additions
FY09
|
|
|
Utilized
FY09
|
|
|
Ending
Balance
January 30,
2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
markdowns for planned store closings
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
Lease
contract termination liability
|
|
|
3.4 |
|
|
|
- |
|
|
|
2.4 |
|
|
|
1.0 |
|
|
|
$ |
3.4 |
|
|
$ |
- |
|
|
$ |
2.4 |
|
|
$ |
1.0 |
|
Fixed Asset
Impairment
During
the fourth quarter of 2007, the Company recorded a charge of $4.6 million in
selling, general and administrative expense for the impairment of fixed assets
and leasehold improvements associated with the planned closure of 75 stores in
2008. During the second quarter of fiscal 2008, the Company recorded
an additional charge of $.1 million associated with store closures that
occurred in the third quarter 2008. Impairment of $0.2 million for the planned
store closures was recorded in fiscal 2009.
NOTE 12 – QUARTERLY FINANCIAL DATA
(UNAUDITED)
The
Company’s unaudited quarterly financial information for the fiscal years ended
January 30, 2010 and January 31, 2009 is reported below:
(in thousands)
|
|
First Quarter
|
|
|
Second
Quarter
|
|
|
Third Quarter
|
|
|
Fourth
Quarter
|
|
Year
ended January 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
458,380 |
|
|
$ |
434,214 |
|
|
$ |
422,438 |
|
|
$ |
473,104 |
|
Gross
profit
|
|
|
128,977 |
|
|
|
120,742 |
|
|
|
122,869 |
|
|
|
126,649 |
|
Net
income
|
|
|
8,550 |
|
|
|
4,240 |
|
|
|
5,032 |
|
|
|
5,793 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.21 |
|
|
$ |
0.11 |
|
|
$ |
0.13 |
|
|
$ |
0.15 |
|
Diluted
|
|
$ |
0.21 |
|
|
$ |
0.11 |
|
|
$ |
0.13 |
|
|
$ |
0.15 |
|
Cash
dividends paid per share
|
|
$ |
0.02 |
|
|
$ |
0.03 |
|
|
$ |
0.03 |
|
|
$ |
0.03 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended January 31, 2009
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$ |
464,292 |
|
|
$ |
447,127 |
|
|
$ |
418,036 |
|
|
$ |
469,385 |
|
Gross
profit
|
|
|
132,481 |
|
|
|
123,851 |
|
|
|
124,186 |
|
|
|
122,500 |
|
Net
income
|
|
|
7,250 |
|
|
|
1,033 |
1
|
|
|
6,089 |
|
|
|
2,270 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per share
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$ |
0.18 |
|
|
$ |
0.03 |
1
|
|
$ |
0.15 |
|
|
$ |
0.06 |
|
Diluted
|
|
$ |
0.18 |
|
|
$ |
0.03 |
1
|
|
$ |
0.15 |
|
|
$ |
0.06 |
|
Cash
dividends paid per share
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
1
Results include certain charges for the non-routine closing of 75 stores in 2008
and the 17 stores closed in 2007 (see Note 11 - Exit and Disposal
Activities).
None.
ITEM
9A. Controls and Procedures
(a) Conclusion Regarding the
Effectiveness of 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 Rules 13a-15(e) under the Securities and Exchange Act
of 1934, as amended (the “Exchange Act”)). Based on that evaluation,
the Chief Executive Officer and the Chief Financial Officer concluded that the
Company’s disclosure controls and procedures are effective to ensure that
information required to be disclosed by the issuer in the reports that it files
or submits under the Act (15 U.S.C. 78 et seq.) is recorded, processed,
summarized and reported, within the time periods specified in the Commission’s
rules and forms. Additionally, they concluded that our disclosure
controls and procedures are designed to ensure that information required to be
disclosed by the Company in the reports that the Company is required to file or
submit under the Exchange Act is accumulated and communicated to management,
including the Chief Executive Officer and the Chief Financial Officer, as
appropriate to allow timely decisions regarding required
disclosures.
(b) Management’s Annual Report
on Internal Control Over Financial Reporting. The management of FRED’S,
Inc. is responsible for establishing and maintaining adequate internal control
over financial reporting as defined in Rule 13a – 15(f) under the
Securities Exchange Act of 1934. FRED’S, Inc. internal control system was
designed to provide reasonable assurance to the Company’s management and board
of directors regarding the fair and reliable preparation and presentation of the
Consolidated Financial Statements.
All
internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.
