Fred's, Inc.
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 February 2, 2008
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
(State or Other Jurisdiction of
Incorporation or Organization)
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62-0634010
(I.R.S. Employer
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: None
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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 |
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
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Accelerated filer
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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 3,
2007, the last business day of the registrants most recently completed second fiscal
quarter, was approximately $388 million. For the purposes of this disclosure only, the
registrant has assumed that its directors, executive officers, and beneficial owners of
greater than 10% of the registrants common stock are the affiliates of the registrant.
As of April 11, 2008, there were 39,913,687 shares outstanding of the Registrants
Class A no par value voting common stock.
As of
April 11, 2008, 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 2008 annual shareholders meeting, to be
filed within 120 days of the registrants fiscal year end, are incorporated herein 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
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EXHIBIT INDEX |
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EX-31 Certification of Chief Executive Officer and Chief Financial Officer) |
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EX-32 (Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350) |
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EX-21.1 SUBSIDIARIES OF THE REGISTRANT |
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EX-23.1 CONSENT OF BDO SEIDMAN, LLP |
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EX-31.1 SECTION 302 CERTIFICATION OF THE CEO |
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EX-31.2 SECTION 302 CERTIFICATION OF THE CFO |
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EX-32 SECTION 906 CERTIFICATION OF THE CEO & CFO |
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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 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 affect 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
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 practices for pharmaceuticals; |
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Governmental regulation; |
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Increases 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 1, 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.
PART I
ITEM 1: Business
General
Freds, founded in 1947, operates 692 (as of February 2, 2008) 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 65% of Freds stores are in markets with populations of 15,000 or
fewer people). Full service pharmacies are included in 296 of the Companys stores (as of
February 2, 2008). 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
3
availability of products at everyday low
prices and regularly advertised departmental promotions and seasonal specials. Freds
stores have average selling space of 15,239 square feet and had average sales of $2,625,000
in fiscal 2007. No single store accounted for more than 1.0% of net sales during fiscal
2007.
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, 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 37% 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.
Freds opened 35 stores and closed 20 stores in 2007. The majority of new stores opened
in 2007 were located in Mississippi, Georgia, Texas, South Carolina and North Carolina.
The Companys new store prototype has 16,000 square feet of space. Opening a new store
currently costs between $450,000 and $575,000 for inventory, furniture, fixtures,
equipment and leasehold improvements.
In 2007, the Company added 11 new pharmacies and closed 4 pharmacies. Approximately 43% of
Freds stores as of February 2, 2008 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 2008, the Company plans to take a more conservative expansion approach and intends to open
approximately 18 stores and 10 to 15 pharmacies. Additionally, the Company plans to increase
the number of store closings when compared to historic patterns. A complete discussion of this
strategic plan was released to the public on February 6, 2008 and is contained herein in Item
7, Managements Discussion and Analysis of Financial Condition and Results of Operation.
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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2007 |
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2006 |
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2005 |
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2004 |
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2003 |
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Stores open at beginning of period |
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677 |
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621 |
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563 |
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488 |
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414 |
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Stores opened/acquired during period |
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35 |
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59 |
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65 |
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81 |
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79 |
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Stores closed during period |
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(20 |
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(3 |
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(7 |
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(6 |
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(5 |
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Stores open at end 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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Number of stores with pharmacies at end of period |
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296 |
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289 |
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275 |
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258 |
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241 |
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Square feet of selling space at end of period (in thousands) |
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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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7,134 |
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Average square feet of selling space per store |
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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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15,166 |
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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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25 |
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26 |
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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
2007, 2006, and 2005 were 2.7%, 3.1%, and 2.7%, respectively, and gross profit, as a percentage
of total gross profit for the same time period was 2.4%, 2.3%, and 2.0%, 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 Freds has a distinctive niche in that it offers a wider variety of
merchandise at 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
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offered in high traffic departments, such as health and
beauty aids and paper and cleaning supplies, are comparable to those of larger discount
retailers. Management believes that its knowledge of regional and local consumer
preferences, developed over its 61 year history, enables the Company to compete very
effectively in its region.
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 three Divisional Senior Vice Presidents of Merchandising who are supported by a staff
of 22 buyers and assistants. The buyers and assistants are participants in an incentive
compensation program, which is based upon various factors primarily relating to gross margin
return on inventory. The Company purchases its merchandise from a wide variety of domestic
and import suppliers. Many of the import suppliers generally require long lead times and
orders are placed four to six months in advance of delivery. These products are either
imported directly by us or acquired from distributors based in the United States and their
purchase prices are denominated in United States dollars. The merchandising department
manages all replenishment and forecasting functions with the 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 13% in 2007, 12% in 2006 and 11% in 2005 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 2007, 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 2007, 2006, and 2005 approximately 36%, 37%, and 36%,
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. 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 Proctor and
Gamble mentioned previously, no other supplier accounted for more than 3% of the Companys
total purchases for the years 2007, 2006, and 2005.
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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February 2, |
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February 3, |
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January 28, |
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2008 |
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2007 |
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2006 |
Pharmaceuticals |
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32.2 |
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31.9 |
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31.3 |
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Household Goods |
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24.8 |
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24.7 |
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24.8 |
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Apparel and Linens |
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9.9 |
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11.7 |
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12.7 |
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Food and Tobacco Products |
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14.2 |
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13.0 |
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12.5 |
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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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Paper and Cleaning Supplies |
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8.8 |
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8.6 |
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8.5 |
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Sales to Franchised Freds Stores |
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2.1 |
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2.1 |
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2.2 |
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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 2007, the average customer
transaction size for comparable stores was approximately $18.75, and the number of customer
transactions totaled approximately 88 million. The average transaction size was approximately
$18.57 in 2006 and $17.91 in 2005.
