10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended January 31, 2009
Or
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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
FREDS,
INC.
(Exact Name of Registrant as Specified in its Charter)
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TENNESSEE
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62-0634010 |
(State or Other Jurisdiction of
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(I.R.S. Employer |
Incorporation or Organization)
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Identification Number) |
4300 New Getwell Road
MEMPHIS, TENNESSEE 38118
(Address of Principal Executive Offices)
Registrants telephone number, including area code (901) 365-8880
Securities Registered Pursuant to Section 12(b) of the Act:
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Title of Class
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Name of exchange on which registered |
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Class A Common Stock, no par value
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The NASDAQ Global Select Market |
Preferred Share Purchase Rights |
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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 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 Registrants 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):
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Large accelerated filer o
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Accelerated filer þ
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Non-accelerated filer o`
(Do not check if a smaller reporting company)
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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, 2008, the last
business day of the registrants most recently completed second fiscal quarter, was approximately
$483 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 15, 2009, there were 40,011,557 shares outstanding of the Registrants Class A no par
value voting common stock.
As of
April 15, 2009, there were no shares outstanding of the Registrants Class B no par value
non-voting common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Companys Proxy Statement for the 2009 annual shareholders meeting, to be filed
within 120 days of the registrants 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.
FREDS, INC.
FORM 10-K
TABLE OF CONTENTS
- 2 -
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. FREDS Inc. (FREDS 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:
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Economic and weather conditions which effect buying patterns of our customers and
supply chain efficiency; |
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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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Continued availability of capital and financing; |
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Competitive factors; |
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Changes in reimbursement factors for pharmaceuticals; |
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Governmental regulation; |
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Increase in fuel and utility rates; |
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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.
- 3 -
PART I
ITEM 1: Business
General
FREDS, founded in 1947, operates 639 (as of January 31, 2009) discount general merchandise stores
in fifteen states primarily in the southeastern United States. FREDS stores generally serve low,
middle and fixed income families located in small- to medium- sized towns (approximately 82% of
FREDS stores are in markets with populations of 15,000 or fewer people). Full service pharmacies
are included in 284 of the Companys stores (as of January 31, 2009). The Company also markets
goods and services to 24 franchised FREDS stores. The Company is headquartered in Memphis,
Tennessee.
FREDS stores stock over 12,000 frequently purchased items which address the everyday needs of its
customers, including nationally recognized brand name products, proprietary FREDS label products
and lower priced off-brand products. FREDS management believes its customers shop FREDS 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. FREDS stores have average selling space of 14,590 square feet and had average sales of
$2,815,000 in fiscal 2008. No single store accounted for more than 1.0% of net sales during fiscal
2008.
Business Strategy
The Companys 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 FREDS 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 Companys reliance on
promotional activities. As part of this strategy, FREDS 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 FREDS stores are typically located in convenient
shopping and/or residential areas. Approximately 43% of the Companys 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. FREDS stores are of a manageable size, and have an
understandable 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
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
Companys continuing operations, we perform research to discover potential underperforming stores.
The Company uses such research and analysis to identify potential store closures.
FREDS opened 21 stores and closed 74 stores in 2008. The majority of new stores opened in 2008
were located in Mississippi, Alabama, Georgia and South Carolina. The Companys 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 2008, the Company added 11 new pharmacies and closed 23 pharmacies. Approximately 44% of FREDS
stores as of January 31, 2009 contain a pharmacy and sell prescription drugs. The Companys 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 move to FREDS, thereby providing continuity in the
pharmacist-patient relationship.
In 2009, the Company plans to continue our conservative expansion approach and intends to open
approximately 12 - 16 stores and 10 - 14 pharmacies.
- 4 -
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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2008 |
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2007 |
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2006 |
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2005 |
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2004 |
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Stores open at beginning of period |
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692 |
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677 |
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621 |
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563 |
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488 |
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Store opened/acquired during period |
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21 |
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35 |
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59 |
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65 |
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81 |
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Stores closed during period |
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(74 |
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(20 |
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(3 |
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(7 |
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(6 |
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Stores open at end of period |
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639 |
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692 |
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677 |
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621 |
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563 |
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Number of stores with pharmacies at end of period |
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284 |
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296 |
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289 |
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275 |
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258 |
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Square feet of selling space at end of period (in thousands) |
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9,323 |
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10,215 |
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9,946 |
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9,091 |
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8,270 |
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Average square feet of selling space per store |
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14,590 |
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15,239 |
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15,290 |
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15,269 |
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15,267 |
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Franchise stores at end of period |
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24 |
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24 |
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24 |
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24 |
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25 |
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FREDS Xpress Designation: The term Xpress is given to a location that is intended to
transition to a typical FREDS 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 FREDS store. Therefore, the new store location is given the Xpress
designation, and is marked for conversion to a typical FREDS 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 FREDS 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 25
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 2008, 2007, and 2006 were 2.3%,
2.7%, and 3.1%, respectively, and gross profit, as a percentage of total gross profit for the same
time period was 2.1%, 2.4%, and 2.3%, 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 merchandising 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 62 year history, enables the Company to compete very effectively in
its region.
Management believes that FREDS 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 Companys primary buying activities (other than prescription drug buying) are directed from the
corporate office by the Executive Vice President and General Merchandise Manager through two
Divisional Senior Vice Presidents of Merchandising. The Merchandising Department is supported by a
staff of 24 merchants and assistants. The buyers 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
- 5 -
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 Companys 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 14% in 2008, 13% in 2007 and 12% in 2006 of the Companys
warehouse purchases from Procter and Gamble. The Company believes that adequate alternative sources
of products are available for these categories of merchandise.
During 2008, all of the Companys prescription drugs were ordered by its pharmacies individually
and shipped direct from the Companys primary pharmaceutical wholesaler AmerisourceBergen
Corporation (Bergen). Bergen provides substantially all of the Companys prescription drugs.
During 2008, 2007, and 2006 approximately 37%, 36%, and 37%, respectively, of the Companys 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 Companys 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 4% of the Companys total
purchases for the years 2008, 2007, and 2006.
Sales Mix
The Companys sales, which occur through Company owned stores and to franchised FREDS stores,
constitute a single reportable operating segment.
The Companys sales mix by major category for the preceding three years was as follows:
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For the Year Ended |
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January 31, |
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February 2, |
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February 3, |
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2009 |
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2008 |
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2007 |
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Pharmaceuticals |
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31.7% |
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32.2% |
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31.9% |
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Household Goods |
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24.8% |
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24.8% |
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24.7% |
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Food and Tobacco Products |
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15.5% |
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14.2% |
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13.0% |
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Paper and Cleaning Supplies |
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9.2% |
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8.8% |
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8.6% |
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Apparel and Linens |
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8.6% |
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9.9% |
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11.7% |
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Health and Beauty Aids |
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8.0% |
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8.0% |
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8.0% |
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Sales to Franchised Freds Stores |
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2.2% |
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2.1% |
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2.1% |
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Total Sales Mix |
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100.0% |
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100.0% |
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100.0% |
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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 2008, the average customer transaction
size for comparable stores was approximately $19.05, and the number of customer transactions
totaled approximately 88 million. The average transaction size was approximately $18.75 in 2007 and
$18.57 in 2006.
Our private label or Own Brand products includes household cleaning supplies, health and beauty
aids, disposable diapers, pet foods, paper products and a variety of beverage and other products.
Private label products sold constituted approximately 6.6% of total sales in 2008 compared to 3.0%
in 2007 and 2006. 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 Companys private label products. As part of our 2008 strategic plan, we expanded our
private label program and plan to continue that expansion in 2009. For a complete discussion,
reference Item 7, Managements Discussion and Analysis of Financial Condition and Results of
Operation.
The Company sells merchandise to its 24 franchised FREDS stores. These sales during the last
three years totaled approximately $39.6 million in 2008, $37.3 million in 2007, and $36.5 million
in 2006. Franchise and other fees earned totaled approximately $2.1 million in 2008, $2.0 million
in 2007, and $2.0 million in 2006. These fees represent a reimbursement for use of the FREDS name
and administrative costs incurred on behalf of the franchised stores. The Company does not intend
to expand its franchise network in the future.
- 6 -
Advertising and Promotions
Net advertising and promotion costs represented approximately 1.2% of net sales in 2008 and 1.5% of
net sales in 2007 and 2006. The Company uses direct mail, television, radio and select newspaper
advertising to deliver the FREDS value message. The Company utilizes 16 page 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 Companys branding
strategy.
The Companys buyers have discretion to mark down slow moving items. The Company offers regular
clearances 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 FREDS 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 open only until 6:00 p.m. Each FREDS store is managed by a full-time
store manager and those stores with a pharmacy employ a full-time pharmacist. The Companys 38
district managers and 5 Regional Vice Presidents supervise the management and operation of FREDS
stores.
FREDS operates 284 pharmacies (as of January 31, 2009), which offer brand name and generic
pharmaceuticals and are staffed by licensed pharmacists and are managed by 11 healthcare managers
(equivalent to district managers at the store level). The addition of acquired pharmacies in the
Companys stores has resulted in increased store sales and sales per selling square foot.
Management believes that the pharmacy department, in addition to the 41 other merchandise
departments, increases customer traffic and repeat visits and is an integral part of the stores
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 Companys store management training program, are
instrumental in maximizing store performance. The Companys training program covers all aspects of
the Companys operation from product knowledge to handling customers with courtesy.
Inventory Control
The Companys 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. The Company conducts annual
physical inventory counts at all FREDS 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 centralized distribution center in Memphis, Tennessee that
services 348 stores and a 600,000 square foot distribution center in Dublin, Georgia that services
291 stores (see Properties below). Approximately 47% of the merchandise received by FREDS stores
in 2008 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 Companys 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 Companys 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 Companys sales volume is heavier around the first of
the calendar month. Many of the customers who shop at FREDS 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. Generally, the highest volume of
sales and net income occur in the fourth fiscal quarter, coincident with the holiday shopping
season.
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The following table reflects the seasonality of net sales, gross profit, operating income, and net
income by quarter. All of the quarters below are comprised of 13 weeks except for the
4th quarter of fiscal 2006 which is comprised of 14 weeks due to the 53 week year ending
February 3, 2007.
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For the year ended: |
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2nd |
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3rd |
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4th |
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Quarter |
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Quarter |
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Quarter |
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Quarter |
January 31, 2009 |
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Net Sales
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25.8 |
% |
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24.9 |
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23.2 |
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26.1 |
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Gross Profit
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26.3 |
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24.6 |
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24.7 |
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24.4 |
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Operating Profit *
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44.6 |
% |
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7.4 |
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35.7 |
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12.3 |
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Net Income *
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43.6 |
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6.2 |
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36.6 |
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13.6 |
% |
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February 2, 2008 |
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Net Sales
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24.8 |
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23.8 |
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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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
February 3, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
|
24.0 |
% |
|
|
23.4 |
% |
|
|
23.5 |
% |
|
|
29.1 |
% |
Gross Profit
|
|
|
24.2 |
% |
|
|
23.3 |
% |
|
|
24.1 |
% |
|
|
28.4 |
% |
Operating Profit
|
|
|
27.0 |
% |
|
|
15.2 |
% |
|
|
22.7 |
% |
|
|
35.1 |
% |
Net Income
|
|
|
27.3 |
% |
|
|
16.1 |
% |
|
|
22.3 |
% |
|
|
34.3 |
% |
|
|
|
|
* Results include certain charges for the closings of 75 stores in 2008 and 17 stores in 2007 (see Item 7 Exit
and Disposal Activities section) and implementation of FIN 48, primarily in the fourth quarter of 2007 and
the second quarter of 2008. |
Employees
At January 31, 2009, the Company had approximately 9,979 full-time and part-time employees,
comprised of 927 corporate and distribution center employees and 9,052 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 Companys pharmacy department, in particular, is subject to extensive federal and
state laws and regulations.
Licensure and Regulation of Retail Pharmacies
- 8 -
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 insurance laws and regulations in connection with the Companys
pharmacy operations.
Future 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 Company
is unable to predict accurately whether or when legislation may be enacted or regulations may be
adopted relating to the Companys pharmacy operations or what the effect of such legislation or
regulations may be.
Substantial Compliance
The Companys management believes the Company is in substantial compliance with all existing
statutes and regulations material to the operation of the Companys 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 2008, 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.
- 9 -
ITEM 1A. Risk Factors
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 FREDS
securities. Additional risks and uncertainties not presently known to management, or that
management currently deems immaterial, may also impair the Companys 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 FREDS 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 and net income during the Christmas
selling season in the fourth quarter. Our inventories and short-term borrowings 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 merchandise business. 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 31, 2009 and February 2, 2008, 31.7% of our sales were
derived from pharmaceutical sales. 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, 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 continued increases in energy costs would increase our
transportation costs and overall cost of doing business and could adversely affect the 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.
- 10 -
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 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 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 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.
- 11 -
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 current economic and financial crisis 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 the ongoing liquidity crisis in the United States financial system.
ITEM 1B: Unresolved Staff Comments
None.
- 12 -
ITEM 2: Properties
As of January 31, 2009, the geographical distribution of the Companys 639 retail store locations
in 15 states was as follows:
|
|
|
|
|
State |
|
Number of Stores |
|
Georgia |
|
|
111 |
|
Mississippi |
|
|
108 |
|
Alabama |
|
|
88 |
|
Tennessee |
|
|
88 |
|
Arkansas |
|
|
69 |
|
South Carolina |
|
|
52 |
|
Louisiana |
|
|
44 |
|
North Carolina |
|
|
23 |
|
Texas |
|
|
18 |
|
Florida |
|
|
13 |
|
Kentucky |
|
|
10 |
|
Illinois |
|
|
7 |
|
Missouri |
|
|
6 |
|
Indiana |
|
|
1 |
|
Oklahoma |
|
|
1 |
|
|
|
|
|
|
|
|
639 |
|
|
|
|
|
The Company owns the real estate and the buildings for 63 locations (6 of which are closed), and
owns the buildings at 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 576
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 27,000 square feet. Three hundred and sixty-six
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 Companys expansion program in the near term. It is managements 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 Companys 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 FREDS 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.
ITEM 3: Legal Proceedings
In June 2006, a lawsuit entitled Sarah Ziegler, et al. v. FREDS 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 FREDS 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, 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 cut off 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 Company is and will continue to vigorously defend these actions
in this matter. Discovery is closed. The parties agreed to mediate this case and did so
successfully in
January 2009. The total settlement amount, (including attorneys fees and costs) is $5,000,000.
FREDS believes this is a favorable settlement in consideration of the substantial costs of
continuing litigation, high jury verdicts against other retailers who were sued for
- 13 -
practices similar
to the claims alleged in this case as well as the constant distraction to management of a possible
protracted jury trial. FREDS has admitted no liability or wrongdoing and no liability has been
found against FREDS. The parties are finalizing settlement documents and will jointly present the
settlement to the court, which must approve the settlement.
In August 2007, a lawsuit entitled Julia Atchinson, et al. v. FREDS 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 FREDS 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, attorneys 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. Discovery has not yet begun. The parties also agreed to mediate this case in
January 2009 and did so successfully, reaching a settlement of $1,500,000 (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 FREDS. FREDS 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 July 2008, a lawsuit styled Jessica Chapman, on behalf of herself and others similarly situated,
v. FREDS 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 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: Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal
year ended January 31, 2009.