The
management of FRED’S, Inc. assessed the effectiveness of the Company’s internal
control over financial reporting as of January 30, 2010. In making its
assessment, the Company used criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control – Integrated
Framework. Based on its assessment, management has concluded that the
Company’s internal control over financial reporting is effective as of January
30, 2010.
Our
independent registered public accounting firm has issued an audit report on our
internal controls over financial reporting, which is included in this Form
10-K.
(c) Changes in Internal Control
over Financial Reporting. There have been no changes during the quarter
ended January 30, 2010 in the Company’s internal control over financial
reporting (as defined in Exchange Act Rule 13a-15(f)) that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.
Report
of Independent Registered Public Accounting Firm
Board of
Directors and Shareholders
FRED’S,
Inc.
Memphis,
Tennessee
We have
audited FRED’S, Inc.’s (the “Company’s”) internal control over financial
reporting as of January 30, 2010, based on criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). The Company’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying report, “Item 9A(b), Management’s Annual
Report on Internal Control Over Financial Reporting”. Our responsibility is to
express an opinion on the company’s internal control over financial reporting
based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed 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. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of January 30, 2010, based on the COSO
criteria.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of the Company
as of January 30, 2010 and January 31, 2009, and the related consolidated
statements of income and comprehensive income, changes in shareholders’ equity,
and cash flows for each of the three years in the period ended January 30, 2010
and our report dated April 15, 2010 expressed an unqualified opinion
thereon.
/s/ BDO
Seidman, LLP
Memphis,
Tennessee
April 15,
2010
None.
The
following information is furnished with respect to each of the directors and
executive officers of the Company:
Name
|
|
Age
|
|
Postions
and Offices
|
Michael
J. Hayes (1)
|
|
68
|
|
Director,
Chairman of the Board
|
John
R. Eisenman (1)
|
|
68
|
|
Director
|
Roger
T. Knox (1)
|
|
72
|
|
Director
|
Thomas
H. Tashjian(1)
|
|
55
|
|
Director
|
B.
Mary McNabb (1)
|
|
61
|
|
Director
|
Michael
T. McMillan (1)
|
|
50
|
|
Director
|
Bruce
A. Efird (1)
|
|
50
|
|
Director,
Chief Executive Officer and President
|
Jerry
A. Shore
|
|
57
|
|
Executive
Vice President, Chief Financial Officer and Chief Administative
Officer
|
Rick
A. Chambers
|
|
46
|
|
Executive
Vice President – Pharmacy Operations
|
Charles
S. Vail
|
|
67
|
|
Corporate
Secretary, Senior Vice President – Legal Services and General
Counsel
|
Reggie
E. Jacobs
|
|
39
|
|
Executive
Vice President - Corporate Services, Distribution and
Transportation
|
Earl
L. Taylor
|
|
60
|
|
Executive
Vice President - Store
Operations
|
1 Seven
directors, constituting the entire Board of Directors, are to be elected at the
2010 Annual Meeting to serve one year or until their successors are
elected.
Michael
J. Hayes served as Managing Director of the Company from October 1989 until
March 2002 when he was elected Chairman of the Board. He was the Chief
Executive Officer from October 1989 through January 2009. He was previously
employed by Oppenheimer & Company, Inc. in various capacities from 1976 to
1985, including Managing Director and Executive Vice President — Corporate
Finance and Financial Services.
John R.
Eisenman is involved in real estate investment and development with REMAX Island
Realty, Inc., located in Hilton Head Island, South Carolina. Mr. Eisenman has
been engaged in commercial and industrial real estate brokerage and development
since 1983. Previously, he founded and served as President of Sally’s, a chain
of fast food restaurants from 1976 to 1983, and prior thereto held various
management positions in manufacturing and in securities brokerage.
Roger T.
Knox is President Emeritus of the Memphis Zoological Society and was its
President and Chief Executive Officer from January 1989 through
March 2003. Mr. Knox was the President and Chief Operating Officer of
Goldsmith’s Department Stores, Inc. (a full-line department store in Memphis and
Jackson, Tennessee) from 1983 to 1987 and it’s Chairman of the Board and Chief
Executive Officer from 1987 to 1989. Prior thereto, Mr. Knox was with
Foley’s Department Stores in Houston, Texas for 20 years. Mr. Knox is also
a director of The Plough Foundation.
Thomas H.
Tashjian was elected a director of the Company in March 2001. Mr. Tashjian
is a private investor. Mr. Tashjian has served as a managing director and
consumer group leader at Banc of America Montgomery Securities in San Francisco.
Prior to that, Mr. Tashjian held similar positions at First Manhattan
Company, Seidler Companies, and Prudential Securities. Mr. Tashjian’s
earlier retail operating experience was in discount retailing at the Ayr-way
Stores, which were acquired by Target, and in the restaurant business at Noble
Roman’s.