Our private label program 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 3% of total sales for the years 2007, 2006, and 2005.
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 intend to expand our private label
program. 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 $37.3 million in 2007, $36.5 million in 2006, and $34.8
million in 2005. Franchise and other fees earned totaled approximately $2.0 million in 2007,
$2.0 million in 2006, and $1.9 million in 2005. 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, and therefore, expects that this
category will continue to decrease as a percentage of the Companys total revenues.
Advertising
and Promotions
Net advertising and promotion costs represented approximately 1.5% of net sales in 2007 and
2006, and 1.4% in 2005. The Company uses direct mail, television, radio and 14 major
newspaper-advertising circulars, one at the first of each
month and two during the Christmas season. The Company utilizes 20 page full-color circulars
coordinated by an 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 runs
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
managers have the flexibility to tailor the price structure at their particular store to
meet competitive conditions within each stores marketing area.
7
Store Operations
All Freds stores are open six days a week (Monday through Saturday), and most stores are open
seven days a week (other than 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 42 district managers and 5 Regional Vice Presidents supervise the management and
operation of Freds stores.
Freds operates 296 pharmacies (as of February 2, 2008), which offer brand name and generic
pharmaceuticals and are staffed by licensed pharmacists. 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 and Distribution
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 inventory counts at all Freds stores and has implemented the use of radio
frequency devices (RF guns) to conduct cycle counts to insure replenishment accuracy.
Distribution
The Company has an 850,000 square foot centralized distribution center in Memphis, Tennessee that
services 370 stores and a 600,000 square foot distribution center in Dublin, Georgia that
services 346 stores (see Properties below). Approximately
49% of the merchandise received by Freds stores in 2007 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 through out the year to insure accuracy within the
Warehouse Management System.
Seasonality
Our business is somewhat seasonal in that the Companys sales volume is heavier around the
1st 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 1st
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
8
holiday shopping season. 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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1st |
|
2nd |
|
3rd |
|
4th |
For the year ended: |
|
Quarter |
|
Quarter |
|
Quarter |
|
Quarter |
February 2, 2008 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
24.8 |
% |
|
|
23.8 |
% |
|
|
23.6 |
% |
|
|
27.8 |
% |
Gross profit |
|
|
25.9 |
% |
|
|
24.8 |
% |
|
|
25.5 |
% |
|
|
23.8 |
% |
Operating
profit (loss) * |
|
|
67.8 |
% |
|
|
34.6 |
% |
|
|
43.7 |
% |
|
|
-46.1 |
% |
Net income (loss) * |
|
|
69.4 |
% |
|
|
28.5 |
% |
|
|
43.0 |
% |
|
|
-40.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
January 28, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
|
24.1 |
% |
|
|
23.5 |
% |
|
|
23.7 |
% |
|
|
28.7 |
% |
Gross profit |
|
|
24.3 |
% |
|
|
23.4 |
% |
|
|
24.3 |
% |
|
|
28.0 |
% |
Operating profit |
|
|
25.4 |
% |
|
|
13.7 |
% |
|
|
24.6 |
% |
|
|
36.3 |
% |
Net income |
|
|
25.8 |
% |
|
|
13.3 |
% |
|
|
24.2 |
% |
|
|
36.7 |
% |
|
|
|
* |
|
Results for 2007 include certain charges for the planned closing of 75 stores (see Item 7
Exit and disposal activities section) and implementations of FIN 48. |
Employees
At February 2, 2008, the Company had approximately 10,150 full-time and part-time employees,
comprised of 1,020 corporate and distribution center employees and 9,130 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,
2005. 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 other retailers, including mass merchandise, grocery, drug,
convenience, variety and other specialty 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
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
9
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
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.
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 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 2007, 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 address, 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 or furnished to the SEC.
ITEM 1A. RISK FACTORS
10
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.
The Companys business is somewhat seasonal.
The Company typically realizes a significant portion of its 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 the Companys 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, the Companys profitability and operating results could be adversely affected by
unanticipated markdowns, especially in seasonal merchandise.
The Company operates in a competitive industry.
The Company is in a highly competitive sector of the discount retail merchandise business. This
competitive environment subjects the Company to the risk of reduced profitability because of lower
prices, and lower margins, required to maintain the Companys competitive position. The Company
competes with discount stores and with many other retailers, including mass merchandise, grocery,
drug, convenience, variety and other specialty stores, some of whom may have greater resources
than the Company. This competitive environment subjects the Company to various risks, including
the ability to continue to provide competitively priced merchandise to our customers that will
allow the Company to maintain profitability and continue its store growth. Some of the Companys
competitors utilize aggressive promotional activities, advertising programs, and pricing discounts
and the Companys results of
operations could be adversely affected if the Company does not respond effectively to these
efforts.
Changes in third-party reimbursements, including government programs, could adversely affect
our business.
A significant portion of the Companys sales is funded by federal and state governments and
private insurance plans. For the years ended February 2, 2008 and February 3, 2007, approximately
32% 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, 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 the Companys 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 the Companys business by reducing consumer spending or causing
consumers to shift their spending to other products. The Company might be unable to anticipate
these buying patterns and implement
11
appropriate inventory strategies, which would adversely affect
its sales and gross profit performance. In addition, continued increases in fuel and energy costs
would increase the Companys transportation costs and overall cost of doing business and could
adversely affect the Companys 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 the Companys net sales. In addition, these disruptions could also adversely affect the
Companys supply chain efficiency and make it more difficult for the Company to obtain sufficient
quantities of merchandise from its suppliers. A number of our stores are located in areas that are
susceptible to hurricanes and tornados.