- 14 -
PART II
ITEM 5: Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities
The Companys 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 Companys common stock during
each quarter in fiscal 2008 and fiscal 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1st |
|
2nd |
|
3rd |
|
4th |
|
|
Quarter |
|
Quarter |
|
Quarter |
|
Quarter |
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High |
|
$ |
15.74 |
|
|
$ |
15.00 |
|
|
$ |
12.49 |
|
|
$ |
11.07 |
|
Low |
|
$ |
13.12 |
|
|
$ |
11.40 |
|
|
$ |
9.71 |
|
|
$ |
7.71 |
|
Dividends |
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
The
Companys stock price at the close of the market on
April 15, 2009 was $12.34. There were
approximately 14,500 shareholders of record of the Companys common stock as of April 15, 2009. The
Board of Directors regularly reviews the Companys dividend plans to ensure that they are
consistent with the Companys earnings performance, financial condition, need for capital and other
relevant factors. 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 31, 2009, is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities |
|
|
|
Number of Securities |
|
|
|
|
|
|
Remaining Available for |
|
|
|
to be Issued upon |
|
|
Weighted-Average |
|
|
Issuance Under Equity |
|
|
|
Exercise of |
|
|
Exercise Price of |
|
|
Compensation Plans |
|
|
|
Outstanding Options, |
|
|
Outstanding Options, |
|
|
(Excluding Securities |
|
|
|
Warrants and Rights |
|
|
Warrants and Rights |
|
|
Reflected in Column (a)) |
|
Plan Category |
|
(a) |
|
(b) |
|
(c) |
Equity Compensation plans approved by security holders |
|
|
1,138,111 |
|
|
$ |
15.13 |
|
|
|
2,023,079 |
|
Equity Compensation plans not approved by security
holders |
|
|
- |
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,138,111 |
|
|
$ |
15.13 |
|
|
|
2,023,079 |
|
|
|
|
|
|
|
|
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 Companys 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 Companys 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
31, 2009 (amounts in thousands, except price data). The repurchased shares have been cancelled and
returned to authorized but unissued shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of Shares |
|
|
Maximum Number of |
|
|
|
|
|
|
|
|
|
|
|
Purchased as Part of |
|
|
Shares That May Yet |
|
|
|
Total Number of |
|
|
Average Price Paid |
|
|
Publicly Announced |
|
|
Be Purchased Under |
|
|
|
Shares Purchased |
|
|
Per Share |
|
Plans or Program |
|
the Plans or Program |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,573.5 |
|
February 3, 2008 -
January 31, 2009 |
|
|
- |
|
|
$ |
- |
|
|
|
- |
|
|
|
3,573.5 |
|
- 15 -
ITEM 6: Selected Financial Data
Our selected financial data set forth below should be read in connection with Managements
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)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 5 |
|
2007 5 |
|
2006 2 & 4 |
|
2005 |
|
2004 |
Statement of Income Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
1,798,840 |
|
|
$ |
1,780,923 |
|
|
$ |
1,767,239 |
|
|
$ |
1,589,342 |
|
|
$ |
1,441,781 |
|
Operating income |
|
|
26,318 |
|
|
|
16,457 |
|
|
|
40,949 |
|
|
|
40,081 |
|
|
|
39,426 |
|
Income before income taxes |
|
|
25,910 |
|
|
|
15,664 |
|
|
|
40,213 |
|
|
|
39,255 |
|
|
|
38,633 |
|
Provision for income taxes |
|
|
9,268 |
|
|
|
4,946 |
|
|
|
13,467 |
|
|
|
13,161 |
|
|
|
10,681 |
|
Net income |
|
|
16,642 |
|
|
|
10,718 |
|
|
|
26,746 |
|
|
|
26,094 |
|
|
|
27,952 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
0.42 |
|
|
|
0.27 |
|
|
|
0.67 |
|
|
|
0.66 |
|
|
|
0.71 |
|
Diluted |
|
|
0.42 |
|
|
|
0.27 |
|
|
|
0.67 |
|
|
|
0.66 |
|
|
|
0.71 |
|
Cash dividends declared per share |
|
|
0.08 |
|
|
|
0.08 |
|
|
|
0.08 |
|
|
|
0.08 |
|
|
|
0.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selected Operating Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income as a percentage of sales |
|
|
1.5% |
|
|
|
0.9% |
|
|
|
2.3% |
|
|
|
2.5% |
|
|
|
2.7% |
|
Increase in comparable store sales 1 |
|
|
1.8% |
|
|
|
0.3% |
|
|
|
2.4% |
3 |
|
|
1.2% |
|
|
|
2.2% |
|
Stores open at end of period |
|
|
639 |
|
|
|
692 |
|
|
|
677 |
|
|
|
621 |
|
|
|
563 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance Sheet Data (at period end): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
544,775 |
|
|
$ |
550,572 |
|
|
$ |
515,709 |
|
|
$ |
498,141 |
|
|
$ |
465,224 |
|
Short-term debt (including capital leases) |
|
|
243 |
|
|
|
285 |
|
|
|
737 |
|
|
|
1,053 |
|
|
|
684 |
|
Long-term debt (including capital leases) |
|
|
4,866 |
|
|
|
35,653 |
|
|
|
2,331 |
|
|
|
6,815 |
|
|
|
24,212 |
|
Shareholders equity |
|
|
387,081 |
|
|
|
372,059 |
|
|
|
369,268 |
|
|
|
339,595 |
|
|
|
314,546 |
|
1 A store is first included in the comparable store sales calculation after the end of the 12th
month following the stores 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 FAS 123 (R).
5 Results include certain charges for the closing of 75 stores in 2008 and 17 in 2007, (see Exit
and Disposal Activities section) and implementation of FIN 48.
- 16 -
ITEM 7: Managements Discussion and Analysis of Financial Condition and Results of Operations
General Accounting Periods
The following information contains references to years 2008, 2007, and 2006, which represent fiscal
years ended January 31, 2009 and February 2, 2008 (which were 52-week accounting periods) and
February 3, 2007 (which was a 53-week accounting period). 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
During 2008, the Company continued with the execution of its previously announced strategic plan to
improve profitability and operating margin. Management believes that the plan, which included the
closing of 75 underperforming stores and 22 underperforming pharmacies, coupled with slowing growth
in 2008, will have a continued positive impact on the Companys cash flow and operating margin in
2009 and beyond. During 2008, we closed a total of 74 stores and 23 pharmacies and have opened 21
stores and 11 pharmacies. The one remaining going out of business sale and the resulting store
closure will be substantially completed in the first half of 2009. Our new store and pharmacy
openings during the year were primarily in Mississippi, Alabama, Georgia and South Carolina. We
did not enter into any new states during the year.
Another key area of concentration during the year was our initiative to improve service level and
in-stock positions. Our We Got It program focuses on our highest demand consumable items (700 -
800 items). These are items that we have promised, through our We Got It campaign, to always
have on our shelves and available for our customers. We continued in 2008 to implement supply
chain and distribution procedures to ensure that our We Got It pledge is fulfilled.
In the second quarter of 2008, we introduced to our customers a new pricing strategy and marketing
campaign entitled Price Alert. This campaign focuses the customers attention on particular
items in our stores that are value priced and attractive to any budget, especially during current
economic conditions. This marketing campaign is chain-wide and is delivered to the customer via
print and media advertising in addition to specifically designed in-store signage. We will
continue to use the Price Alert campaign to deliver value priced products to our customers.
Our Battleship Store Program, which was developed late in 2007 and became fully operational in the
first quarter of 2008, is intended to sharpen focus on our upper tier of profit producing stores.
This program is designed to reward our customers with additional benefits such as expanded
selections of products, one time or one-of-a-kind type items, or special events such as treasure
hunts or outdoor activities. Customer and employee appreciation are key tenets of the Battleship
Store Program. As this program is in its infancy, we continued in the third and fourth quarters to
refine our understanding of our customers needs in our Battleship Stores markets. We also
continued to hone our delivery and execution of this strategy so that our Battleship Stores will
help drive increased operating profit in line with the Companys overall profit improvement
strategies.
Also during 2008, we continued to focus on building our private label line of products which should
build and solidify customer loyalty while simultaneously increasing gross margin. We are currently
developing additional private label brand names that we believe the customer will find appealing
and will become synonymous with FREDS promise to deliver quality products at low prices. As a
result of our focus in this area, we continue to increase our market penetration in our private
label products.
We continued in 2008 with capital improvements in infrastructure, including existing store
expansions and remodels, distribution center upgrades and further development of our information
technology capabilities. Technology upgrades are being made in the areas of direct store delivery
systems, stores point of sale systems, and pharmacy systems.
During 2009, the Company will continue to execute its strategic plan to improve profitability and
operating margin. Particular emphasis will be placed on improving the customers shopping
experience by improving the store format and layout. We will also be focusing on our real estate
strategy in order to choose the best locations for our customers. These initiatives, in
conjunction with our traffic driving strategies and our planned inventory productivity
improvements, will help improve profitability and operating margin.
Our private label or Own Brand products will continue to be a focus in 2009 and beyond. By
increasing market presentation of our Own Brand products, we will build customer loyalty and
subsequent traffic and simultaneously increase gross margin. Our Own Brand products cross multiple
product lines and include household cleaning supplies, health and beauty aids, disposable diapers,
pet foods, paper products and a variety of beverage and other products.
- 17 -
We will continue in 2009 with technology upgrades in our Direct Store Delivery systems (NEX / DEX),
stores point of sale systems, Pharmacy systems, as well as capital investments in infrastructure,
distribution center upgrades and stores, including new stores and remodels.
Key factors that will be critical to the Companys 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, controlling the effects of
inflation, especially in regard to occupancy costs, controlling product mix, increasing operating
margin through improved gross margin and leveraging operating costs, and generating adequate cash
flow to fund the Companys future needs. Additionally, managing the store closing process
effectively and efficiently will be a key factor in delivering projected benefits in 2009 and
beyond.
Other factors that will affect Company performance in 2009 include the continuing management of the
impacts of the changing regulatory environment in which our pharmacy department operates,
especially the anticipated implementation of the federally approved change in pricing of generic
pharmaceuticals to Average Manufacturers Price (AMP), which could negatively affect gross margin.
We also believe that the economic and financial crisis has had and will continue to have an impact
on the disposable income of our customers. However, we believe falling fuel prices late in 2008
have been the one economic bright spot and have, to some extent, eased the enormous economic
pressures being felt by consumers. We also believe that we have experienced some down shopping
in 2008 due to economic pressures being felt by consumers that might not normally shop in our
stores, and expect this trend to continue into 2009.
Our business is subject to seasonal influences, but has tended to experience less seasonal
fluctuation than many other retailers due to the mix of everyday basic merchandise and pharmacy
business. Our fiscal fourth quarter is typically the most profitable quarter because it includes
the Christmas selling season. The overall strength of the fourth quarter is partially mitigated,
however, by the inclusion of the month of January, which is generally the least profitable month of
the year.
Critical Accounting Policies
The preparation of FREDS 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 31, 2009. 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 Companys 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 FREDS 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 2008, 2007, and
2006 was $2,145, $2,008, and $2,019, 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.
- 18 -
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 stores shrink rate, which is based on the previously mentioned factors, by the interim
periods 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 Companys 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 Companys 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 $30.8 million, and $31.1 million at
January 31, 2009 and February 2, 2008, 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 $19.1 million at January 31, 2009 and $15.4 million at February 2, 2008. The LIFO
reserve increased by approximately $3.7 million and $1.6 million during 2008 and 2007,
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 buying, warehousing, and
accounting, as well as inbound freight. During the second quarter of FY07, we revised our estimate
to include certain costs internally captured within our Merchandise Planning, Information
Technology and Human Resources departments as they relate to the inventory functions and support of
procurement and storage. This revision follows growth in the role of these departments in support
of the procurement and warehousing functions, including additional personnel hired over the
previous few quarters. Further, our Merchandise Planning department has evolved from being
previously included within the buying function to a stand alone function with responsibility for
inbound logistics and commodity procurement. The total amount of procurement and storage costs and
inbound freight included in merchandise inventory at January 31, 2009 is $19.0 million, with the
corresponding amount of $21.9 million at February 2, 2008.
Impairment. The Companys 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 Statement of Financial Accounting Standards
(SFAS) 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we review for
impairment all stores opened 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 managements 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 assets fair value. The
- 19 -
fair value is based on estimated market values for similar assets or other reasonable estimates of
fair market value based upon managements judgment.
Exit and Disposal Activities. During fiscal 2007, the Company closed 17 underperforming
stores.
During the course of 2008, the Company has closed 74 stores and 23 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 last 10 quarters. The study revealed that FREDS 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 Companys 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. The one remaining store closure is scheduled for the first half of fiscal 2009, bringing
the total number of store closures to 75.
Inventory Impairment
During fiscal 2006, which ended February 3, 2007, we recorded a below-cost inventory adjustment of
approximately $0.9 million to reduce the value of inventory to lower of cost or market in the 20
stores that were planned for closure in fiscal 2007, of which 17 were closed. The entire impairment
was utilized in fiscal 2007.
During fiscal 2007, which ended February 2, 2008, 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 Companys 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 SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities.
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 SFAS 146. 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, which ended February 2, 2008, 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, which ended January 31, 2009, 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 $7.6 million during
the period, leaving $3.5 million in the reserve at January 31, 2009. During the first half of
fiscal 2009, the Company expects to incur $.2 million in lease contract termination costs related
to the remaining store closure.
- 20 -
The following table illustrates the exit and disposal activity related to the store closures
discussed in the previous paragraphs (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending |
|
|
|
Balance at |
|
|
|
|
|
|
|
|
|
Balance |
|
|
February |
|
Additions |
|
Utilized |
|
January |
|
|
2, 2008 |
|
FY08 |
|
FY08 |
|
31, 2009 |
Inventory markdowns for planned store closings |
|
$ |
10.0 |
|
|
$ |
0.3 |
|
|
$ |
10.3 |
|
|
$ |
- |
|
Lease contract termination liability |
|
|
0.6 |
|
|
|
10.5 |
|
|
|
7.6 |
|
|
|
3.5 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
10.6 |
|
|
$ |
10.8 |
|
|
$ |
17.9 |
|
|
$ |
3.5 |
|
|
|
|
|
|
|
|
|
|
Fixed Asset Impairment
During fiscal 2006, which ended February 3, 2007, the Company recorded a charge of $0.8 million in
selling, general and administrative expense for the impairment of fixed assets and leasehold
improvements associated with the 20 store closings planned for fiscal 2007.
During during the fourth quarter of 2007, which ended February 2, 2008, 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. There were no other fixed asset
impairment charges incurred during 2008.
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:
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Estimated Useful Lives |
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Building and building improvements |
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8 - 30 years |
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Furniture, fixtures and equipment |
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3 - 10 years |
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Leasehold improvements |
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3 - 10 years or term of lease, if shorter |
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Automobiles and vehicles |
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3 - 5 years |
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Airplane |
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9 years |
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Assets under capital lease are depreciated in accordance with the Companys 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 the Emerging Issues Task Force Issue No. 02-16, Accounting by a Customer
(including a Reseller) for Certain Consideration Received from a Vendor (EITF 02-16), 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 31, 2009, the Company had approximately 1,130 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.
- 21 -
In accordance with The American Institute of Certified Public Accountants Statement of Position No.