B. Mary
McNabb was elected a director of the Company in April 2005. Most recently
she served as Chief Executive Officer for Kid’s Outlet in California.
She has served as a member of the Board of Directors of C-ME (Cyber Merchants
Exchange), a public company. McNabb was executive vice president of
merchandising and marketing for Factory 2-U from 1989 – 2001.
Michael
T. McMillan was elected a director of the Company in February 2007. He
currently serves as Director of Franchise Development for Pepsi-Cola North
America, a Division of PepsiCo, where he has spent the last 25 years in
various roles including marketing, sales, franchise development, and general
management of its bottling operations.
Bruce A.
Efird joined the Company in September 2007 as President and became Chief
Executive Officer effective February 1, 2009. Mr. Efird was Executive Vice
President-Merchandising for Meijer, Inc., a leading supercenter retailer in the
Midwest with more than $13 billion in sales, from October 2005 until
August 2007. There he was responsible for all merchandising functions,
including softlines, home furnishings, drugstore, general merchandise, groceries
and perishables. He also was in charge of marketing and advertising functions as
well as pricing and e-commerce for the chain’s 179 stores across a five-state
area. From 1997 until October 2005, Mr. Efird was with Bruno’s
Supermarkets, Inc. in Birmingham, Alabama, and served as Senior Vice President
of Merchandising from 1999 through 2003 and Executive Vice President/General
Manager thereafter.
Jerry A.
Shore joined the Company in April 2000 as Executive Vice President and
Chief Financial Officer. Prior to joining the Company, Mr. Shore was
employed by Wang’s International, a major importing and wholesale distribution
company as Chief Financial Officer from 1989 to 2000, and in various financial
management capacities with IPS Corp., and Caterpillar, Inc. from 1975 to
1989.
Rick A.
Chambers was named Executive Vice President – Pharmacy Operations in
August 2006. Prior to this he held the position of Senior Vice President –
Pharmacy operations from June 2004 to August 2006. Mr. Chambers
joined the Company in July of 1992 and has served in various positions in
Pharmacy Operations. Mr. Chambers earned a Doctor of Pharmacy Degree in
1992.
Charles
S. Vail has served the Company as General Counsel since 1973, as Corporate
Secretary since 1975, and as Senior Vice President — Legal since 2006.
Mr. Vail joined the Company in 1968.
Reggie E.
Jacobs was named Executive Vice President – Corporate Services, Distribution and
Transportation in August of 2008. Prior to this Mr. Jacobs served as SVP
of Distribution, CIO and Director of DC Systems. Prior to joining the
company Mr. Jacobs was employed by Dollar General from 1994 to 1998 and by
Wal-Mart from 1992 to 1994. Mr. Jacobs holds a B.A from the University of
Oklahoma.
Earl L.
Taylor has served the Company for over 40 years and was promoted to Executive
Vice President - Store Operations in 2008. Mr. Taylor began his
retail career with the Company in 1968 as a manager trainee and has served in a
variety of positions since including store manager from 1971 to 1979, District
Manager from 1979 to 1998, Director of Store Operations from 1998 to 2001 and
Regional Vice President from 2001 to 2008.
The
remainder of the information required by this item is incorporated herein by
reference to the proxy statement for our fiscal 2009 Annual
Meeting.
Information
required by this item is incorporated herein by reference to the proxy statement
for our 2010 Annual Meeting.
Information
required by this item is incorporated herein by reference to the proxy statement
for our 2010 Annual Meeting.
Information
required by this item is incorporated herein by reference to the proxy statement
for our 2010 Annual Meeting.
Information
required by this item is incorporated herein by reference to the proxy statement
for our 2010 Annual Meeting.
(a)(1)
Consolidated Financial Statements (See ITEM 8)
Report of
Independent Registered Public Accounting Firm – BDO Seidman, LLP.