Merchandise supply and pricing and the interruption of and dependence on imports could
adversely affect our business.
The Company has maintained good relations with its vendors and believes that it is 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 or duties on imports could cause significant
delays or interruptions in the supply of our merchandise or increase our costs. Also, our cost of
these goods is affected by the fluctuation of the local currencies where these goods are produced
against the dollar. 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. The Company purchases a
significant amount of goods from Proctor and Gamble and several large import vendors and any
disruption in that supply and or pricing of such merchandise could negatively impact the Companys
operations and results.
Delays and costs of operating new stores and distribution facilities could have an adverse
impact on our business.
The Company maintains two distribution facilities in its geographic territory, and plans on
constructing new facilities as needed to support its growth. One of our key business strategies is
to expand our base of retail stores. The Company plans on expanding and refreshing its network of
stores through opening new stores and remodeling existing stores each year. Delays in opening
stores or delays in opening distribution facilities to service those new stores could adversely
affect the Companys 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 the Company.
Operational difficulties could disrupt our business.
The Companys stores are managed through a network of geographically dispersed management
personnel. Inability of the Company to effectively and efficiently operate its stores, including
the ability to control losses resulting from inventory shrinkage, may negatively impact the
Companys sales and/or margin. In addition, the Company relies upon its 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. The Companys operation depends on a variety of information technology systems for the
efficient functioning of its business. The Company relies on certain software vendors to maintain
and upgrade these systems as needed. The Company relies on telecommunications carriers to gather
and disseminate its operations information. The disruption or failure of these systems or carriers
could negatively impact the Companys operations.
Use of a single supplier of pharmaceutical products and our ability to negotiate satisfactory
terms could adversely affect our business.
The Company has 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 the Companys operations.
12
Higher costs and achievement of targeted results associated with the implementation of new
programs, systems and technology could adversely affect our business.
The Company is 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 the future operating results of the Company.
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 the Companys ability to achieve its financial targets. Changes
in trade restrictions, new tariffs and quotas, and higher shipping costs for goods could also
adversely impact the ability of the Company to achieve anticipated operating results.
We depend on the success of new store opening program for Company growth and profitability.
The Companys growth is dependent on both increases in sales in existing stores and the ability to
open new stores. Unavailability of store locations that the Company deems 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 the Companys new store growth, the costs associated with new stores and/or the
profitability of new stores.
Changes in the Companys ability to attract and retain employees, and changes in health care
and other insurance costs could adversely affect our business.
The growth of the Company could be adversely impacted by its inability to attract and retain
employees at the store operations level, in distribution facilities, and at the corporate level,
including the Companys senior management team. Adverse changes in health care costs could also
adversely impact the Companys ability to achieve its operational and financial goals and to offer
attractive benefit programs to its employees.
Adverse impacts associated with legal proceedings and claims could affect our business.
The Company is party to a variety of legal proceedings and claims, including those described
elsewhere in this Report. Operating results for the Company could be adversely impacted if legal
proceedings and claims against the Company 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.
On February 6, 2008, the Company announced a strategic plan to improve profitability and operating
margin by closing 75 under-performing stores, which is discussed in detail in Item 7, Managements
Discussion and Analysis of Financial Condition and Results of Operation. 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
13
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.
ITEM 1B: UNRESOLVED STAFF COMMENTS
None.
ITEM 2: Properties
As of February 2, 2008, the geographical distribution of the Companys 692 retail store locations
in 15 states was as follows:
|
|
|
State |
|
Number of Stores |
Georgia |
|
124 |
Mississippi |
|
103 |
Tennessee |
|
96 |
Alabama |
|
90 |
Arkansas |
|
69 |
South Carolina |
|
55 |
Louisiana |
|
43 |
North Carolina |
|
34 |
Texas |
|
27 |
Florida |
|
22 |
Kentucky |
|
10 |
Missouri |
|
9 |
Illinois |
|
7 |
Indiana |
|
1 |
Oklahoma |
|
2 |
|
|
Total stores: |
|
692 |
|
|
The Company owns the real estate and the buildings for 67 locations (6 of which are closed), and
owns the buildings at six locations which are subject to ground leases. The Company leases the
remaining 631 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. Four
hundred and thirty-nine 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,
14
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 ongoing and data continues to be reviewed.
Following the close of the discovery period in this case, the Company will have an
opportunity to seek decertification of the class, and the Company expects to file such a
decertification and other motions.
In addition to the matter described above, the Company is party to other 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 energies 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 February 2, 2008.
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 2007 and fiscal 2006.