93-7, Reporting on Advertising Costs (AICPA SOP 93-7), 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 2008, 2007, and 2006, were $24.1 million, $27.6
million, and $27.4 million, respectively. Gross advertising expenses were reduced by vendor
cooperative advertising allowances of $2.3 million, $1.5 million, and $1.1 million, for 2008, 2007,
and 2006, respectively. It would be the Companys 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 Companys 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 Companys results
of operations. The Company carries additional coverage for excessive or catastrophic claims with
stop loss limits of $250,000 for property and general liability and $200,000 for employee medical.
The Companys insurance reserve was $8.6 million and $8.2 million on January 31, 2009 and
February 2, 2008, respectively. Changes in the reserve over that time period were attributable to
additional reserve requirements of $40.3 million netted with reserve utilization of $39.9 million.
Income Taxes. The Company reports income taxes in accordance with SFAS No. 109, Accounting
for Income Taxes. Under SFAS No. 109, the asset and liability method is used for computing future
income tax consequences of events, which have been recognized in the Companys Consolidated
Financial Statements or income tax returns. Deferred income tax expense or benefit is the net
change during the year in the Companys deferred income tax assets and liabilities (see Note 4 -
Income Taxes).
In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No.109. We
adopted FIN 48 as of February 4, 2007, the first day of fiscal 2007. This interpretation clarifies
the accounting for uncertainty in income taxes recognized in an enterprises financial statements
in accordance with SFAS No. 109 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 FIN 48, 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, FIN 48 provides guidance on de-recognition, measurement, classification, interest and
penalties, accounting in interim periods, disclosure and transition (see Note 4 Income Taxes).
FIN 48 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 FIN 48 in the
financial statements as a component of income tax expense. As of January 31, 2009, accrued interest
and penalties related to our unrecognized tax benefits totaled $2.4 million and $0.4 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 SFAS No. 123(R), Share-Based Payment, 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 SFAS No. 123, 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 SFAS No. 123(R). Results for prior periods have not been restated.
In November 2005, FASB issued Staff Position No. FAS 123(R)-3, Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards (FSP FAS 123R-3). Effective January 29,
2006, the Company elected to adopt the alternative transition method provided in FSP FAS 123R-3 for
calculating the income tax effects of stock-based compensation pursuant to SFAS 123(R). 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 SFAS 123(R).
SFAS 123(R) 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 as
required prior to SFAS 123(R). The impact of adopting SFAS 123(R) 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.
- 22 -
Stock-based compensation expense, post adoption of SFAS 123(R), 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 Companys 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 FREDS financial results for the past three years. In
this table, categories of income and expense are expressed as a percentage of sales.
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For the Year Ended |
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January 31, |
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February 2, |
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February 3, |
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2009 3 |
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2008 3 |
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2007 3 |
Net sales |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Cost of good sold 1 |
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72.0 |
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72.5 |
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72.0 |
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Gross profit |
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28.0 |
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27.5 |
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28.0 |
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Selling, general and administrative expenses 2 |
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26.5 |
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26.6 |
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25.7 |
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Operating income |
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1.5 |
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0.9 |
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2.3 |
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Interest expense, net |
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0.1 |
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- |
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- |
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Income before taxes |
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1.4 |
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0.9 |
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2.3 |
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Income taxes |
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0.5 |
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0.3 |
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0.8 |
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Net income |
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0.9 |
% |
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0.6 |
% |
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|
1.5 |
% |
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|
|
|
|
|
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 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 stores 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 stores
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 FREDS 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 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.
- 23 -
The Companys 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.
FREDS 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 Companys 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 Companys 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 Companys mail order operation caused by a lack of competitive sourcing for its primary
product, contraceptives.
Sales to FREDS 24 franchised locations increased approximately $2.3 million in 2008 and
represented 2.2% of the Companys total sales, compared to 2.1% of the Companys 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 Companys 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 Companys assessment of future tax consequences of transactions that
have been reflected in the Companys 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 Companys judgment of the probable outcome
of the tax contingencies and are adjusted, from time to time, based upon changing facts and
circumstances.
- 24 -
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 Companys 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.
Fiscal 2007 Compared to Fiscal 2006
Sales
Net sales increased 0.8% ($13.7 million) in 2007. Approximately $8.4 million of the increase was
attributable to a net addition of 15 new stores, and a net addition of 7 pharmacies during 2007,
together with the sales of 56 store locations and 14 pharmacies that were opened or upgraded during
2006 and contributed a full year of sales in 2007. During 2007, the Company closed 20 stores and 4
pharmacy locations. Comparable store sales, consisting of sales from stores that have been open for
more than one year, increased 0.3% in 2007, which accounted for $ 5.3 million in sales. Comparable
store sales for 2007 are computed excluding the effect of the extra week in 2006 due to the 53-week
period.
The Companys 2007 front store (non-pharmacy) sales increased approximately 0.3% over 2006 front
store sales. Excluding week 53 sales the front store sales increased approximately 2.9% over 2006
front store sales. Front store sales growth benefited from the above mentioned store additions and
improvements, and sales increases in certain categories such as food, beverages, paper and
chemicals, tobacco, greeting cards, prepaid products, electronics, hardware, and pets.
FREDS pharmacy sales were 32.2% of total sales in 2007 and 31.9% of total sales in 2006 and
continue to rank as the largest sales category within the Company. The total sales in this
department, including the Companys mail order operation, increased 1.6% over 2006, with third
party prescription sales representing approximately 92% of total pharmacy sales, the same as in the
prior year. The Companys pharmacy sales growth continued to benefit from an ongoing program of
purchasing prescription files from independent pharmacies and the addition of pharmacy departments
in existing store locations.
Sales to FREDS 24 franchised locations increased approximately $0.8 million in 2007 and
represented 2.1% of the Companys total sales, the same as in 2006. The increase in sales to
franchised locations results primarily from the sales volume increases experienced by the franchise
locations during the year. It is anticipated that this category of business will continue to
decline as a percentage of total Company sales since the Company has not added and does not intend
to add any additional franchisees.
Gross Margin
Gross margin as a percentage of sales decreased to 27.5% in 2007 compared to 28.0% in 2006. The
decrease in gross margin results primarily from the $10.0 million below-cost inventory adjustment
associated with the planned closure of 75 under performing stores in 2008. An improvement in the
pharmacy departments gross margin due to a greater percentage of generic dispensing offset lower
general merchandise margins in 2007.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $445.2 million (25.0% of net sales) in 2007
compared to $424.9 million (24.0% of net sales) in 2006. The increase as a percent of net sales was
from the recording of $4.6 million for asset impairments for the planned closure of 75 under
performing stores (0.3%), increased payroll cost of $5.1 million (0.2%), increased property rents
of $4.4 million
(0.2%), higher utilities of $2.4 million (0.1%), and increased legal and professional cost of
$2.2 million (0.1%). Depreciation and amortization expense was $28.6 million (1.6% of net sales) in
2007 compared to $29.1 million (1.6 % of net sales) for 2006.
Operating Income
Operating income decreased to $16.5 million in 2007 from $40.9 million in 2006. Operating income as
a percentage of sales was 0.9% in 2007 down from 2.3% in 2006. As discussed within the captions,
Sales, Gross Margin and Selling, General and Administrative Expenses above, operating income
decreased to $16.5 million in 2007 from $40.9 million in 2006, due to a reduction in gross margin,
primarily associated with the planned closure of 75 stores and an increase of $20.3 million in
selling, general and administrative costs.
- 25 -
The reduction in gross profit from the $10.0 million
charge for merchandise at stores targeted for closure was partially offset by an improvement in the
pharmacys departments gross profit, also described above.
Interest Expense, Net
Net interest expense for 2007 totaled $.8 million or less than .1% of sales compared to $.7 million
which was also less than .1% of sales in 2006.
Income Taxes
The effective income tax rate was 31.6% in 2007 compared to 33.5% in 2006, primarily as a result of
various jobs tax credits.
The Companys 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 Companys assessment of future tax consequences of transactions that
have been reflected in the Companys 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 Companys 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 $122.2 million for state income tax purposes and expire at
various times during 2008 through 2027. If certain substantial changes in the Companys 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 2008 to 35% 36% from fiscal 2007 and
fiscal 2006 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
As a result of the fluctuations described in the preceding sections, net income decreased to $10.7
million (or $.27 per diluted share) in 2007 from $26.7 million (or $.67 per diluted share) in 2006.
While comparable store sales increased by 0.3% in 2007, gross margin was reduced primarily by a
provision for merchandise at 75 stores targeted for closing, partially offset by increased pharmacy
department product margins. Net income was also reduced by asset impairments related to the
planned store closures and increased payroll due to the federally mandated minimum wage increase.
Conversely, net income benefited from lower tax expense due to various jobs tax credits and the
$24.4 million reduction in pre-tax income.
Liquidity and Capital Resources
The Companys 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. FREDS primary sources of working capital have traditionally
been cash flow from operations and borrowings under its credit facility. The Company had working
capital of $263.3 million, $270.5 million, and $239.9 million at year-end 2008, 2007, and 2006,
respectively. Working capital fluctuates in relation to profitability, seasonal inventory levels,
and the level of store openings and closings. Working capital at year-end 2008 decreased by
approximately $7.2 million from 2007. The decrease was primarily due to $6.6 million in accrued
expenses related to the settlement of two legal cases (see Item 3. Legal Proceedings). The Company
plans to open 3 new stores and 2 new pharmacies during the first quarter of 2009.
During 2005, 2006 and 2007, we incurred losses caused by fire and tornado 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 $78.3 million in 2008, $19.3 million in
2007, and $35.3 million in 2006.
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 (see Item 3. Legal Proceedings). Other non-current liabilities increased by $8.7 million due
to an increase in the Company FIN 48 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
- 26 -
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.
In fiscal 2006, inventory, net of the LIFO reserve, increased by approximately $2.1 million due to
controlling inventory and improving merchandise quality during the fiscal year. Accounts receivable
increased by approximately $17.5 million due primarily to the shift in our year ending date to
include the higher volume of activity around the 1st of the month, combined with
increased vendor rebates not yet collected.
Capital expenditures in 2008 totaled $17.0 million compared to $31.4 million in 2007 and $26.5
million in 2006. The 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). The Company
also assumed debt of $6.1 million and issued $1.2 million in common stock for the acquisition of
store real estate. The 2006 capital expenditures included approximately $11.9 million for new
stores and pharmacies, $11.7 million for upgrading existing stores and $2.9 million for technology,
corporate and other capital expenditures. Cash used for investing activities also includes $5.7
million in 2008, $1.7 million in 2007, and $3.4 million in 2006 for the acquisition of prescription
lists and other pharmacy related items and $0.6 million in 2008, $1.1 million in 2007 and
$0.3 million in 2006 from insurance proceeds related to fixed assets reimbursements.
In 2009, the Company is planning capital expenditures totaling approximately $18.8 million.
Expenditures are planned totaling $13.5 million for new and existing stores and pharmacies. Planned
expenditures also include approximately $1.3 million for technology upgrades, and approximately
$4.0 million for distribution center equipment and other capital maintenance. Technology upgrades
in 2009 will be made in the areas of direct store delivery systems and POS systems and equipment
for the stores. In addition the Company plans expenditures of approximately $5.0 million in 2009
for the acquisition of prescription lists and other pharmacy related items.
Cash and cash equivalents were $35.1 million at the end of 2008 compared to $10.3 million at the
end of 2007 and $2.5 million at the end of 2006. 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 Companys 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 Companys 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 2008, the Company did not repurchase any shares compared to a repurchase of 426,500 shares
for $4.4 million in 2007.
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. 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
Companys 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 bear
interest at 1.5% below the prime rate or a LIBOR-based rate. Under the most restrictive covenants
of the Agreement, the Company is required to maintain specified shareholders equity (which was
$292.3 million at February 2, 2008) and net income levels. The Company is 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 FREDS 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.
On October 10, 2005, the Company and Regions Bank, successor in interest to Union Planters, entered
into a Seventh Modification Agreement of the Revolving Loan and Credit Agreement to provide a
temporary increase of commitment of $20 million and
- 27 -
increasing the available credit line to
$70 million. The term of the agreement was from October 10, 2005 until December 15, 2005. On
December 15, 2005, the available credit line reverted to $50 million. All terms, conditions and
covenants remained in place for the Note and credit facility.
On July 29, 2005 the Company and Regions Bank, successor in interest to Union Planters, entered
into a Sixth Modification Agreement of the Revolving Loan and Credit Agreement (the Agreement)
dated April 3, 2000 to increase the commitment from the bank from $40 million to $50 million and to
extend the term until July 31, 2009. The Agreement bears interest at 1.5% below the prime rate or a
LIBOR-based rate. All terms, conditions and covenants remained in place for the Note and credit
facility.
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 2008, 2007 and 2006.
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
percent 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 and certain transportation equipment under capital leases.
The following table summarizes the Companys significant contractual obligations as of January 31,
2009, which excludes the effect of imputed interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
2009 |
|
2010 |
|
2011 |
|
2012 |
|
2013 |
|
Thereafter |
|
Total |
Operating leases 1 |
|
$ |
54,582 |
|
|
$ |
41,719 |
|
|
$ |
35,451 |
|
|
$ |
28,694 |
|
|
$ |
19,549 |
|
|
$ |
31,258 |
|
|
$ |
211,253 |
|
Inventory purchase obligations 2 |
|
|
94,527 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
94,527 |
|
Equipment leases 3 |
|
|
2,300 |
|
|
|
1,808 |
|
|
|
1,438 |
|
|
|
457 |
|
|
|
58 |
|
|
|
6 |
|
|
|
6,067 |
|
Mortgage loans on land & buildings and other 4 |
|
|
243 |
|
|
|
786 |
|
|
|
202 |
|
|
|
169 |
|
|
|
1,111 |
|
|
|
2,841 |
|
|
|
5,352 |
|
Postretirement benefits 5 |
|
|
31 |
|
|
|
33 |
|
|
|
34 |
|
|
|
35 |
|
|
|
38 |
|
|
|
233 |
|
|
|
404 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total contractual obligations |
|
$ |
151,683 |
|
|
$ |
44,346 |
|
|
$ |
37,125 |
|
|
$ |
29,355 |
|
|
$ |
20,756 |
|
|
$ |
34,338 |
|
|
$ |
317,603 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 31, 2009.
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 $9.7 million at January 31, 2009 and $14.3 million at
February 2, 2008 on issued letters of credit, which support purchase orders for merchandise.
Additionally, the Company had outstanding letters of credit aggregating approximately $12.0 million
at January 31, 2009 and $17.1 million at February 2, 2008 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, a director and officer of the Company, purchased the land and buildings occupied
by thirteen FREDS 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 $1.4 million for the
year ended January 31, 2009. Total future commitments under related party leases are $10.9 million.
- 28 -
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS No. 157). SFAS No. 157
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. SFAS
No. 157 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 SFAS No. 157, fair value measurements are required to be disclosed by level
within that hierarchy. SFAS No. 157 is effective for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. However, FASB Staff Position No. FAS (FSP
SFAS) 157-2, Effective Date of FASB Statement No. 157, issued in February 2008, delays the
effective date of SFAS No. 157 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 SFAS No. 157 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 FSP SFAS 157-2 and determined that it will have no impact on its results of operations or
financial position. In October 2008, the FASB issued FSP SFAS 157-3, Determining the Fair Value
of a Financial Asset in a Market That Is Not Active. FSP SFAS 157-3 clarifies the application of
SFAS No. 157 when the market for a financial asset is inactive. The guidance in FSP SFAS 157-3 is
effective immediately and has no effect on our financial statements. In April 2009, the FASB
issued FSP SFAS 157-4, Determining Whether a Market Is Not Active and a Transaction Is Not
Distressed which further clarifies the principles established by SFAS No. 157. 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 is assessing the impact, if any, and will not elect to
early adopt FSP SFAS 157-4.