(a)(2)
Financial Statement Schedules
Schedule 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:
|
3.1
|
Certificate
of Incorporation, as amended [incorporated herein by reference to
Exhibit 3.1 to the registration statement on Form S-8 as filed
with the Securities and Exchange Commission (“SEC”) on March 18, 2003
(SEC File No. 333-103904) (such registration statement, the
“Form S-8”)].
|
|
3.2
|
Articles
of Amendment to the Charter of Fred’s Inc. [incorporated herein by
reference to Exhibit 3.1 to the registration statement on Form 8-A as
filed with the SEC on October 17, 2008 (SEC File No. 001-14565) (the “Form
8-A”)].
|
|
3.3
|
By-laws,
as amended [incorporated herein by reference to Exhibit 3.2 to the
Form S-8].
|
|
4.1
|
Specimen
Common Stock Certificate [incorporated herein by reference to
Exhibit 4.2 to Pre-Effective Amendment No. 3 to the Registration
Statement on Form S-1 (SEC File No. 33-45637) (such Registration
Statement, 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].
|
|
4.3
|
Rights
Agreement, dated as of October 10, 2008, between Fred’s Inc. and Regions
Bank [incorporated herein by reference to Exhibit 4.1 to the Form
8-A].
|
|
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
|
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].
|
|
*10.5
|
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].
|
|
***10.6
|
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].
|
|
***10.7
|
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].
|
|
***10.8
|
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 10.4) [incorporated herein by reference to the Company’s
report on Form 10-K for the year ended January 29,
2000].
|
|
***10.9
|
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].
|
|
***10.10
|
Loan
modification agreement dated May 26, 2000 (modifies the Revolving
Loan Agreement included as Exhibit 10.9) [incorporated herein by
reference to the Company’s report on Form 10-K for the year ended
January 29, 2000].
|
|
***10.11
|
Seasonal
Over line 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].
|
|
***10.12
|
Second
Loan modification agreement dated April 30, 2002 (modifies the
Revolving Loan and Credit Agreement included as exhibit 10.9).
[incorporated herein by reference to the Company’s Report on
Form 10-Q for the quarter ended August 3,
2002].
|
|
10.15
|
Third
loan modification agreement dated July 31, 2003 (modified the
Revolving Loan and Credit Agreement dated April 3, 2000.)
[incorporated herein by reference to the Company’s Report on
Form 10-Q for the quarter ended August 2,
2003].
|
|
10.16
|
Fourth
modification agreement dated June 28, 2004 modifying the Revolving
Loan and Credit Agreement to grant a temporary over line. [incorporated
herein by reference to the Company’s Report on Form 10-Q for the
quarter ended October 30,
2004].
|
|
10.17
|
Fifth
modification agreement dated October 19, 2004 modifying the Revolving
Loan and Credit Agreement to grant a temporary over line. [incorporated
herein by reference to the Company’s Report on Form 10-Q for the
quarter ended October 30,
2004].
|
|
10.18
|
Sixth
Modification Agreement of the Revolving Loan and Credit Agreement dated
July 29, 2005 (modifies the Revolving Loan and Credit Agreement dated
April 3, 2000.) [incorporated herein by reference to the Company’s
Report on Form 10-Q for the quarter ended July 30,
2005].
|
|
10.19
|
Lease
agreement by and between Banc of America Leasing & Capital, LLC and
FRED’S Stores of Tennessee, Inc. dated July 26, 2005 for the lease of
equipment to FRED’S Stores of Tennessee, Inc. [incorporated herein by
reference to the Company’s Report on Form 10-Q for the quarter ended
October 29, 2005].
|
|
10.20
|
Seventh
modification agreement dated October 10, 2005 modifying the Revolving
Loan and Credit Agreement to grant a temporary over line. [incorporated
herein by reference to the Company’s report on Form 10-K for the year
ended January 28, 2006].
|
|
10.21
|
Eighth
modification agreement dated October 30, 2007 modifying the Revolving
Loan and Credit Agreement. [incorporated herein by reference to the
Company’s Report on Form 10-Q for the quarter ended November 3,
2007].
|
|
10.22
|
Ninth
Modification Agreement of the Revolving Loan and Credit Agreement” dated
September 16, 2008 (modifies the Revolving Loan and Credit Agreement dated
April 3, 2000.)
|
|
*10.23
|
Employment
agreement, effective as of September 22, 2007, between the Company
and Bruce A. Efird. [incorporated herein by reference to the Company’s 8-K
filed on March 24, 2008].
|
|
*10.24
|
Amendment
to Employment Agreement, dated December 22, 2008, between the Company and
Bruce A. Efird [incorporated herein by reference to the Company’s Form 8-K
filed on December 16, 2008].
|
|
*10.25
|
Amendment
to Employment Agreement, dated February 16, 2009, between the Company and
Bruce A. Efird [incorporated herein by reference to the Company’s Form 8-K
filed on February 20, 2009].
|
|
*10.26
|
Amendment
to Employment Agreement, dated December 16, 2008, between the Company and
Michael J. Hayes [incorporated herein by reference to the Company’s Form
8-K filed on December 23, 2008].
|
|
**21.1
|
Subsidiaries
of Registrant
|
|
**23.1
|
Consent
of BDO Seidman LLP
|
|
**31.1
|
Certification
of Chief Executive Officer pursuant to Exchange Rule 13a-14(a) of the
Securities Exchange Act.
|
|
**31.2
|
Certification
of Chief Financial Officer pursuant to Exchange Rule 13a-14(a) of the
Securities Exchange Act.
|
|
**32.
|
Certification
of Chief Executive Officer and Chief Financial Officer pursuant to 18
U.S.C. Section 1350.
|
(b)
Reports on
Form 8-K
None.