15
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First |
|
Second |
|
Third |
|
Fourth |
Fiscal 2007 |
|
Quarter |
|
Quarter |
|
Quarter |
|
Quarter |
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First |
|
Second |
|
Third |
|
Fourth |
Fiscal 2006 |
|
Quarter |
|
Quarter |
|
Quarter |
|
Quarter |
High |
|
$ |
16.40 |
|
|
$ |
15.32 |
|
|
$ |
15.00 |
|
|
$ |
13.74 |
|
Low |
|
$ |
12.37 |
|
|
$ |
12.75 |
|
|
$ |
11.45 |
|
|
$ |
11.30 |
|
Dividends |
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
|
$ |
0.02 |
|
The Companys stock price at the close of the market on April 11, 2008, was $9.88. There
were approximately 21,000 shareholders of record of the Companys common stock as of April
11, 2008. 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 February 2, 2008, is as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of Securities |
|
|
|
|
|
|
|
|
|
Remaining Available for |
|
|
|
|
|
|
Weighted-Average |
|
|
Future Issuance Under |
|
|
|
Number of Securities to |
|
|
Exercise Price of |
|
|
Equity Compensation |
|
|
|
be Issued upon Exercise |
|
|
Outstanding |
|
|
Plans (Excluding |
|
|
|
of Outstanding Options, |
|
|
Options, Warrants |
|
|
Securities Reflected in |
|
|
|
Warrants and Rights |
|
|
and Rights |
|
|
Column(a)) |
|
Plan Category |
|
(a) |
|
|
(b) |
|
|
(c) |
|
Equity compensation
plans approved by
security holders |
|
|
1,216,451 |
|
|
$ |
15.40 |
|
|
|
2,057,344 |
|
Equity compensation
plans not approved
by security holders |
|
|
0 |
|
|
not applicable |
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
1,216,451 |
|
|
$ |
15.40 |
|
|
|
2,057,344 |
|
|
|
|
|
|
|
|
|
|
|
Recent Sales of Unregistered Equity Securities and Use of Proceeds.
During the second and third quarter of fiscal 2007, we sold in a private placement an aggregate
of 103,053 shares of our Class A common stock to Summit Properties, LLC (Summit) pursuant to
the exemptions from registration provided in Section 4(2) of the Securities Act of 1933, as
amended (the Act), and Rule 506 of Regulation D promulgated thereunder. The shares were
issued in connection with our acquisition of the membership interests of certain Limited
Liability Companies and related real estate rights. The shares have subsequently been
registered under the Act. We will not receive any proceeds from the resale of these shares.
The private placement that we made in reliance on the exemptions from registration under Section
4(2) of the Act and Rule 506 of Regulation D thereunder did not involve any public offering of
common stock. In addition, Summit provided us with written representations that it was an
accredited investor within the meaning of Rule 501(e) of Regulation D, that it was a
sophisticated investor and that it had the knowledge and experience necessary to evaluate the
risks and merits of the investment in our common stock. In addition, Summit was solicited on a
private and
16
confidential basis in a manner not involving any general solicitation or advertising
in compliance with Regulation D.
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 February
2, 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 |
|
|
|
|
|
|
|
|
|
|
Purchased as Part of |
|
of Shares That May Yet |
|
|
Total Number of |
|
Average Price |
|
Publicly Announced |
|
Be Purchased Under |
|
|
Shares Purchased |
|
Paid Per Share |
|
Plan or Programs |
|
the Plans or Programs |
August 27, 2007
September 10,
2007 |
|
|
|
|
|
$ |
|
|
|
|
|
|
|
|
4,000.0 |
|
September 11,
2007 October 3,
2007 |
|
|
190.1 |
|
|
$ |
10.25 |
|
|
|
190.1 |
|
|
|
3,809.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 4, 2007
November 3, 2007 |
|
|
236.4 |
|
|
$ |
10.24 |
|
|
|
236.4 |
|
|
|
3,573.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 4, 2007
February 2,
2008 |
|
|
|
|
|
$ |
|
|
|
|
|
|
|
|
3,573.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
426.5 |
|
|
$ |
10.25 |
|
|
|
426.5 |
|
|
|
|
|
17
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)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20076 |
|
20063 & 5 |
|
2005 |
|
2004 |
|
2003 |
Statement of Income Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
1,780,923 |
|
|
$ |
1,767,239 |
|
|
$ |
1,589,342 |
|
|
$ |
1,441,781 |
|
|
$ |
1,302,650 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
16,457 |
|
|
|
40,949 |
|
|
|
40,081 |
|
|
|
39,426 |
|
|
|
49,100 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
15,664 |
|
|
|
40,213 |
|
|
|
39,255 |
|
|
|
38,633 |
|
|
|
48,702 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes |
|
|
4,946 |
|
|
|
13,467 |
|
|
|
13,161 |
|
|
|
10,681 |
|
|
|
15,907 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
10,718 |
|
|
|
26,746 |
|
|
|
26,094 |
|
|
|
27,952 |
|
|
|
32,795 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share:1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
.27 |
|
|
|
.67 |
|
|
|
.66 |
|
|
|
.71 |
|
|
|
.85 |
|
Diluted |
|
|
.27 |
|
|
|
.67 |
|
|
|
.66 |
|
|
|
.71 |
|
|
|
.83 |
|
Cash dividend declared per share1 |
|
|
.08 |
|
|
|
.08 |
|
|
|
.08 |
|
|
|
.08 |
|
|
|
.08 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selected Operating Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income as a percentage of sales |
|
|
0.9 |
% |
|
|
2.3 |
% |
|
|
2.5 |
% |
|
|
2.7 |
% |
|
|
3.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Increase in
comparable store sales2 |
|
|
0.3 |
%7 |
|
|
2.4 |
%4 |
|
|
1.2 |
% |
|
|
2.2 |
% |
|
|
5.7 |
% |
Stores open at end of period |
|
|
692 |
|
|
|
677 |
|
|
|
621 |
|
|
|
563 |
|
|
|
488 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance Sheet Data (at period end): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets |
|
$ |
550,572 |
|
|
$ |
515,709 |
|
|
$ |
498,141 |
|
|
$ |
465,224 |
|
|
$ |
408,793 |
|
Short-term debt (including capital leases) |
|
|
285 |
|
|
|
737 |
|
|
|
1,053 |
|
|
|
684 |
|
|
|
743 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt (including capital leases) |
|
|
35,653 |
|
|
|
2,331 |
|
|
|
6,815 |
|
|
|
24,212 |
|
|
|
7,289 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders equity |
|
|
372,059 |
|
|
|
369,268 |
|
|
|
339,595 |
|
|
|
314,546 |
|
|
|
286,350 |
|
|
|
|
1 |
|
Adjusted for the 3-for-2 stock split effected on July
1, 2003. |
|
2 |
|
A store is first included in the comparable store sales
calculation after the end of the twelfth-month following the stores grand
opening month. (See additional information regarding calculation of
comparable store sales in Item 7 Results of Operations section.) |