In February 2007, the Financial Accounting Standards Board issued SFAS No. 159, The Fair Value
Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement
No. 115, (SFAS No. 159). SFAS No. 159 allows companies the choice to measure many financial
instruments and certain other items at fair value. This gives a company the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007. The Company has determined that this statement will have
no impact on its results of operations or financial position.
In June 2007, the Emerging Issues Task Force (EITF) of the FASB ratified their consensus position
06-11 (EITF 06-11), Accounting for Income Tax Benefits of Dividends on Share-Based Payment
Awards. EITF 06-11 provides guidance on how a company should recognize the income tax benefit
received on dividends that are paid to employees holding equity-classified nonvested shares,
equity-classified nonvested share units, or equity-classified outstanding share options charged to
retained earnings under FASB Statement 123(R), Share-Based Payment. The Company was required to
apply the guidance provided in EITF 06-11 prospectively to income tax benefits of dividends on
equity-classified employee share-based payment awards that are declared in fiscal years beginning
after September 15, 2007, which is our fiscal 2008. Early application of EITF 06-11 was permitted
for the income tax benefit of dividends on equity-classified employee share-based payment awards
that are declared in periods for which financial statements have not yet been issued. The Company
evaluated EITF 06-11 and determined that it has no significant impact on its results of operations
or financial position.
In December 2007, the FASB issued FASB Statement No. 141(R), Business Combinations (SFAS
141(R)), which establishes accounting principles and disclosure requirements for all transactions
in which a company obtains control over another business. SFAS No. 141(R) applies prospectively to
business combinations for which the acquisition date is on or after the beginning of the first
annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.
The Company has evaluated SFAS No. 141(R) and determined it will have no impact its results of
operations or financial position.
In December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51 (SFAS No. 160). SFAS No. 160 establishes new
accounting and reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited.
The Company has evaluated SFAS No. 160 and determined it will have no impact its results of
operations or financial position.
In March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments
and Hedging Activities an amendment of FASB Statement No. 133 (SFAS No. 161). SFAS No. 161
requires enhanced disclosures about an entitys
derivative and hedging activities. SFAS No. 161 is effective for fiscal years, and interim periods
within those fiscal years, beginning after November 15, 2008. Earlier adoption is available. The
Company has evaluated SFAS No. 161 and determined that it will have no impact on its results of
operations or financial position.
In May 2008, the FASB issued FASB Statement No. 162, The Hierarchy of Generally Accepted
Accounting Principles (SFAS 162), which became effective in November 2008. This statement
identifies the framework for selecting the principles to be used in
- 29 -
the preparation of financial
statements of nongovernmental entities that are presented in conformity with GAAP. The Company has
determined that this statement will not materially effect its financial statements.
ITEM 7a: Quantitative and Qualitative Disclosure about Market Risk
The Company has no holdings of derivative financial or commodity instruments as of January 31,
2009. The Company is exposed to financial market risks, including changes in interest rates. All
borrowings under the Companys 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 Companys income. All of the Companys 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.
ITEM 8: Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
FREDS, Inc.
Memphis, Tennessee
We have audited the accompanying consolidated balance sheets of FREDS, Inc. (the Company), as of
January 31, 2009 and February 2, 2008 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 31, 2009. These financial statements are the responsibility of the
Companys 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 FREDS, Inc. at January 31, 2009 and February 2 2008,
and the results of its operations and its cash flows for each of the three years in the period
ended January 31, 2009, 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 Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty
in Income Taxes. Also, the Company changed its method of accounting for defined benefit pension
and other postretirement plans and the quantifying of prior year misstatements in the year ended
February 3, 2007 due to the adoption of Statements of Financial Account Standards No. 158,
Employers Accounting for Defined Benefit Pension and Other Postretirement Plans and SEC Staff
Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements When Quantifying
Misstatements in the Current Year Financial Statements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight
Board (United States), FREDS, Inc.s internal control over financial reporting as of January 31,
2009, 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
16, 2009 expressed an unqualified opinion thereon.
/s/BDO Seidman, LLP
Memphis, Tennessee
April 16, 2009
- 30 -
FREDS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except for number of shares)
|
|
|
|
|
|
|
|
|
|
|
January 31, |
|
|
February 2, |
|
|
|
2009 |
|
|
2008 |
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
35,128 |
|
|
$ |
10,266 |
|
Receivables, less allowance for doubtful accounts of $885 and $879, respectively |
|
|
28,857 |
|
|
|
30,972 |
|
Inventories |
|
|
301,537 |
|
|
|
320,268 |
|
Other non-trade receivables |
|
|
15,782 |
|
|
|
20,536 |
|
Prepaid expenses and other current assets |
|
|
11,912 |
|
|
|
11,792 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
393,216 |
|
|
|
393,834 |
|
Property and equipment, at depreciated cost |
|
|
138,036 |
|
|
|
145,985 |
|
Equipment under capital leases, less accumulated amortization of $4,928 and $4,836,
respectively |
|
|
39 |
|
|
|
132 |
|
Other noncurrent assets, net |
|
|
13,484 |
|
|
|
10,621 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
544,775 |
|
|
$ |
550,572 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
69,955 |
|
|
$ |
70,416 |
|
Current portion of indebtedness |
|
|
243 |
|
|
|
159 |
|
Current portion of capital lease obligations |
|
|
- |
|
|
|
126 |
|
Accrued expenses and other |
|
|
46,659 |
|
|
|
39,469 |
|
Deferred income taxes |
|
|
13,061 |
|
|
|
13,151 |
|
Other current liabilities |
|
|
7,749 |
|
|
|
- |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
137,667 |
|
|
|
123,321 |
|
Long-term portion of indebtedness |
|
|
4,866 |
|
|
|
35,653 |
|
Deferred income taxes |
|
|
1,328 |
|
|
|
6,698 |
|
Other noncurrent liabilities |
|
|
13,833 |
|
|
|
12,841 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
157,694 |
|
|
|
178,513 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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,
40,028,484 and 39,880,836 shares issued and outstanding, respectively |
|
|
136,877 |
|
|
|
135,335 |
|
Common stock, Class B nonvoting, no par value, 11,500,000 shares authorized,
none outstanding |
|
|
- |
|
|
|
- |
|
Retained earnings |
|
|
249,141 |
|
|
|
235,684 |
|
Accumulated other comprehensive income |
|
|
1,063 |
|
|
|
1,040 |
|
|
|
|
|
|
|
|
Total shareholders equity |
|
|
387,081 |
|
|
|
372,059 |
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
544,775 |
|
|
$ |
550,572 |
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
- 31 -
FREDS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended |
|
|
January 31, |
|
February 2, |
|
February 3, |
|
|
2009 |
|
2008 |
|
2007 |
Net sales |
|
$ |
1,798,840 |
|
|
$ |
1,780,923 |
|
|
$ |
1,767,239 |
|
Cost of goods sold |
|
|
1,295,822 |
|
|
|
1,290,680 |
|
|
|
1,272,320 |
|
|
|
|
|
|
|
|
Gross profit |
|
|
503,018 |
|
|
|
490,243 |
|
|
|
494,919 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
26,425 |
|
|
|
28,614 |
|
|
|
29,102 |
|
Selling, general and administrative expenses |
|
|
450,275 |
|
|
|
445,172 |
|
|
|
424,868 |
|
|
|
|
|
|
|
|
Operating income |
|
|
26,318 |
|
|
|
16,457 |
|
|
|
40,949 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
|
(308 |
) |
|
|
(567 |
) |
|
|
(68 |
) |
Interest expense |
|
|
716 |
|
|
|
1,360 |
|
|
|
804 |
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
25,910 |
|
|
|
15,664 |
|
|
|
40,213 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes |
|
|
9,268 |
|
|
|
4,946 |
|
|
|
13,467 |
|
|
|
|
|
|
|
|
Net income |
|
$ |
16,642 |
|
|
$ |
10,718 |
|
|
$ |
26,746 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share |
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.42 |
|
|
$ |
0.27 |
|
|
$ |
0.67 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
0.42 |
|
|
$ |
0.27 |
|
|
$ |
0.67 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
39,628 |
|
|
|
39,771 |
|
|
|
39,770 |
|
Effect of dilutive stock options |
|
|
223 |
|
|
|
111 |
|
|
|
88 |
|
|
|
|
|
|
|
|
Diluted |
|
|
39,851 |
|
|
|
39,882 |
|
|
|
39,858 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
16,642 |
|
|
$ |
10,718 |
|
|
$ |
26,746 |
|
Other comprehensive income (expense), net of tax
postretirement plan adjustment |
|
|
(23 |
) |
|
|
(43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
$ |
16,619 |
|
|
$ |
10,675 |
|
|
$ |
26,746 |
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
- 32 -
FREDS, 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, January 28, 2006 |
|
|
39,860,188 |
|
|
$ |
134,218 |
|
|
$ |
207,643 |
|
|
$ |
(2,266 |
) |
|
$ |
- |
|
|
$ |
339,595 |
|
|
|
|
|
|
|
|
Cumulative effect of the adoption of
SAB 108 (Note 1) (net
of tax $597) |
|
|
|
|
|
|
|
|
|
|
1,185 |
|
|
|
|
|
|
|
|
|
|
|
1,185 |
|
|
|
|
|
|
|
|
Cash dividends paid ($.08 per share) |
|
|
|
|
|
|
|
|
|
|
(3,192 |
) |
|
|
|
|
|
|
|
|
|
|
(3,192 |
) |
|
|
|
|
|
|
|
Restricted stock grants, cancellations and
withholdings, net |
|
|
63,509 |
|
|
|
(38 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(38 |
) |
|
|
|
|
|
|
|
Issuance of shares under employee stock purchase
plan |
|
|
83,104 |
|
|
|
951 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
951 |
|
|
|
|
|
|
|
|
Adjustment to initially apply FAS 123 (R) |
|
|
|
|
|
|
(2,266 |
) |
|
|
|
|
|
|
2,266 |
|
|
|
|
|
|
|
- |
|
|
|
|
|
|
|
|
Stock-based compensation |
|
|
|
|
|
|
2,199 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,199 |
|
|
|
|
|
|
|
|
Exercises of stock options |
|
|
62,152 |
|
|
|
684 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
684 |
|
|
|
|
|
|
|
|
Income tax benefit on exercise of stock options |
|
|
|
|
|
|
55 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
55 |
|
|
|
|
|
|
|
|
Adjustment to initially apply SFAS No. 158 (net of tax) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,083 |
|
|
|
1,083 |
|
|
|
|
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
|
26,746 |
|
|
|
|
|
|
|
|
|
|
|
26,746 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, February 3, 2007 |
|
|
40,068,953 |
|
|
|
135,803 |
|
|
|
232,382 |
|
|
|
- |
|
|
|
1,083 |
|
|
|
369,268 |
|
|
|
|
|
|
|
|
Adjustment to initially apply FIN 48 as of February 4,
2007 |
|
|
|
|
|
|
|
|
|
|
(4,212 |
) |
|
|
|
|
|
|
|
|
|
|
(4,212 |
) |
|
|
|
|
|
|
|
Cash dividends paid ($.08 per share) |
|
|
|
|
|
|
|
|
|
|
(3,204 |
) |
|
|
|
|
|
|
|
|
|
|
(3,204 |
) |
|
|
|
|
|
|
|
Restricted stock grants, cancellations and
withholdings, net |
|
|
64,036 |
|
|
|
(43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(43 |
) |
|
|
|
|
|
|
|
Issuance of shares under employee stock purchase
plan |
|
|
71,294 |
|
|
|
667 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
667 |
|
|
|
|
|
|
|
|
Repurchase of shares |
|
|
(426,500 |
) |
|
|
(4,371 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,371 |
) |
|
|
|
|
|
|
|
Stock-based compensation |
|
|
|
|
|
|
2,116 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,116 |
|
|
|
|
|
|
|
|
Issuance of shares for real estate purchase |
|
|
103,053 |
|
|
|
1,173 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,173 |
|
|
|
|
|
|
|
|
Income tax benefit on exercise of stock options |
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(10 |
) |
|
|
|
|
|
|
|
Adjustment for SFAS No. 158 (net of tax) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(43 |
) |
|
|
(43 |
) |
|
|
|
|
|
|
|
Net income |
|
|
|
|
|
|
|
|
|
|
10,718 |
|
|
|
|
|
|
|
|
|
|
|
10,718 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, February 2, 2008 |
|
|
39,880,836 |
|
|
|
135,335 |
|
|
|
235,684 |
|
|
|
- |
|
|
|
1,040 |
|
|
|
372,059 |
|
|
|
|
|
|
|
|
Cash dividends paid ($.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 SFAS No. 158 (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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to condensed consolidated financial statements.
- 33 -
FREDS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended |
|
|
January 31, 2009 |
|
February 2, 2008 |
|
February 3, 2007 |
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
16,642 |
|
|
$ |
10,718 |
|
|
$ |
26,746 |
|
Adjustments to reconcile net income to net cash flows from
operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
26,425 |
|
|
|
28,614 |
|
|
|
29,102 |
|
Net (gain) loss on asset disposition |
|
|
(831 |
) |
|
|
(335 |
) |
|
|
594 |
|
Provision for store closures and asset impairment |
|
|
419 |
|
|
|
14,559 |
|
|
|
1,792 |
|
Stock-based compensation |
|
|
990 |
|
|
|
2,116 |
|
|
|
2,199 |
|
Provision for uncollectible receivables |
|
|
486 |
|
|
|
255 |
|
|
|
69 |
|
LIFO reserve increase |
|
|
3,700 |
|
|
|
1,657 |
|
|
|
1,571 |
|
Deferred income tax expense (benefit) |
|
|
(4,080 |
) |
|
|
(6,604 |
) |
|
|
(547 |
) |
Income tax benefit upon exercise of stock options |
|
|
14 |
|
|
|
10 |
|
|
|
(55 |
) |
Provision for post retirement medical |
|
|
34 |
|
|
|
(43 |
) |
|
|
- |
|
(Increase) decrease in operating assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Trade receivables |
|
|
4,925 |
|
|
|
(8,162 |
) |
|
|
(17,529 |
) |
Insurance receivables |
|
|
902 |
|
|
|
1,537 |
|
|
|
2,713 |
|
Inventories |
|
|
14,751 |
|
|
|
(26,981 |
) |
|
|
(3,681 |
) |
Other assets |
|
|
(169 |
) |
|
|
432 |
|
|
|
(1,434 |
) |
Increase (decrease) in operating liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses |
|
|
5,537 |
|
|
|
3,377 |
|
|
|
(3,433 |
) |
Income taxes payable |
|
|
1,178 |
|
|
|
(3,508 |
) |
|
|
(2,550 |
) |
Other noncurrent liabilities |
|
|
7,362 |
|
|
|
1,699 |
|
|
|
(234 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities |
|
|
78,285 |
|
|
|
19,341 |
|
|
|
35,323 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
|
(16,727 |
) |
|
|
(31,289 |
) |
|
|
(26,534 |
) |
Proceeds from asset dispositions |
|
|
2,182 |
|
|
|
463 |
|
|
|
138 |
|
Insurance recoveries for replacement assets |
|
|
556 |
|
|
|
1,094 |
|
|
|
282 |
|
Asset acquisition, net (primarily intangibles) |
|
|
(5,686 |
) |
|
|
(1,663 |
) |
|
|
(3,439 |
) |
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(19,675 |
) |
|
|
(31,395 |
) |
|
|
(29,553 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Payments of indebtedness and capital lease obligations |
|
|
(469 |
) |
|
|
(1,656 |
) |
|
|
(1,367 |
) |
Proceeds from revolving line of credit |
|
|
205,996 |
|
|
|
344,755 |
|
|
|
208,450 |
|
Payments on revolving line of credit |
|
|
(236,631 |
) |
|
|
(316,293 |
) |
|
|
(211,983 |
) |
Excess tax benefits (charges) from stock-based compensation |
|
|
(14 |
) |
|
|
(10 |
) |
|
|
55 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from exercise of stock options and employee stock
purchase plan |
|
|
566 |
|
|
|
624 |
|
|
|
1,597 |
|
Repurchase of treasury shares |
|
|
- |
|
|
|
(4,371 |
) |
|
|
- |
|
Cash dividends paid |
|
|
(3,196 |
) |
|
|
(3,204 |
) |
|
|
(3,192 |
) |
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
(33,748 |
) |
|
|
19,845 |
|
|
|
(6,440 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents |
|
|
24,862 |
|
|
|
7,791 |
|
|
|
(670 |
) |
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
|
10,266 |
|
|
|
2,475 |
|
|
|
3,145 |
|
|
|
|
|
|
|
|
End of year |
|
$ |
35,128 |
|
|
$ |
10,266 |
|
|
$ |
2,475 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
408 |
|
|
$ |
1,269 |
|
|
$ |
818 |
|
Income taxes paid |
|
$ |
2,559 |
|
|
$ |
18,200 |
|
|
$ |
16,781 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash investing and financial activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Assets acquired through term loan |
|
$ |
274 |
|
|
$ |
6,065 |
|
|
$ |
100 |
|
Common stock issued for purchase of capital assets |
|
$ |
- |
|
|
$ |
1,173 |
|
|
$ |
- |
|
See accompanying notes to condensed consolidated financial statements.