*
|
Management
Compensatory Plan
|
***
|
(SEC
File No. under the Securities Exchange Act of 1934 is
000-19288)
|
Report
of Independent Registered Public Accounting Firm
Board of
Directors and Shareholders
FRED’S,
Inc.
Memphis,
Tennessee
The
audits referred to in our report dated April 15, 2010 relating to the
consolidated financial statements of FRED’S, Inc., which is contained in Item 8
of this Form 10-K also
included the audit of the financial statement schedule listed in the
accompanying index. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to
express an opinion on this financial statement schedule based on our
audits.
In our
opinion such financial statement schedule, when considered in relation to the
basic consolidated financial statements taken as a whole, presents fairly, in
all material respects, the information set forth therein.
/s/ BDO
Seidman, LLP
Memphis,
Tennessee
April 15,
2010
Schedule II
— Valuation and Qualifying Accounts
(dollars in thousands)
|
|
Beginning Balance
|
|
|
Additions Charged
to Costs and
Expenses
|
|
|
Deductions and
Reclass Adjustments
|
|
|
Ending Balance
|
|
Deducted
from applicable assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance
for doubtful accounts
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended January 30, 2010
|
|
$ |
885 |
|
|
$ |
636 |
|
|
$ |
757 |
|
|
$ |
764 |
|
Year
ended January 31, 2009
|
|
$ |
879 |
|
|
$ |
486 |
|
|
$ |
480 |
|
|
$ |
885 |
|
Year
ended February 2, 2008
|
|
$ |
719 |
|
|
$ |
255 |
|
|
$ |
95 |
|
|
$ |
879 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
valuation reserves
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended January 30, 2010
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
|
$ |
- |
|
Year
ended January 31, 2009
|
|
$ |
10,025 |
|
|
$ |
280 |
|
|
$ |
10,305 |
|
|
$ |
- |
|
Year
ended February 2, 2008
|
|
$ |
2,119 |
|
|
$ |
10,025 |
|
|
$ |
2,119 |
|
|
$ |
10,025 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance
reserves
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
ended January 30, 2010
|
|
$ |
8,633 |
|
|
$ |
44,568 |
|
|
$ |
44,207 |
|
|
$ |
8,994 |
|
Year
ended January 31, 2009
|
|
$ |
8,186 |
|
|
$ |
40,304 |
|
|
$ |
39,857 |
|
|
$ |
8,633 |
|
Year
ended February 2, 2008
|
|
$ |
8,604 |
|
|
$ |
38,172 |
|
|
$ |
38,590 |
|
|
$ |
8,186 |
|
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 15th day of April,
2010.
|
|
|
|
|
|
FRED’S,
INC.
|
|
|
By:
|
/s/
Bruce A. Efird
|
|
|
|
Bruce
A. Efird, Chief Executive Officer and President
|
|
|
|
|
|
|
By:
|
/s/
Jerry A. Shore
|
|
|
|
Jerry
A. Shore, Executive Vice
|
|
|
|
President
and Chief 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 15th day of April, 2010.
|
|
|
Signature
|
|
Title
|
|
|
|
|
|
Director
and Chairman of the Board
|
Michael
J. Hayes
|
|
|
|
|
Director,
Chief Executive Officer and President (Principle |
|
|
Executive
Officer)
|
Bruce
A. Efird
|
|
|
|
|
|
/s/
Jerry A. Shore
|
|
Executive
Vice President and Chief Financial
|
Jerry
A. Shore
|
|
Officer
(Principal Accounting and Financial Officer)
|
|
|
|
/s/
Roger T. Knox
|
|
Director
|
Roger
T. Knox
|
|
|
|
|
|
/s/
John R. Eisenman
|
|
Director
|
John
R. Eisenman
|
|
|
|
|
|
/s/
Thomas H. Tashjian
|
|
Director
|
Thomas
H. Tashjian
|
|
|
|
|
|
/s/
B. Mary McNabb
|
|
Director
|
B.
Mary McNabb
|
|
|
|
|
|
/s/
Michael T. McMillan
|
|
Director
|
Michael
T. McMillan
|
|
|