|
3 |
|
Results for 2006 include 53 weeks. |
|
4 |
|
The increase in comparable store sales for 2006 is computed on the
same 53-week period for 2005. |
|
5 |
|
Results for 2006 include the implementation of FAS 123 (R). |
|
6 |
|
Results for 2007 include certain charges for the planned closing of
75 stores, (see Item 7 Exit and disposal activities section) and
implementation of FIN 48. |
|
7 |
|
The comparable store sales for 2007 is computed on a 52-week
period. |
18
ITEM 7: Managements Discussion and Analysis of Financial Condition and Results of
Operations
General Accounting Periods
The following information contains references to years 2007, 2006, and 2005, which represent fiscal
years ended February 2, 2008 (which was a 52-week accounting period), February 3, 2007 (which was a
53-week accounting period), and January 28, 2006 (which was a 52-week accounting period). 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
In 2007, we continued our strategy of refreshing and revitalizing our stores and capitalizing on
our over 60 years of experience in the discount retail sector. Our Merchandise Refresher Program
was completed during the third quarter of 2007. This program refreshed the look and feel of our
stores with new paint and flooring, updated signage and the expansion and relocation of several
departments. Additionally, our new branding and advertising campaign, which focuses on our over 60
year history while emphasizing the new look and feel of Freds continued to be a key strategy as
the year drew to a close. Two additional strategies that will be key to our success in 2008
continued to be focal points in the second half of 2007. The first involves an extensive market
research program to determine customer preferences and expectations when visiting a Freds store
and the second involves a new site selection and real estate program to determine which locations
best suit our customers. Another key element of our strategic plan that began to unfold in the
latter part of 2007 was the introduction of new leadership, as well as an internal realignment of
existing leadership. Continuing enhancements to or changes in our leadership team will also be
focal points in 2008.
The integration of the aforementioned strategies coupled with our unique store layout allows us to
offer our customers all the attractive elements of a discount dollar store, drug store and mass
merchant under one roof. By offering elements of all three types of businesses, we are able to
provide our customers with a ten minute Superstore experience in a smaller, easier and more
convenient store layout.
The Company continued during the year to see paybacks on productivity improvements and key
technology initiatives. Some of these include continuing enhancement of our point of sale and
radio frequency (RF) store systems, refinement and upgrades to our merchandise planning and
allocation systems and process and productivity standards improvements in our distribution centers.
As discussed in our Form 10-K for the fiscal year ended February 3, 2007, we slowed our new store
growth during the year. This slow down in growth, coupled with the closing of unproductive stores,
should have a positive impact on the Companys operating margin over time. In 2007, the Company
opened 35 new stores and closed 20 stores. The majority of our new store openings were in
Mississippi, Georgia, Texas and North and South Carolina. We did not enter into any new states
during the year. Additionally, we opened eleven new pharmacies and closed four pharmacies
throughout the course of the year.
During 2008, the Company will continue with its strategy of slowing growth and closing
underperforming stores. Pursuant to this strategy, Freds expects to open 18 new stores and 15 new
pharmacies while closing 75 underperforming stores and 22 pharmacies. By closing underperforming
locations, the Company intends to improve its cash flow and operating margin, both of which are
core goals of the Companys overall strategic plan.
Also in 2008, we will 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.
19
Our Battleship Store Program which was developed late in 2007 will be operational in early 2008 and
is intended to sharpen focus on our upper tier of profit producing stores. The intention of this
program is 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 tenants of the Battleship Program.
We will also continue in 2008 to focus on the 700 800 items we refer to as our We Got It items.
These are consumable type items that we have promised, through our We Got It branding campaign,
to always have on our shelves and available for our customers. We have implemented supply chain
and distribution procedures to ensure that our We Got It pledge is fulfilled.
Over the course of 2008, we intend to continue with capital improvements in infrastructure,
including new and existing store expansions and remodels, distribution center upgrades and further
development of our information technology capabilities. Technology upgrades will be made in the
areas of direct store delivery systems, stores POS systems, and pharmacy systems.
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, increasing operating margin through improved
gross margin and leveraging operating costs, and generating adequate cash flow to fund the
Companys expansion. Additionally, managing the store closing process effectively and efficiently
will be a key factor in delivering projected benefits in 2008 and beyond.
Other factors that will affect Company performance in 2008 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.
Additionally, inflated oil and gas prices continue to have a negative impact on our business in
terms of reducing our customers disposable income, as well as increasing the cost of our petroleum
based products and increasing our transportation costs. We also believe that the current housing
crisis is having an impact on the disposable income of our customers and will continue to do so
well into 2008. Also, the Company will again experience an initial negative impact in selling,
general and administrative expenses from the second year incremental raising of the Federal minimum
wage; however, the increase should be a positive factor over time because it will directly impact
the disposable income of our primary customer base. We also believe that the Economic Stimulus
Package of 2008 and lower interest rates could be positive factors and may benefit our customers in
the upcoming year.