- 34 -
Notes to Consolidated Financial Statements
NOTE 1 DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of business. The primary business of FREDS, 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 31, 2009, the
Company had 639 retail stores and 284 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 2008, 2007, and 2006, as used herein, refer to the years ended
January 31, 2009, February 2, 2008 and February 3, 2007, respectively. The fiscal year 2006 had
53 weeks and the fiscal years 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. Included in accounts payable are outstanding checks in
excess of funds on deposit, which totaled $10,432 at January 31, 2009 and $4,052 at February 2,
2008.
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 Companys
estimates. Additionally, updated regulations and contract negotiations occur frequently,
necessitating the Companys 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
- 35 -
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 stores shrink rate, which is based on the previously mentioned factors, by the
interim periods 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 Companys 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 Companys 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 $30.8 million and $31.1 million at
January 31, 2009 and February 2, 2008, 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 $19.1 million at January 31, 2009 and $15.4 million at February 2, 2008. The LIFO
reserve increased by approximately $3.7 million during 2008 and $1.6 million during both 2007 and
2006.
The Company has historically included an estimate of inbound freight and certain general and
administrative expenses in merchandise inventory as prescribed by GAAP. These costs include
activities surrounding the procurement and storage of merchandise inventory such as buying,
warehousing, and accounting, as well as inbound freight. During the second quarter which ended
August 4, 2007, we revised our estimate to include certain costs internally captured within our
Merchandise Planning, Information Technology and Human Resources departments as they relate to the
inventory functions and support of procurement and storage. This revision follows growth in the
role of these departments in support of the procurement and warehousing functions, including
additional personnel hired over the past few quarters. Further, our Merchandise Planning department
has evolved from being previously included within the buying function to a stand alone function
with responsibility for inbound logistics and commodity procurement. The total amount of expenses
and inbound freight included in merchandise inventory at January 31, 2009 is $19.0 million, with
the corresponding amount of $21.9 million at February 2, 2008.
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 Companys 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 (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:
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Estimated Useful Lives |
Building and building improvements
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8 - 30 years |
Furniture, fixtures and equipment
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3 - 10 years |
Leasehold improvements
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3 - 10 years or term of lease, if shorter |
Automobiles and vehicles
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3 - 5 years |
Airplane
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|
9 years |
Assets under capital lease are depreciated in accordance with the Companys 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,
- 36 -
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 EITF Issue 98-9, Accounting for Contingent Rent. The
amount expensed but not paid was $1.1 million at January 31, 2009 and February 2, 2008, 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 SFAS 146, Accounting
for Costs Associated with Exit or Disposal Activities. 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
SFAS 146. 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 Companys 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 Statement of Financial
Accounting Standards (SFAS) 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, we review for impairment all stores open 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 managements 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 assets fair value. The fair value is based on
estimated market values for similar assets or other reasonable estimates of fair market value based
upon managements 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.
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. The
Emerging Issues Task Force (EITF) Issue No. 02-16, Accounting by a Customer (including a
Reseller) for Certain Consideration Received from a Vendor (EITF 02-16) is effective for
arrangements with vendors initiated on or after January 1, 2003. EITF 02-16 addresses the
accounting and income statement classification for consideration given by a vendor to a retailer in
connection with the sale of the vendors products or for the promotion of sales of the vendors
products. The EITF concluded that such consideration received from vendors should be 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. The provisions of this consensus have been applied
prospectively.
Prior to the close of the year ended February 3, 2007, the Company discovered additional rebates
due from its primary pharmacy vendor (AmerisourceBergen) that were associated with purchases made
from 2002 to 2006 and aggregated to approximately $2.8 million. In accordance with the transition
guidance in the Securities and Exchange Commissions Staff Accounting Bulletin No. 108, Considering
the Effects of Prior Year Misstatements in Current Year Financial Statements (SAB No. 108) the
Company recorded, net of tax, the prior year effects ($1.2 million) of the misstatement as a
cumulative adjustment to the retained earnings in the Stockholders Equity Section. This treatment
is directed in the guidance for amounts that are deemed immaterial to the respective prior years
statements, as these amounts were to the years mentioned previously. The $1.0 million
(pretax) related to fiscal 2006 was recognized in that years income for the quarterly period ended
February 3, 2007.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin
No. 108 (SAB 108). Due to diversity in practice among registrants, SAB 108 expresses SEC staff
views regarding the process by which misstatements in financial statements are evaluated for
purposes of determining whether financial statement restatement is necessary. SAB 108 is
- 37 -
effective for fiscal years ending after November 15, 2006, and early application is permitted. The
Company adopted SAB 108 for the fiscal year ended February 3, 2007. See Note 1 to the Consolidated
Financial Statements for further discussion.
The following table summarizes the effects of applying the guidance in SAB 108 (in thousands):
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Period in which the Mistatement Originated 1 |
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Adjustment |
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Cumulative |
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recorded as of |
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Prior to January |
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|
January 29, |
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|
January 28, |
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|
February 3, |
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31, 2004 |
|
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2005 |
|
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2006 |
|
|
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|
2007 |
Other non trade receivables 2 |
|
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|
$ |
674 |
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|
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|
$ |
485 |
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|
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|
$ |
623 |
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|
|
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|
$ |
1,782 |
|
Income taxes payable 3 |
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|
(226 |
) |
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|
(162 |
) |
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(209 |
) |
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(597 |
) |
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Impact on net income 4 |
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|
$ |
448 |
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|
$ |
323 |
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|
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$ |
414 |
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Retained Earnings 5 |
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$ |
1,185 |
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|
|
|
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|
1 The Company quantified these errors under both the roll-over and iron- curtain
methods and concluded that they were immaterial to the respective periods.
2 As a result of the misstatement described above, the Companys cost of goods sold was
overstated by approximately $0.7 million in years 2002 to 2003, $0.5 million in 2004, and $0.6
million in 2005. The Company recorded an increase in other non trade receivables of $1.8 million as
of February 3, 2007 with a corresponding increase in retained earnings to correct these
misstatements.
3 As a result of the misstatement described above, the Companys income tax expense was
understated by $0.2 million in years 2002 to 2003, $0.2 million in 2004, and $0.2 million in 2005.
The Company recorded an increase in income taxes payable of $0.6 million as of February 3, 2007
with a corresponding decrease in retained earnings to correct these misstatements.
4 Represents the net understatement of net income for the indicated periods resulting
from these misstatements.
5 Represents the net increase to retained earnings as of February 3, 2007 to record as a
prior period adjustment.
Selling, general and administrative expenses. The Company includes buying, warehousing,
distribution, depreciation and amortization and occupancy costs in selling, general and
administrative expenses.
Advertising. In accordance with The American Institute of Certified Public Accountants Statement of
Position No. 93-7, Reporting on Advertising Costs (AICPA SOP 93-7), 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 2008, 2007, and 2006, were
$24.1 million, $27.6 million, and $27.4 million, respectively. Gross advertising expenses were
reduced by vendor cooperative advertising allowances of $2.3 million, $1.5 million, and
$1.1 million for 2008, 2007, and 2006, respectively. It would be the Companys 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 31, 2009. 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 Companys 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 FREDS 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 2008, 2007, and
2006 was $2,145, $2,008, and $2,019, 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
- 38 -
accumulated amortization, totaled $8,955 at January 31, 2009, and $6,139 at February 2, 2008. Accumulated
amortization at January 31, 2009 and February 2, 2008 totaled $15,642 and $13,089 respectively.
Amortization expense for 2008, 2007, and 2006, was $2,553, $2,414, and $2,663, respectively.
Estimated amortization expense for each of the next 5 years is
as follows: 2009 - $2,903, 2010 -
$2,327, 2011 - $1,665, 2012 - $1,302, and 2013 - $758.
Financial instruments. January 31, 2009, the Company did not have any outstanding derivative
instruments. The recorded value of the Companys 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 Companys 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 Companys 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 Companys results of
operations. The Company carries additional coverage for excessive or catastrophic claims with stop
loss limits of $250,000 for property and general liability and $200,000 for employee medical. The
Companys insurance reserve was $8.6 million and $8.2 million on January 31, 2009 and February 2,
2008, respectively. Changes in the reserve during fiscal 2008 were attributable to additional
reserve requirements of $40.3 million netted with reserve utilization of $39.9 million.
Stock-based compensation. Effective January 29, 2006, the Company adopted the fair value
recognition provisions of SFAS No. 123(R), Share-Based Payment, 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 SFAS No. 123, 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 SFAS No. 123(R). Results for prior periods have not been restated.
In November 2005, FASB issued Staff Position No. FAS 123(R)-3, Transition Election Related to
Accounting for Tax Effects of Share-Based Payment Awards (FSP FAS 123R-3). Effective January 29,
2006, the Company elected to adopt the alternative transition method provided in FSP FAS 123R-3 for
calculating the income tax effects of stock-based compensation pursuant to SFAS 123(R). 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 SFAS 123(R).
SFAS 123(R) 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 as
required prior to SFAS 123(R). The impact of adopting SFAS 123(R) 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 SFAS 123(R), 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 Companys 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 SFAS No. 109, Accounting for
Income Taxes. Under SFAS No. 109, the asset and liability method is used for computing future
income tax consequences of events, which have been recognized in the Companys Consolidated
Financial Statements or income tax returns. Deferred income tax expense or benefit is the net
change during the year in the Companys deferred income tax assets and liabilities (see Note 4
Income Taxes).
In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxes An Interpretation of FASB Statement 109.
Effective February 4, 2007, we adopted FIN 48, which clarifies the accounting for uncertainties in
income taxes recognized in the Companys financial statements in accordance with SFAS No. 109 by
defining the criterion that an individual tax position must meet in order to be recognized in the
financial statements. FIN 48 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.
- 39 -
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 Companys accumulated other 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) 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 2008
presentation.
Recent Accounting Pronouncements. In September 2006, the Financial Accounting Standards Board
(FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements (SFAS No. 157). SFAS No. 157 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. SFAS No. 157 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 SFAS No. 157, fair value
measurements are required to be disclosed by level within that hierarchy. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007, and interim periods within those
fiscal years. However, FASB Staff Position No. FAS (FSP SFAS) 157-2, Effective Date of FASB
Statement No. 157, issued in February 2008, delays the effective date of SFAS No. 157 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 SFAS No. 157
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 FSP SFAS 157-2 and determined
that it will have no impact on its results of operations or financial position. In October 2008,
the FASB issued FSP SFAS 157-3, Determining the Fair Value of a Financial Asset in a Market That
Is Not Active. FSP SFAS 157-3 clarifies the application of SFAS No. 157 when the market for a
financial asset is inactive. The guidance in FSP SFAS 157-3 is effective immediately and has no
effect on our financial statements. In April 2009, the FASB issued FSP SFAS 157-4, Determining
Whether a Market Is Not Active and a Transaction Is Not Distressed which further clarifies the
principles established by SFAS No. 157. 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 is assessing the impact, if any, and will not elect to early adopt FSP SFAS 157-4.
In February 2007, the Financial Accounting Standards Board issued SFAS No. 159, The Fair Value
Option for Financial Assets and Financial LiabilitiesIncluding an Amendment of FASB Statement
No. 115, (SFAS No. 159). SFAS No. 159 allows companies the choice to measure many financial
instruments and certain other items at fair value. This gives a company the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal
years beginning after November 15, 2007. The Company has determined that this statement will have
no impact on its results of operations or financial position.
In June 2007, the Emerging Issues Task Force (EITF) of the FASB ratified their consensus position
06-11 (EITF 06-11), Accounting for Income Tax Benefits of Dividends on Share-Based Payment
Awards. EITF 06-11 provides guidance on how a company should recognize the income tax benefit
received on dividends that are paid to employees holding equity-classified nonvested shares,
equity-classified nonvested share units, or equity-classified outstanding share options charged to
retained earnings under FASB Statement 123(R), Share-Based Payment. The Company was required to
apply the guidance provided in EITF 06-11 prospectively to income tax benefits of dividends on
equity-classified employee share-based payment awards that are declared in fiscal years beginning
after September 15, 2007, which is our fiscal 2008. Early application of EITF 06-11 was permitted
for the income tax benefit of dividends on equity-classified employee share-based payment awards
that are declared in periods for which financial statements have not yet been issued. The Company
evaluated EITF 06-11 and determined that it has no significant impact on its results of operations
or financial position.
In December 2007, the FASB issued FASB Statement No. 141(R), Business Combinations (SFAS
141(R)), which establishes accounting principles and disclosure requirements for all transactions
in which a company obtains control over another business. SFAS No. 141(R) applies prospectively to
business combinations for which the acquisition date is on or after the beginning of the first
annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited.
The Company has evaluated SFAS No. 141(R) and determined it will have no impact its results of
operations or financial position.
In December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51 (SFAS No. 160). SFAS No. 160 establishes new
accounting and reporting standards for the noncontrolling interest in a subsidiary and for the
deconsolidation of a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited.
The Company has evaluated SFAS No. 160 and determined it will have no impact its results of
operations or financial position.
- 40 -
In March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative Instruments
and Hedging Activities an amendment of FASB Statement No. 133 (SFAS No. 161). SFAS No. 161
requires enhanced disclosures about an entitys derivative and hedging activities. SFAS No. 161 is
effective for fiscal years, and interim periods within those fiscal years, beginning after November
15, 2008. Earlier adoption is available. The Company has evaluated SFAS No. 161 and determined
that it will have no impact on its results of operations or financial position.