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
20
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 and the
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 February 2, 2008. 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 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 2007, 2006, and
2005 was $2,008, $2,019, and $1,891, respectively.
Inventories. Merchandise inventories are valued at the lower of cost or market using the
retail first-in, first-out (FIFO) method for goods in our stores and the cost first-in, first-out
(FIFO) method for goods in our distribution centers. The retail inventory method is a reverse
mark-up, averaging method which has been widely used in the retail industry for many years. This
method calculates a cost-to-retail ratio that is applied to the retail value of inventory to
determine the cost value of inventory and the resulting cost of goods sold and gross margin. The
assumption that the retail inventory method provides for valuation at lower of cost or market and
the inherent uncertainties therein are discussed in the following paragraphs.
In order to assure valuation at the lower of cost or market, the retail value of our inventory is
adjusted on a consistent basis to reflect current market conditions. These adjustments include
increases to the retail value of inventory for initial markups to set the selling price of goods or
additional markups to adjust pricing for inflation and decreases to the retail value of inventory
for markdowns associated with promotional, seasonal or other declines in the market value. Because
these adjustments are made on a consistent basis and are based on current prevailing market
conditions, they approximate the carrying value of the inventory at net realizable value (market
value). Therefore, after applying the cost to retail ratio, the cost value of our inventory is
stated at the lower of cost or market as is prescribed by 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.
21
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 $31.1 million, and $36.4 million at
February 2, 2008 and February 3, 2007, 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 $15.4 million at February 2, 2008 and $13.8 million at February 3, 2007. The LIFO
reserve increased by approximately $1.6 million, $1.6 million, and $2.5 million, during 2007,
2006, and 2005, respectively.
The Company has historically included an estimate of inbound freight and certain general and
administrative expenses in merchandise inventory as prescribed by Generally Accepted Accounting
Principles. 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
February 2, 2008 is $21.9 million, with the corresponding amount of $19.8 million at February 3,
2007.
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 open or remodeled 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
22
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 the year ended February 2, 2008, the Company
recorded a below-cost inventory adjustment of approximately $10.0 million in cost of goods sold
to value inventory at the lower of cost or market and 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 the upcoming fiscal year. The planned
closures will take place during the first three quarters of the upcoming year and are 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 75
underperforming stores the Company will improve its cash flow and operating margin, both of
which are core goals of the Companys overall strategic plan. With the successful execution of
this plan, the Company will become stronger and will be in a better position to respond to
fluctuations in the economy and take advantage of opportunities to further improve our business.
Also during the year ended February 2, 2008, the Company utilized the $0.9 million reserve that
was taken as a below-cost inventory adjustment and charged to cost of goods sold in the year
ended February 3, 2007 for store closures that took place during the current year.
In addition, the Company completed its exit from the boys and girls apparel lines and as such
utilized the reserve of $1.2 million that was taken as a below-cost inventory adjustment and
charged to cost of goods sold in the year ended February 3, 2007.
The following table summarizes the current year balances and activity of the liabilities associated
with the aforementioned exit and disposal activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Beginning |
|
|
|
|
|
Reversal for stores |
|
Additional |
|
Ending |
|
|
Balance |
|
Utilized during |
|
not closed during |
|
Reserves Added |
|
Balance |
(in millions) |
|
February 3, 2007 |
|
2007 |
|
2007 |
|
2007 |
|
February 2, 2008 |
|
Inventory markdowns for
discontinuance of boys &
girls apparel
|
|
$ |
1.2 |
|
|
$ |
1.2 |
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
Inventory markdowns for
planned store closings
|
|
|
0.9 |
|
|
|
0.8 |
|
|
|
0.1 |
|
|
|
10.0 |
|
|
|
10.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lease contract termination costs
|
|
|
0.1 |
|
|
|
1.1 |
|
|
|
|
|
|
|
1.6 |
|
|
|
0.6 |
|
|
|
|
|
|
|
$ |
2.2 |
|
|
$ |
3.1 |
|
|
$ |
0.1 |
|
|
$ |
11.6 |
|
|
$ |
10.6 |
|
|
|
|
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.
Associated with the store closings in the current year, the Company incurred $1.6 million in lease
contract termination cost, which was charged to rent expense, and expects to incur $10.8 million in
lease contract termination costs in association with the stores that are planned to be closed in
the upcoming year.
23
Property and equipment and intangibles. Property and equipment are carried at cost.
Depreciation is calculated using the straight-line method over the estimated useful lives of the
assets and recorded in selling, general and administrative expenses. Improvements to leased
premises are depreciated using the straight-line method over the shorter of the initial term of
the lease or the useful life of the improvement. Leasehold improvements added late in the lease
term are depreciated over the shorter of the remaining term of the lease (including the upcoming
renewal option, if the renewal is reasonably assured) or the useful life of the improvement,
whichever is lesser. Gains or losses on the sale of assets are recorded at disposal as a
component of operating income. The following average estimated useful lives are generally
applied:
|
|
|
|
|
|
|
Estimated Useful Lives |
Building and building improvements
|
|
8 |
- |
30 years |
Furniture, fixtures and equipment
|
|
3 |
- |
10 years |
Leasehold improvements
|
|
3 |
- |
10 years or term of lease, if shorter |
Automobiles and vehicles
|
|
3 |
- |
5 years |
Airplane
|
|
|
|
9 years |
Assets under capital leases 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 February 2, 2008, the Company had approximately 750 vendors who participate in vendor rebate
programs and the terms of the agreements with those vendors vary in length from short-term
arrangements to be completed within three months to longer-term arrangements that could last up to
three years.
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 2007, 2006, and 2005, were $27.6 million, $27.4
million, and $22.3 million, respectively. Gross advertising expenses were reduced by vendor
cooperative advertising allowances of $1.5 million, $1.1 million, and $.5 million, for 2007, 2006,
and 2005, 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
24
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 $8.2
million and $8.6 million on February 2, 2008 and February 3, 2007, respectively. Changes in the
reserve over that time period were attributable to additional reserve requirements of $38.3 million
netted with reserve utilization of $38.7 million.
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.
As a result of the adoption of FIN 48, we recognized a cumulative effect adjustment of $4.2 million
decrease to beginning retained earnings and a reclassification of certain amounts between deferred
income taxes ($2.3 million decrease) and other non-current liabilities ($6.5 million increase,
including $1.0 million of interest and penalties) to conform to the balance sheet presentation
requirements of 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 4, 2007 |
|
$ |
7.3 |
|
Additions for tax position related to current year |
|
|
1.5 |
|
Additions for tax position of prior years |
|
|
.4 |
|
Reductions for tax position of prior years |
|
|
(.8 |
) |
Settlements |
|
|
|
|
|
|
|
|
Balance at February 2, 2008 |
|
$ |
8.4 |
|
|
|
|
|
As of February 4, 2007, our liability for unrecognized tax benefits totaled $7.3 million, of which
$0.5 million and $0.3 million were recognized as income tax benefit during the periods ending
November 3, 2007 and February 2, 2008, respectively, as a result of a lapse in applicable statute
of limitations. As of February 2, 2008, our liability for unrecognized tax benefits totaled $8.4
million and is recorded in our consolidated balance sheet with Other Liabilities, all of which,
if recognized, would affect our effective tax rate.
FIN 48 further requires that interest 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 February 2, 2008, accrued interest and penalties
related to
25
our unrecognized tax benefits totaled $ 1.0 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.
Prior to January 28, 2006, the Company accounted for share-based payments using the
intrinsic-value-based recognition method prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, (APB 25). As stock options were granted at an
exercise price equal to the market value of the underlying common stock on the date of grant, no
stock option compensation expense was reflected in net income prior to adopting SFAS 123(R).
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. For periods prior
to 2006, the Company in its proforma disclosures under SFAS 123, recognized forfeitures as they
occurred.
The following represents total stock based compensation expense (a component of selling, general
and administrative expenses) recognized in the consolidated financial statements (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Stock option expense |
|
$ |
1,312 |
|
|
$ |
1,408 |
|
Restricted stock expense |
|
|
591 |
|
|
|
512 |
|
ESPP expense |
|
|
213 |
|
|
|
279 |
|
|
|
|
|
|
|
|
Total stock-based compensation |
|
|
2,116 |
|
|
|
2,199 |
|
|
|
|
|
|
|
|
|
|
Income tax benefit on stock-based compensation |
|
$ |
340 |
|
|
$ |
210 |
|
26
As a result of adopting SFAS 123(R), the Companys income before income taxes and net income for
fiscal year 2006, were $1.7 million and $1.7 million lower, respectively, than if it had continued
to account for share-based compensation under APB 25. Basic and diluted earnings per share for
fiscal year 2006 were $.04 and $.04 lower respectively, than if the Company had continued to
account for share-based compensation under APB 25.
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Pro |
|
|
|
|
|
|
|
|
|
|
Forma) |
|
|
2007 |
|
2006 |
|
2005 |
Stock Options |
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility
|
|
|
42.8 |
% |
|
|
41.4 |
% |
|
|
46.6 |
% |
Risk-free interest rate
|
|
|
4.1 |
% |
|
|
4.8 |
% |
|
|
4.3 |
% |
Expected option life (in years)
|
|
|
5.8 |
|
|
|
5.9 |
|
|
|
5.3 |
|
Expected dividend yield
|
|
|
0.4 |
% |
|
|
0.4 |
% |
|
|
0.5 |
% |
Weighted average fair value at grant date
|
|
$ |
4.68 |
|
|
$ |
6.01 |
|
|
$ |
7.35 |
|
|
Employee Stock Purchase Plan |
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility
|
|
|
37.2 |
% |
|
|
38.7 |
% |
|
|
41.4 |
% |
Risk-free interest rate
|
|
|
4.7 |
% |
|
|
4.8 |
% |
|
|
4.3 |
% |
Expected option life (in years)
|
|
|
0.63 |
|
|
|
0.63 |
|
|
|
0.5 |
|
Expected dividend yield
|
|
|
0.38 |
% |
|
|
0.3 |
% |
|
|
0.2 |
% |
Weighted average fair value at grant date
|
|
$ |
3.31 |
|
|
$ |
4.31 |
|
|
$ |
3.37 |
|
The following is a summary of the methodology applied to develop each assumption:
Expected Volatility This is a measure of the amount by which a price has fluctuated or is
expected to fluctuate. The Company uses actual historical changes in the market value of our stock
to calculate expected price volatility because management believes that this is the best indicator
of future volatility. The Company calculates weekly market value changes from the date of grant
over a past period representative of the expected life of the options to determine volatility. An
increase in the expected volatility will increase compensation expense.
Risk-free Interest Rate This is the yield of a U.S. Treasury zero-coupon bond issue
effective at the grant date with a remaining term equal to the expected life of the option. An
increase in the risk-free interest rate will increase compensation expense.