In May 2008, the FASB issued FASB Statement No. 162, The Hierarchy of Generally Accepted
Accounting Principles (SFAS 162), which became effective in November 2008. This statement
identifies the framework for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with GAAP. The Company has
determined that this statement will not materially effect its financial statements.
NOTE 2 DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
2008 |
|
|
|
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, at cost: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Buildings and building improvements |
|
|
|
|
|
$ |
91,826 |
|
|
|
|
|
|
$ |
88,459 |
|
Leasehold improvements |
|
|
|
|
|
|
49,775 |
|
|
|
|
|
|
|
50,859 |
|
Automobiles and vehicles |
|
|
|
|
|
|
5,223 |
|
|
|
|
|
|
|
5,500 |
|
Airplane |
|
|
|
|
|
|
4,697 |
|
|
|
|
|
|
|
4,697 |
|
Furniture, fixtures and equipment |
|
|
|
|
|
|
230,272 |
|
|
|
|
|
|
|
224,734 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
381,793 |
|
|
|
|
|
|
|
374,249 |
|
Less: Accumulated depreciation and amortization |
|
|
|
|
|
|
(251,002 |
) |
|
|
|
|
|
|
(235,281 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
130,791 |
|
|
|
|
|
|
|
138,968 |
|
Construction in progress |
|
|
|
|
|
|
912 |
|
|
|
|
|
|
|
1,034 |
|
Land |
|
|
|
|
|
|
6,333 |
|
|
|
|
|
|
|
5,983 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Property and equipment, at depreciated cost |
|
|
|
|
|
$ |
138,036 |
|
|
|
|
|
|
$ |
145,985 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation expense totaled $23,872, $26,200, and $26,488, for 2008, 2007, and 2006, respectively.
During the second and third quarter of fiscal 2007, the Company acquired the land and buildings,
occupied by thirteen FREDS stores which we had previously leased. In consideration for the
thirteen properties, the Company paid cash of $4.417 million, issued 103,053 shares of our common
stock valued at $1.173 million and assumed current debt of $.971 million and long term debt of
$5.094 million.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
|
2008 |
|
|
|
|
|
2007 |
Other non trade receivables: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vendor receivables |
|
|
|
|
|
$ |
12,381 |
|
|
|
|
|
|
$ |
13,276 |
|
Franchise stores receivable |
|
|
|
|
|
|
1,026 |
|
|
|
|
|
|
|
618 |
|
Income tax receivable |
|
|
|
|
|
|
220 |
|
|
|
|
|
|
|
4,018 |
|
Insurance claims receivable |
|
|
|
|
|
|
112 |
|
|
|
|
|
|
|
1,058 |
|
Landlord receivables |
|
|
|
|
|
|
109 |
|
|
|
|
|
|
|
59 |
|
Other |
|
|
|
|
|
|
1,934 |
|
|
|
|
|
|
|
1,507 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total non trade receivable |
|
|
|
|
|
$ |
15,782 |
|
|
|
|
|
|
$ |
20,536 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
|
|
|
2007 |
Prepaid expenses and other current assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplies |
|
|
|
|
|
$ |
5,002 |
|
|
|
|
|
|
$ |
3,866 |
|
Prepaid rent |
|
|
|
|
|
|
4,045 |
|
|
|
|
|
|
|
4,424 |
|
Prepaid insurance |
|
|
|
|
|
|
1,351 |
|
|
|
|
|
|
|
1,630 |
|
Prepaid advertising |
|
|
|
|
|
|
434 |
|
|
|
|
|
|
|
701 |
|
Other |
|
|
|
|
|
|
1,080 |
|
|
|
|
|
|
|
1,171 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total prepaid expenses and other current assets |
|
|
|
|
|
$ |
11,912 |
|
|
|
|
|
|
$ |
11,792 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
- 41 -
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
|
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued expenses and other: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance reserves |
|
|
|
|
|
$ |
8,633 |
|
|
|
|
|
|
$ |
8,186 |
|
Payroll and benefits |
|
|
|
|
|
|
9,240 |
|
|
|
|
|
|
|
10,573 |
|
Legal Settlement and related fees |
|
|
|
|
|
|
6,600 |
|
|
|
|
|
|
|
- |
|
Sales and use tax |
|
|
|
|
|
|
5,090 |
|
|
|
|
|
|
|
6,333 |
|
Lease liability |
|
|
|
|
|
|
4,341 |
|
|
|
|
|
|
|
557 |
|
Deferred / contingent rent |
|
|
|
|
|
|
3,150 |
|
|
|
|
|
|
|
4,683 |
|
Other |
|
|
|
|
|
|
9,605 |
|
|
|
|
|
|
|
9,137 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total prepaid expenses and other current assets |
|
|
|
|
|
$ |
46,659 |
|
|
|
|
|
|
$ |
39,469 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
|
|
|
2007 |
Other current liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrecognized tax benefit related to IRS exam (see Note 4 - Income Taxes) |
|
|
|
|
|
$ |
7,749 |
|
|
|
|
|
|
$ |
- |
|
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. 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
Companys 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.
During the second and third quarter of fiscal 2007, the Company acquired the land and buildings,
occupied by 7 FREDS 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 below table shows the long term debt related to these
properties due for the next five years as of January 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
2009 |
|
2010 |
|
2011 |
|
2012 |
|
2013 |
|
Thereafter |
|
Total |
Mortgage loans on land & buildings |
|
$ |
175 |
|
|
$ |
665 |
|
|
$ |
157 |
|
|
$ |
169 |
|
|
$ |
1,111 |
|
|
$ |
2,749 |
|
|
$ |
5,026 |
|
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) |
|
|
|
|
|
2008 |
|
|
|
|
|
|
2007 |
|
|
|
|
|
|
2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
|
|
$ |
12,677 |
|
|
|
|
|
|
$ |
10,886 |
|
|
|
|
|
|
$ |
15,048 |
|
State |
|
|
|
|
|
|
671 |
|
|
|
|
|
|
|
664 |
|
|
|
|
|
|
|
(1,034 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13,348 |
|
|
|
|
|
|
|
11,550 |
|
|
|
|
|
|
|
14,014 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
|
|
|
|
(3,478 |
) |
|
|
|
|
|
|
(5,354 |
) |
|
|
|
|
|
|
(1,135 |
) |
State |
|
|
|
|
|
|
(602 |
) |
|
|
|
|
|
|
(1,250 |
) |
|
|
|
|
|
|
588 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4,080 |
) |
|
|
|
|
|
|
(6,604 |
) |
|
|
|
|
|
|
(547 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
9,268 |
|
|
|
|
|
|
$ |
4,946 |
|
|
|
|
|
|
$ |
13,467 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
- 42 -
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) |
|
|
|
|
|
2008 |
|
|
|
|
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrual for incentive compensation |
|
|
|
|
|
$ |
614 |
|
|
|
|
|
|
$ |
474 |
|
Allowance for doubtful accounts |
|
|
|
|
|
|
479 |
|
|
|
|
|
|
|
455 |
|
Insurance accruals |
|
|
|
|
|
|
2,411 |
|
|
|
|
|
|
|
2,279 |
|
Other accruals |
|
|
|
|
|
|
133 |
|
|
|
|
|
|
|
312 |
|
Net operating loss carryforwards |
|
|
|
|
|
|
5,033 |
|
|
|
|
|
|
|
5,119 |
|
Postretirement benefits other than pensions |
|
|
|
|
|
|
238 |
|
|
|
|
|
|
|
287 |
|
Reserve for below cost inventory adjustment |
|
|
|
|
|
|
110 |
|
|
|
|
|
|
|
- |
|
Legal reserve |
|
|
|
|
|
|
2,581 |
|
|
|
|
|
|
|
- |
|
Deferred revenue |
|
|
|
|
|
|
730 |
|
|
|
|
|
|
|
3,964 |
|
Federal benefit on state reserves |
|
|
|
|
|
|
4,064 |
|
|
|
|
|
|
|
2,656 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangibles |
|
|
|
|
|
|
4,969 |
|
|
|
|
|
|
|
4,406 |
|
Total deferred income tax assets |
|
|
|
|
|
|
21,362 |
|
|
|
|
|
|
|
19,952 |
|
Less: Valuation allowance |
|
|
|
|
|
|
1,609 |
|
|
|
|
|
|
|
1,695 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax assets, net of valuation allowance |
|
|
|
|
|
|
19,753 |
|
|
|
|
|
|
|
18,257 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property, plant and equipment |
|
|
|
|
|
|
(14,446 |
) |
|
|
|
|
|
|
(17,710 |
) |
Inventory valuation |
|
|
|
|
|
|
(18,888 |
) |
|
|
|
|
|
|
(19,928 |
) |
Prepaid expenses |
|
|
|
|
|
|
(808 |
) |
|
|
|
|
|
|
(468 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred income tax liability |
|
|
|
|
|
|
(34,142 |
) |
|
|
|
|
|
|
(38,106 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred income tax liability |
|
|
|
|
|
$ |
(14,389 |
) |
|
|
|
|
|
$ |
(19,849 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The net operating loss carryforwards are available to reduce state income taxes in future years.
These carryforwards total approximately $118.5 million for state income tax purposes and expire at
various times during the period 2009 through 2028.
During 2008, the valuation allowance decreased $86, and during 2007, the valuation allowance
decreased $14. 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008 |
|
|
|
|
|
|
2007 |
|
|
|
|
|
|
2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax provision at statutory rate |
|
|
|
|
|
|
35.0 |
% |
|
|
|
|
|
|
35.0 |
% |
|
|
|
|
|
|
35.0 |
% |
Tax credits, principally jobs |
|
|
|
|
|
|
(3.8 |
) |
|
|
|
|
|
|
(9.9 |
) |
|
|
|
|
|
|
(3.5 |
) |
State income taxes, net of federal benefit |
|
|
|
|
|
|
1.3 |
|
|
|
|
|
|
|
(0.7 |
) |
|
|
|
|
|
|
(1.1 |
) |
Permanent differences |
|
|
|
|
|
|
0.2 |
|
|
|
|
|
|
|
2.2 |
|
|
|
|
|
|
|
0.9 |
|
Uncertain tax provisions |
|
|
|
|
|
|
3.4 |
|
|
|
|
|
|
|
5.1 |
|
|
|
|
|
|
|
- |
|
Change in valuation allowance |
|
|
|
|
|
|
(0.3 |
) |
|
|
|
|
|
|
(0.1 |
) |
|
|
|
|
|
|
2.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective income tax rate |
|
|
|
|
|
|
35.8 |
% |
|
|
|
|
|
|
31.6 |
% |
|
|
|
|
|
|
33.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48 (FIN
48), Accounting for Uncertainty in Income Taxes an Interpretation of FASB Statement No.109. We
adopted FIN 48 as of February 4, 2007, the first day of fiscal 2007. This interpretation clarifies
the accounting for uncertainty in income taxes recognized in an enterprises financial statements
in accordance with SFAS No. 109 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 FIN 48, 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, FIN 48 provides guidance on de-recognition,
measurement, classification, interest and penalties, accounting in interim periods, disclosure and
transition.
As a result of the adoption of FIN 48, 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
- 43 -
liabilities
($6.5 million increase, including $1.0 million of interest and penalties) to conform to the balance
sheet presentation requirements of FIN 48. 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) |
|
|
|
|
|
|
|
|
Balance at February 2, 2008 |
|
|
|
|
|
$ |
8.4 |
|
Additions for tax position during the current year |
|
|
|
|
|
|
1.1 |
|
Additions for tax positions of prior years |
|
|
|
|
|
|
7.7 |
|
Reductions for tax positions of prior years from lapse of statue |
|
|
|
|
|
|
(0.7 |
) |
|
|
|
|
|
|
|
|
Balance at January 31, 2009 |
|
|
|
|
|
$ |
16.5 |
|
|
|
|
|
|
|
|
As of February 2, 2008, our liability for unrecognized tax benefits totaled $8.4 million, of which
$0.6 million and $0.1 million were recognized as income tax benefit during the quarterly periods
ending November 1, 2008 and January 31, 2009, respectively, as a result of a lapse in applicable
statute of limitations. We had additions of $8.8 million during fiscal 2008, $1.1 million of which
resulted from state tax positions during the current year and $7.7 million resulted from the
Internal Revenue Service beginning an exam of the Company during 2008 covering fiscal years 2004
through 2007. The examination is ongoing and the included amount is for potential tax and interest
and is based on proposed adjustments to date, which are primarily timing differences. As of
January 31, 2009, our liability for unrecognized tax benefits totaled $16.5 million is recorded in
our consolidated balance sheet as other current and non-current liabilities, $9.8 million of which,
if recognized, would affect our effective tax rate. During the next 12 months, the Company
anticipates the current Internal Revenue Service examination covering the years 2004 2007 will be
settled, resulting in an estimated decrease in our liability for unrecognized tax benefits of
approximately $7.7 million.
FIN 48 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 FIN 48 in the
financial statements as a component of income tax expense. As of January 31, 2009, accrued interest
and penalties related to our unrecognized tax benefits totaled $2.4 million and $0.4 million,
respectively, and are both 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 2004-2007. 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 31, 2009. Total rent expense
under operating leases was $54,112, $54,539, and $48,670, for 2008, 2007, and 2006, respectively.
Total contingent rentals included in operating leases above was $1,109, $1,150, and $1,322, for
2008, 2007, and 2006, respectively.
Future minimum rental payments under all operating leases as of January 31, 2009 are as follows:
|
|
|
|
|
|
|
|
|
(in thousands) |
|
|
|
|
|
Operating Leases |
|
2009 |
|
|
|
|
|
$ |
54,852 |
|
2010 |
|
|
|
|
|
|
41,719 |
|
2011 |
|
|
|
|
|
|
35,451 |
|
2012 |
|
|
|
|
|
|
28,694 |
|
2013 |
|
|
|
|
|
|
19,549 |
|
Thereafter |
|
|
|
|
|
|
31,258 |
|
|
|
|
|
|
|
|
Total minimum lease payments |
|
|
|
|
|
$ |
211,523 |
|
|
|
|
|
|
|
|
- 44 -
The gross amount of property and equipment under capital leases was $4,967 at January 31, 2009 and
February 2, 2008. Accumulated depreciation on property and equipment under capital leases was
$4,928 and $4,836 at January 31, 2009 and February 2, 2008, respectively. Depreciation expense on
assets under capital lease for 2008, 2007, and 2006, was $92, $258, and $375, respectively.
Related Party Transactions
During the year ended February 2, 2008, Atlantic Retail Investors, LLC, which is partially owned by
Michael J. Hayes, a director and officer of the Company, purchased the land and buildings occupied
by thirteen FREDS 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 $1.4 million and $.5
million for the years ended January 31, 2009 and February 2, 2008, respectively. Total future
commitments under related party leases are $10.9 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
Companys 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 Companys 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 Companys 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 31, 2008 (amounts in thousands, except price data). The repurchased
shares have been cancelled and returned to authorized but un-issued shares.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of Shares |
|
|
|
|
|
Maximum Number of |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchased as Part of |
|
|
|
|
|
Shares That May Yet |
|
|
|
|
|
|
Total Number of |
|
|
|
|
|
Average Price |
|
|
|
|
|
Publicly Announced |
|
|
|
|
|
Be Purchased Under the |
|
|
|
|
|
|
Shares Purchased |
|
|
|
|
|
Paid Per Share |
|
|
|
|
|
Plans or Program |
|
|
|
|
|
Plans or Program |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,573.5 |
February 3, 2008 - January 31, 2009 |
|
|
|
|
|
|
|
- |
|
|
|
|
|
$ |
|
- |
|
|
|
|
|
|
|
- |
|
|
|
|
|
|
|
3,573.5 |
NOTE 7 EQUITY INCENTIVE PLANS
Incentive stock option plan. The Company has a long-term incentive plan, which was approved by
FREDS stockholders, under which an aggregate of 2,023,079 shares as of January 31, 2009 (2,057,344
shares as of February 2, 2008) 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 31, 2009 expire in
2009 through 2015.
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 employees job classification. Options,
which include non-qualified stock options and incentive stock options, are rights to purchase a
specified number of shares of FREDS common stock at a price fixed by the Committee. Stock options
granted have an exercise price equal to the market price of FREDS 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 FREDS 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
- 45 -
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 FREDS 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 73,084, 71,294 and 83,104
shares issued during fiscal years 2008, 2007 and 2006, respectively. There are 1,410,928 shares
approved to be issued under the 2004 Plan and as of January 31, 2009 there were 1,150,863 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) |
|
|
|
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock option expense |
|
|
|
|
|
$ |
526 |
|
|
|
$ |
1,312 |
|
|
|
$ |
1,408 |
|
Restricted stock expense |
|
|
|
|
|
|
282 |
|
|
|
|
591 |
|
|
|
|
512 |
|
ESPP expense |
|
|
|
|
|
|
182 |
|
|
|
|
213 |
|
|
|
|
279 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation |
|
|
|
|
|
|
990 |
|
|
|
|
2,116 |
|
|
|
|
2,199 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax benefit on stock-based compensation |
|
|
|
|
|
$ |
228 |
|
|
|
$ |
340 |
|
|
|
$ |
210 |
|
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 Companys 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
managements 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 |
|
2008 |
|
2007 |
|
2006 |
Expected volatility |
|
|
40.1 |
% |
|
|
42.8 |
% |
|
|
41.4 |
% |
Risk-free interest rate |
|
|
3.3 |
% |
|
|
4.1 |
% |
|
|
4.8 |
% |
Expected option life (in years) |
|
|
5.84 |
|
|
5.84 |
|
|
5.85 |
Expected dividend yield |
|
|
0.5 |
% |
|
|
0.4 |
% |
|
|
0.4 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average fair value at grant date |
|
|
$4.53 |
|
|
$4.68 |
|
|
$6.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Stock Purchase Plan |
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility |
|
|
36.8 |
% |
|
|
37.2 |
% |
|
|
38.7 |
% |
Risk-free interest rate |
|
|
3.1 |
% |
|
|
4.7 |
% |
|
|
4.8 |
% |
Expected option life (in years) |
|
|
0.63 |
|
|
0.63 |
|
|
0.63 |
Expected dividend yield |
|
|
0.4 |
% |
|
|
0.4 |
% |
|
|
0.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average fair value at grant date |
|
|
$2.48 |
|
|
$3.31 |
|
|
$4.31 |
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
- 46 -
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 January 28, 2006 through
January 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
Averaged |
|
|
|
|
|
Aggregate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Contractual Life |
|
|
| | |
Intrinsic Value |
|
|
|
|
|
|
|
Options |
|
|
|
|
|
|
Exercise Price |
|
|
|
|
|
|
(years) |
|
|
|
|
|
|
(000s) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 28, 2006 |
|
|
|
|
|
|
1,190,019 |
|
|
|
|
|
|
$ |
16.92 |
|
|
|
|
|
|
4.0 |
|
|
|
|
|
|
$ |
694 |
|
Granted |
|
|
|
|
|
|
328,025 |
|
|
|
|
|
|
|
13.30 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited / Cancelled |
|
|
|
|
|
|
(352,828 |
) |
|
|
|
|
|
|
15.15 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised |
|
|
|
|
|
|
(62,152 |
) |
|
|
|
|
|
|
11.01 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at January 31, 2009 |
|
|
|
|
|
|
688,234 |
|
|
|
|
|
|
$ |
16.69 |
|
|
|
|
|
|
2.6 |
|
|
|
|
|
|
$ |
6 |
|
The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the
excess of FREDS 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 FREDS stock. As of January 31, 2009, total
unrecognized stock-based compensation expense net of estimated forfeitures related to non-vested
stock options was approximately $.78 million, which is expected to be recognized over a weighted
average period of approximately 3.0 years.
Other information relative to option activity during 2008, 2007 and 2006 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) |
|
|
|
|
2008 |
|
|
|
|
2007 |
|
|
|
|
2006 |
Total fair value of stock options vested |
|
|
|
|
|
$ |
2,240 |
|
|
|
|
|
|
$ |
1,008 |
|
|
|
|
|
|
$ |
663 |
|
Total pretax intrinsic value of stock options exercised |
|
|
|
|
|
$ |
1 |
|
|
|
|
|
|
$ |
- |
|
|
|
|
|
|
$ |
135 |
|
- 47 -
The following table summarizes information about stock options outstanding at January 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
|
|
|
|
Options Exercisable |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Averaged |
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual Life |
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
Range of Exercise Prices |
|
|
|
|
|
Shares |
|
|
|
|
|
(years) |
|
|
|
|
|
|
Exercise Price |
|
|
|
|
|
|
Shares |
|
|
|
|
|
Exercise Price |
|
$9.50 - $14.60 |
|
|
|
|
|
|
666,561 |
|
|
|
|
|
|
|
5.4 |
|
|
|
|
|
|
$ |
12.49 |
|
|
|
|
|
|
|
255,735 |
|
|
|
|
|
|
$ |
12.99 |
|
$14.68 - $20.60 |
|
|
|
|
|
|
423,550 |
|
|
|
|
|
|
|
1.8 |
|
|
|
|
|
|
$ |
18.08 |
|
|
|
|
|
|
|
392,599 |
|
|
|
|
|
|
$ |
18.20 |
|
$23.05 - $33.49 |
|
|
|
|
|
|
48,000 |
|
|
|
|
|
|
|
0.8 |
|
|
|
|
|
|
$ |
25.93 |
|
|
|
|
|
|
|
39,900 |
|
|
|
|
|
|
$ |
25.50 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,138,111 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
688,234 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock. The Companys 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 Companys 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 January 28, 2006 through January 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
Options |
|
|
|
|
|
Exercise Price |
Non-vested Restricted Stock at January 28, 2006 |
|
|
|
|
|
|
172,532 |
|
|
|
|
|
|
$ |
15.51 |
|
Granted |
|
|
|
|
|
|
92,182 |
|
|
|
|
|
|
|
13.93 |
|
Forfeited / Cancelled |
|
|
|
|
|
|
(25,293 |
) |
|
|
|
|
|
|
15.12 |
|
Exercised |
|
|
|
|
|
|
(9,570 |
) |
|
|
|
|
|
|
10.98 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
The aggregate pre-tax intrinsic value of restricted stock outstanding as of January 31, 2009 is
$3.6 million with a weighted average remaining contractual life of 6.0 years. The unrecognized
compensation expense net of estimated forfeitures, related to the outstanding restricted stock is
approximately $2.5 million, which is expected to be recognized over a weighted average period of
approximately 5.5 years. The total fair value of restricted stock awards that vested for the years
ended January 31, 2009, February 2, 2008 and February 3, 2007 was $.2 million, $.2 million and $.1
million, respectively.
The unrecognized compensation expense related to outstanding restricted stock awards was recorded
as unearned compensation in shareholders equity at January 28, 2006. With the adoption of SFAS 123
(R), the unrecognized compensation expense related to outstanding restricted stock awards granted
prior to January 29, 2006 was charged to common stock.
There were no significant modifications to the Companys share-based compensation plans during
fiscal 2008.
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
- 48 -
shared
in the earnings of the entity. Restricted stock is considered contingently issuable and is excluded
from the computation of basic earnings per share until it vests.
A reconciliation of basic earnings per share to diluted earnings per share follows (in thousands,
except per share amount):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 31, 2009 |
|
|
|
|
|
February 2, 2008 |
|
|
|
|
|
February 3, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per Share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Per Share |
(in thousands, except per share amounts) |
|
|
|
|
|
Income |
|
|
|
|
|
Shares |
|
|
|
|
|
Amount |
|
|
|
|
|
Income |
|
|
|
|
|
Shares |
|
|
|
|
|
Amount |
|
|
|
|
|
Income |
|
|
|
|
|
Shares |
|
|
|
|
|
Amount |
Basic EPS |
|
|
|
|
|
$ |
16,642 |
|
|
|
|
|
|
|
39,628 |
|
|
|
|
|
|
$ |
0.42 |
|
|
|
|
|
|
$ |
10,718 |
|
|
|
|
|
|
|
39,771 |
|
|
|
|
|
|
$ |
0.27 |
|
|
|
|
|
|
$ |
26,746 |
|
|
|
|
|
|
|
39,770 |
|
|
|
|
|
|
$ |
0.67 |
|
Effect of dilutive securities |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
223 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
111 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
88 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
|
|
|
|
$ |
16,642 |
|
|
|
|
|
|
|
39,851 |
|
|
|
|
|
|
$ |
0.42 |
|
|
|
|
|
|
$ |
10,718 |
|
|
|
|
|
|
|
39,882 |
|
|
|
|
|
|
$ |
0.27 |
|
|
|
|
|
|
$ |
26,746 |
|
|
|
|
|
|
|
39,858 |
|
|
|
|
|
|
$ |
0.67 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
1,138,111, 1,216,451, and 1,097,064 such options outstanding at January 31, 2009, February 2, 2008
and February 3, 2007.
NOTE 9 COMMITMENTS AND CONTINGENCIES
Commitments. The Company had commitments approximating $9.7 million at January 31, 2009 and $14.3
million at February 2, 2008 on issued letters of credit, which support purchase orders for
merchandise. Additionally, the Company had outstanding letters of credit aggregating approximately
$12.0 million at January 31, 2009 and $17.1 million at February 2, 2008 utilized as collateral for
its risk management programs.
Salary reduction profit sharing plan. The Company has a defined contribution profit sharing plan
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 Companys 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
Companys contributions for 2008, 2007, and 2006, were $258, $251, and $160, 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. SFAS No. 158 requires the Company 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 stockholders equity. Prior to
February 3, 2007, the Company had accounted for its postretirement benefits plan according to the
provisions of SFAS No. 106, Employers Accounting for Postretirement Benefits Other than Pensions.
During 2008, the Company changed its measurement date from November 30 to January 31. In
accordance with SFAS 158, we used the 14-month method to transition to the new measurement date
and calculate the net periodic postretirement benefit cost for the year ending January 31, 2009.
As part of the transition, an adjustment to retained earnings was recorded for the two month period
December 2, 1008 through January 31, 2009.
The Companys change in benefit obligation based upon an actuarial valuation is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 31, |
|
|
|
|
|
February 2, |
(in thousands) |
|
|
|
|
|
2009 |
|
|
|
|
|
2008 |
Benefit obligation at beginning of year |
|
|
|
|
|
$ |
539 |
|
|
|
|
|
|
$ |
591 |
|
Service cost |
|
|
|
|
|
|
25 |
|
|
|
|
|
|
|
33 |
|
Interest cost |
|
|
|
|
|
|
24 |
|
|
|
|
|
|
|
30 |
|
Actuarial (gain) |
|
|
|
|
|
|
(172 |
) |
|
|
|
|
|
|
(82 |
) |
Benefits paid |
|
|
|
|
|
|
(28 |
) |
|
|
|
|
|
|
(33 |
) |
Adjustments due to adoption of FAS 158 measurement date provisions |
|
|
|
|
|
|
8 |
|
|
|
|
|
|
|
- |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit obligation at end of year |
|
|
|
|
|
$ |
396 |
|
|
|
|
|
|
$ |
539 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
- 49 -
The medical care cost trend used in determining this obligation is 8.0% effective December 1, 2007,
decreasing annually before leveling at 5.0% in 2015. 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 |
|
|
January 31, |
|
February 2, |
(in thousands) |
|
2009 |
|
2008 |
Effect of health care trend rate |
|
|
|
|
|
|
|
|
1% increase effect of accumulated benefit obligations |
|
$ |
34 |
|
|
$ |
47 |
|
1% increase effect on periodic cost |
|
|
6 |
|
|
|
7 |
|
1% decrease effect on accumulated benefit obligations |
|
|
(30 |
) |
|
|
(42 |
) |
1% decrease effect on periodic cost |
|
|
(5 |
) |
|
|
6 |
|
The discount rate used in calculating the obligation was 5.75% in 2007 and 6.25% in 2008.
The annual net postretirement cost is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended |
|
|
January 31, |
|
February 2, |
|
February 3, |
(in thousands) |
|
2009 |
|
2008 |
|
2007 |
Service cost |
|
$ |
25 |
|
|
$ |
33 |
|
|
$ |
39 |
|
Interest cost |
|
|
24 |
|
|
|
30 |
|
|
|
31 |
|
Amorization of prior service cost |
|
|
(14 |
) |
|
|
(14 |
) |
|
|
(13 |
) |
Amorization of unrecognized prior service costs |
|
|
(102 |
) |
|
|
(97 |
) |
|
|
(98 |
) |
|
|
|
|
|
|
|
Net periodic postretirement benefit cost |
|
$ |
(67 |
) |
|
$ |
(48 |
) |
|
$ |
(41 |
) |
|
|
|
|
|
|
|
The Companys policy is to fund claims as incurred.
Information about the expected cash flows for the postretirement medical plan follows:
|
|
|
|
|
|
|
Postretirement |
|
|
Medical Plan |
Expected Benefit Payments, net of retiree contributions |
|
|
|
|
2009 |
|
|
30,673 |
|
2010 |
|
|
33,367 |
|
2011 |
|
|
34,148 |
|
2012 |
|
|
34,968 |
|
2013 |
|
|
38,395 |
|
Next 5 years |
|
|
232,598 |
|
Litigation. In June 2006, a lawsuit entitled Sarah Ziegler, et al. v. FREDS 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 FREDS 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, 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 cut off 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 Company is and will continue to vigorously defend these actions
in this matter. Discovery is closed. The parties agreed to mediate this case and did so
successfully in January 2009. The total settlement amount, (including attorneys fees and costs)
is $5,000,000. FREDS believes this is 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. FREDS has admitted no liability or wrongdoing and
no liability has been found against FREDS. The parties are finalizing settlement documents and
will jointly present the settlement to the court, which must approve the settlement.
- 50 -
In August 2007, a lawsuit entitled Julia Atchinson, et al. v. FREDS 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 FREDS 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, attorneys 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. Discovery has not yet begun. The parties also agreed to mediate this case in
January 2009 and did so successfully, reaching a settlement of $1,500,000 (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 FREDS. FREDS 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 July 2008, a lawsuit styled Jessica Chapman, on behalf of herself and others similarly situated,
v. FREDS 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 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 Companys business. As of January 31, 2009, all of the Companys operations were
located within the United States. The following data is presented in accordance with SFAS 131,
Disclosures about Segments of an Enterprise and Related Information.
The Companys sales mix by major category during the last 3 years was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended |
|
|
January 31, |
|
February 2, |
|
February 3, |
|
|
2009 |
|
2008 |
|
2007 |
Pharmaceuticals |
|
|
31.7 |
% |
|
|
32.2 |
% |
|
|
31.9 |
% |
Household Goods |
|
|
24.8 |
% |
|
|
24.8 |
% |
|
|
24.7 |
% |
Food and Tobacco Products |
|
|
15.5 |
% |
|
|
14.2 |
% |
|
|
13.0 |
% |
Paper and Cleaning Supplies |
|
|
9.2 |
% |
|
|
8.8 |
% |
|
|
8.6 |
% |
Apparel and Linens |
|
|
8.6 |
% |
|
|
9.9 |
% |
|
|
11.7 |
% |
Health and Beauty Aids |
|
|
8.0 |
% |
|
|
8.0 |
% |
|
|
8.0 |
% |
Sales to Franchised Freds Stores |
|
|
2.2 |
% |
|
|
2.1 |
% |
|
|
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 the course of 2008, the Company has closed 74 stores and 23 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 last 10 quarters. The study revealed that FREDS 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 Companys 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. The one remaining store closure is scheduled for the first half of fiscal 2009, bringing
the total number of store closures to 75.
- 51 -
Inventory Impairment
During fiscal 2006, which ended February 3, 2007, we recorded a below-cost inventory adjustment of
approximately $0.9 million to reduce the value of inventory to lower of cost or market in the 20
stores that were planned for closure in fiscal 2007, of which 17 were closed. The entire impairment
was utilized in fiscal 2007.
During fiscal 2007, which ended February 2, 2008, 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 Companys 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 SFAS 146, Accounting for Costs Associated with Exit or Disposal Activities.
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 SFAS 146. 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, which ended February 2, 2008, 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, which ended January 31, 2009, 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 $7.6 million during
the period, leaving $3.5 million in the reserve at January 31, 2009. During the first half of
fiscal 2009, the Company expects to incur $.2 million in lease contract termination costs related
to the remaining store closure.
The following table illustrates the exit and disposal activity related to the store closures
discussed in the previous paragraphs (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ending |
|
|
Balance at |
|
|
|
|
|
|
|
|
|
Balance |
|
|
February 2, |
|
Additions |
|
Utilized |
|
January 31, |
|
|
2008 |
|
FY08 |
|
FY08 |
|
2009 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory markdowns for planned store closings |
|
$ |
10.0 |
|
|
$ |
0.3 |
|
|
$ |
10.3 |
|
|
$ |
|
|
Lease contract termination liability |
|
|
0.6 |
|
|
|
10.5 |
|
|
|
7.6 |
|
|
|
3.5 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
10.6 |
|
|
$ |
10.8 |
|
|
$ |
17.9 |
|
|
$ |
3.5 |
|
|
|
|
|
|
|
|
|
|
Fixed Asset Impairment
During fiscal 2006, which ended February 3, 2007, the Company recorded a charge of $0.8 million in
selling, general and administrative expense for the impairment of fixed assets and leasehold
improvements associated with the 20 store closings planned for fiscal 2007.
During the fourth quarter of 2007, which ended February 2, 2008, 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. There were no other fixed asset
impairment charges incurred during 2008.
- 52 -
NOTE 12 QUARTERLY FINANCIAL DATA (UNAUDITED)
The Companys unaudited quarterly financial information for the fiscal years ended January 31, 2009
and February 2, 2008 is reported below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Second |
|
|
|
|
|
Fourth |
|
(in thousands) |
|
First Quarter |
|
Quarter |
|
Third Quarter |
|
Quarter |
|
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 |
|
2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.18 |
|
|
$ |
0.03 |
|
1 |
$ |
0.15 |
|
|
$ |
0.06 |
|
2 |
Diluted |
|
$ |
0.18 |
|
|
$ |
0.03 |
|
1 |
$ |
0.15 |
|
|
$ |
0.06 |
|
2 |
Cash dividends paid per share |
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended February 2, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
442,262 |
|
|
$ |
424,640 |
|
|
$ |
419,913 |
|
|
$ |
494,108 |
|
|
Gross profit |
|
|
127,001 |
|
|
|
121,483 |
|
|
|
124,920 |
|
|
|
116,839 |
|
|
Net income (loss) |
|
|
7,438 |
|
|
|
3,058 |
|
|
|
4,607 |
|
|
|
(4,385 |
) |
1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
0.19 |
|
|
$ |
0.08 |
|
|
$ |
0.12 |
|
|
$ |
(0.11 |
) |
1 |
Diluted |
|
$ |
0.19 |
|
|
$ |
0.08 |
|
|
$ |
0.12 |
|
|
$ |
(0.11 |
) |
1 |
Cash dividends paid per share |
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
1
Results include certain charges for the closing of 75 stores in 2008 and the 17 stores closed in 2007 (see Note 11 - Exit and Disposal Activities).
2
Results include $6.6 million accrual for a legal settlement (see Note 9 - Commitments and Contingencies).
ITEM 9: Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
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 Companys 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
Companys 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
Commissions 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) Managements Annual Report on Internal Control Over Financial Reporting. The management
of FREDS, 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.
FREDS, Inc. internal control system was designed to provide reasonable assurance to the Companys
management and board of directors regarding the fair and reliable preparation and presentation of
the Consolidated Financial Statements.
- 53 -
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 FREDS, Inc. assessed the effectiveness of the Companys internal control over
financial reporting as of January 31, 2009. 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
Companys internal control over financial reporting is effective as of January 31, 2009.
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 31, 2009 in the Companys 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 Companys internal control over financial reporting.
- 54 -
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
FREDS, Inc.
Memphis, Tennessee
We have audited FREDS, Inc.s (the Companys) internal control over financial reporting as of
January 31, 2009, based on criteria established in Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The
Companys 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, Managements Annual Report on Internal Control
Over Financial Reporting. Our responsibility is to express an opinion on the Companys 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 companys 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
companys 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 companys 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 31, 2009, 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 31, 2009 and
February 2, 2008, 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 31, 2009 and our report dated April 16, 2009 expressed an unqualified opinion thereon.
/s/BDO Seidman, LLP
Memphis, Tennessee
April 16, 2009
- 55 -
ITEM 9B. Other Information
None.
PART III
ITEM 10: Directors, Executive Officers and Corporate Governance
The following information is furnished with respect to each of the directors and executive officers
of the Company:
|
|
|
|
|
|
|
Name |
|
|
Age |
|
|
Postions and Offices |
|
|
|
67 |
|
|
Director, Chairman of the Board |
|
|
|
|
|
|
|
John R. Eisenman (1) |
|
|
67 |
|
|
Director |
|
|
|
|
|
|
|
Roger T. Knox (1) |
|
|
71 |
|
|
Director |
|
|
|
|
|
|
|
Thomas H. Tashjian(1) |
|
|
54 |
|
|
Director |
|
|
|
|
|
|
|
B. Mary McNabb (1) |
|
|
60 |
|
|
Director |
|
|
|
|
|
|
|
Michael T. McMillan (1) |
|
|
49 |
|
|
Director |
|
|
|
|
|
|
|
Bruce A. Efird |
|
|
49 |
|
|
Director, Chief Executive Officer and President |
|
|
|
|
|
|
|
Jerry A. Shore |
|
|
56 |
|
|
Executive Vice President, Chief Financial Officer and Chief Administative Officer |
|
|
|
|
|
|
|
Dennis K. Curtis |
|
|
49 |
|
|
Executive Vice-President General Merchandise Manager |
|
|
|
|
|
|
|
John A. Casey |
|
|
62 |
|
|
Executive Vice President Pharmacy Acquisitions |
|
|
|
|
|
|
|
Rick A. Chambers |
|
|
45 |
|
|
Executive Vice President Pharmacy Operations |
|
|
|
|
|
|
|
Charles S. Vail |
|
|
66 |
|
|
Corporate Secretary, Senior Vice President Legal Services and
General Counsel |
|
|
|
|
|
|
|
Reggie E. Jacobs |
|
|
38 |
|
|
Executive Vice President Corporate Services, Distribution and
Transportation |
|
|
|
|
|
|
|
Earl L. Taylor |
|
|
59 |
|
|
Executive Vice President Store Operations |
1 Seven directors, constituting the entire Board of Directors, are to be elected at the 2009 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 Sallys, 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 Goldsmiths Department Stores, Inc. (a full-line department store in Memphis
and Jackson, Tennessee) from 1983 to 1987 and its Chairman of the Board and Chief Executive
Officer from 1987 to 1989. Prior thereto, Mr. Knox was with Foleys 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. Tashjians 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 Romans.
B. Mary McNabb was elected a director of the Company in April 2005. Most recently she served
as Chief Executive Officer for Kids Outlet in California. She has served as a member of the Board
of Directors of C-ME (Cyber Merchants Exchange), a public company,
- 56 -
and now serves as an advisor to
the board. 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 Sales Operations for Pepsi-Cola North America, a Division of PepsiCo, where he has
spent the last 22 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 chains 179 stores across a five-state area. From 1997 until
October 2005, Mr. Efird was with Brunos 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 Wangs 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.
Dennis K. Curtis was named Executive Vice-President General Merchandise Manager in February 2008.
Previously, Mr. Curtis was Executive Vice-President for Store Operations of FREDS from July 2003
to January 2008. Prior to this position, Mr. Curtis held the position of Senior Vice-President -
Divisional Merchandising Manager of Hardlines. Mr. Curtis joined the Company in 1980 as a
management trainee in store operations.
John A. Casey was named Executive Vice President Pharmacy Acquisitions in June of 2004 and was
previously Executive Vice President Pharmacy Operations of FREDS since February 1997. Mr. Casey
joined the Company in 1979 and has served in various positions in Pharmacy Operations. Mr. Casey is
a registered pharmacist.
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.
ITEM 11: Executive Compensation
Information required by this item is incorporated herein by reference to the proxy
statement for our 2009 Annual Meeting.
ITEM 12: Security Ownership of Certain Beneficial Owners and Management
Information required by this item is incorporated herein by reference to the proxy
statement for our 2009 Annual Meeting.
ITEM 13: Certain Relationships and Related Transactions and Director Independence
Information required by this item is incorporated herein by reference to the proxy
statement for our 2009 Annual Meeting.
ITEM 14. Principal Accounting Fees and Services
Information required by this item is incorporated herein by reference to the proxy
statement for our 2009 Annual Meeting.
- 57 -
PART IV
ITEM 15: Exhibits, Financial Statement Schedules and Reports on Form 8-K
(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 Freds 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 Companys Report on Form 10-Q for
the quarter ended October 31, 1998]. |
|
|
|
4.3
|
|
Rights Agreement, dated as of October 10, 2008, between Freds Inc. and Regions Bank [incorporated herein
by reference to Exhibit 4.1 to the Form 8-A]. |
|
|
|
10.1
|
|
Form of FREDS, 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 FREDS, Inc. dated February 5, 1992 for the
lease of truck tractors to FREDS, Inc. and the servicing of those vehicles and other equipment of FREDS,
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
Companys report on Form 10-Q for the quarter ended July 31, 1993]. |
|
|
|
***10.6
|
|
Term Loan Agreement between FREDS, Inc. and First American National Bank dated as of April 23, 1999
[incorporated herein by reference to the Companys Report on Form 10-Q for the quarter ended May 1, 1999]. |
|
|
|
***10.7
|
|
Prime Vendor Agreement between FREDS Stores of Tennessee, Inc. and Bergen Brunswig Drug Company, dated as
of November 24, 1999 [incorporated herein by reference to Companys 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 FREDS, Inc dated September 20, 1999 (modifies the Lease Agreement included as
Exhibit 10.4) [incorporated herein by reference to the Companys report on Form 10-K for the year ended
January 29, 2000]. |
- 58 -
|
|
|
***10.9
|
|
Revolving Loan Agreement between FREDS, Inc. and Union Planters Bank, NA and SunTrust Bank dated April 3,
2000 [incorporated herein by reference to the Companys 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 Companys report on Form 10-K for the year ended
January 29, 2000]. |
|
|
|
***10.11
|
|
Seasonal Over line Agreement between FREDS, Inc. and Union Planters National Bank dated as of October 11,
2000 [incorporated herein by reference to the Companys 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 Companys 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 Companys 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 Companys 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 Companys 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
Companys 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 FREDS Stores of Tennessee, Inc.
dated July 26, 2005 for the lease of equipment to FREDS Stores of Tennessee, Inc. [incorporated herein by
reference to the Companys 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 Companys 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 Companys 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 Companys 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 Companys 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 Companys 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 Companys Form 8-K filed on December 23, 2008]. |
|
|
|
**21.1
|
|
Subsidiaries of Registrant |
- 59 -
|
|
|
**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 Financial Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350. |
|
|
|
* |
|
Management Compensatory Plan |
|
** |
|
Filed herewith |
|
*** |
|
(SEC File No. under the Securities Exchange Act of 1934 is 00-19288) |
- 60 -
Report of Independent Registered Public Accounting Firm
Board
of Directors and Shareholders
FREDS, Inc.
Memphis, Tennessee
The audits referred to in our report dated April 16, 2009 relating to the consolidated financial
statements of FREDS, 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 Companys 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, present fairly, in all material respects, the
information set forth therein.
/s/BDO
Seidman, LLP
Memphis, Tennessee
April 16, 2009
Schedule
II Valuation and Qualifying Accounts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions Charged |
|
|
|
|
|
|
|
|
|
|
to Costs and |
|
Deductions and |
|
|
(dollars in thousands) |
|
Beginning Balance |
|
Expenses |
|
Reclass Adjustments |
|
Ending Balance |
Deducted from applicable assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended January 31, 2009 |
|
$ |
879 |
|
|
$ |
486 |
|
|
$ |
480 |
|
|
$ |
885 |
|
Year ended February 2, 2008 |
|
$ |
719 |
|
|
$ |
255 |
|
|
$ |
95 |
|
|
$ |
879 |
|
Year ended February 3, 2007 |
|
$ |
698 |
|
|
$ |
69 |
|
|
$ |
48 |
|
|
$ |
719 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory valuation reserves |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended January 31, 2009 |
|
$ |
10,025 |
|
|
$ |
280 |
|
|
$ |
10,305 |
|
|
$ |
- |
|
Year ended February 2, 2008 |
|
$ |
2,119 |
|
|
$ |
10,025 |
|
|
$ |
2,119 |
|
|
$ |
10,025 |
|
Year ended February 3, 2007 |
|
$ |
- |
|
|
$ |
2,119 |
|
|
$ |
- |
|
|
$ |
2,119 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Insurance reserves |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
Year ended February 3, 2007 |
|
$ |
8,467 |
|
|
$ |
37,053 |
|
|
$ |
36,916 |
|
|
$ |
8,604 |
|
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, on this 16th day of April, 2009.
|
|
|
|
|
|
FREDS, 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
16th day of April, 2009.
|
|
|
Signature |
|
Title |
|
|
|
/s/ Michael J. Hayes
|
|
Director and Chairman of the Board |
|
|
|
|
|
|
/s/ Bruce A. Efird
Bruce A. Efird
|
|
Director, Chief Executive Officer and President
(Principle Executive Officer) |
|
|
|
/s/ Jerry A. Shore
|
|
Executive Vice President and Chief Financial |
|
|
Officer
(Principal Accounting and Financial Officer) |
|
|
|
/s/ Roger T. Knox
|
|
Director |
|
|
|
|
|
|
/s/ John R. Eisenman
|
|
Director |
|
|
|
|
|
|
/s/ Thomas H. Tashjian
|
|
Director |
|
|
|
|
|
|
/s/ B. Mary McNabb
|
|
Director |
|
|
|
|
|
|
/s/ Michael T. McMillan
|
|
Director |
|
|
|