Expected Lives This is the period of time over which the options granted are expected to
remain outstanding and is based on historical experience. Options granted have a maximum term of
seven and one-half years. An increase in the expected life will increase compensation expense.
27
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.
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.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended |
|
|
February 2, |
|
February 3, |
|
January 28, |
|
|
2008(3) |
|
2007(3) |
|
2006 |
Net Sales |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
Cost of goods sold (1) |
|
|
72.5 |
|
|
|
72.0 |
|
|
|
71.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
27.5 |
|
|
|
28.0 |
|
|
|
28.2 |
|
Selling, general and administrative expenses (2) |
|
|
26.6 |
|
|
|
25.7 |
|
|
|
25.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
0.9 |
|
|
|
2.3 |
|
|
|
2.5 |
|
interest expense, net |
|
|
0.0 |
|
|
|
0.0 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before taxes |
|
|
0.9 |
|
|
|
2.3 |
|
|
|
2.4 |
|
Income taxes |
|
|
0.3 |
|
|
|
0.8 |
|
|
|
0.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
0.6 |
% |
|
|
1.5 |
% |
|
|
1.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Cost of goods sold includes the cost of the 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 for the year ended February 2, 2008 and February 3, 2007, include certain
charges for the planned closing of 75 stores in 2008 and the 20 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
twelfth-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
28
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 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
29
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, due primarily to the
above-mentioned decrease in gross margin and increase in selling, general and administrative
expenses.
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
Net income for 2007 was $10.7 million (or $.27 per diluted share) compared to $26.7 million (or
$.67 per diluted share) reported in 2006.
Fiscal 2006 Compared to Fiscal 2005
Sales
Net sales increased 11.2% ($177.9 million) in 2006. Approximately $139.8 million of the
increase was attributable to a net addition of 56 new stores, and a net addition of 14
pharmacies during 2006, together with the sales of 58 store locations and 17 pharmacies that
were opened or upgraded during 2005 and contributed a full year of sales in 2006. During
2006, the Company closed 3 stores and 2 pharmacy locations. Comparable store sales,
consisting of sales from stores that have been open for more than one year, increased 2.4%
in 2006, which accounted for $ 38.1 million in sales. Comparable store sales for 2006 are
computed on the same 53-week period for 2005.
The Companys front store (non-pharmacy) sales increased approximately 10.4% over 2005 front
store sales. Front store sales growth benefited from the above
30
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 31.9% of total sales in 2006 and 31.3% of total sales in 2005 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 13.5% over 2005, with
third party prescription sales representing approximately 92% of total pharmacy sales, an
increase from 88% 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 $1.7 million in 2006 and
represented 2.1% of the Companys total sales, as compared to 2.2% in 2005. 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 28.0% in 2006 compared to 28.2% in 2005.
The decrease in gross margin results primarily from the $1.2 million below-cost inventory
adjustment associated with the discontinuance of the boys and girls apparel departments, as
well as the $.9 million below-cost inventory adjustment for planned store closings.
Additionally, the increase in lower margin on Medicare sales in the Companys pharmacy
department led to the decline in overall Company gross margin.
Selling, General and Administrative Expenses
Selling, general and administrative expenses were $424.9 million (24.0% of net sales) in
2006 compared to $380.4 million (23.9% of net sales) in 2005. The increase as a percent of
net sales was from higher fuel costs affecting distribution costs (0.1%), higher utilities
(0.1%), increased advertising (0.1%) offset by decreases as a percent to net sales in
payroll (0.1%) and insurance (0.1%). Depreciation and amortization expense was $29.1
million (1.6% of net sales) in 2006 compared to $27.8 million (1.7 % of net sales) for 2005.
Operating Income
Operating income increased $.8 million or 2.0% to $40.9 million in 2006 from $40.1 million in 2005.
Operating income as a percentage of sales was 2.3% in 2006 down from 2.5% in 2005, due primarily
to the above-mentioned decrease in gross margin.
Interest Expense, Net
Net interest expense for 2006 totaled $.7 million or less than .1% of sales compared to $.8 million
or .1% of sales in 2005.
Income Taxes
The effective income tax rate was 33.5% in 2006, the same rate as in 2005.
State net operating loss carry-forwards are available to reduce state income taxes in future years.
These carry-forwards total approximately $116.3 million for state income tax purposes and expire
at various times during the period 2007 through 2026. 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.
The Companys estimates of income taxes and the significant items resulting in the
31
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. We maintain income tax contingency reserves for potential assessments
from the federal government or other taxing authority. 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. Changes to the tax contingency reserve could
materially affect the Companys future consolidated operating results in the period of change.
Net Income
Net income for 2006 was $26.7 million (or $.67 per diluted share) or approximately 2.5% higher than
the $26.1 million (or $.66 per diluted share) reported in 2005.
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 $270.5 million, $239.9 million, and $214.0 million at year-end 2007, 2006, and 2005,
respectively. Working capital fluctuates in relation to profitability, seasonal inventory levels,
net of trade accounts payable, and the level of store openings and closings. Working capital at
year-end 2007 increased by approximately $30.6 million from 2006. The increase was primarily
attributed to an increase in cash and cash equivalents and inventory, supported by increased
long-term borrowings. The Company plans to open 11 new stores and 3 new pharmacies during the first
quarter of 2008.
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 and 2007. 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 $19.3 million in 2007, $35.3 million in
2006, and $48.5 million in 2005.
In fiscal 2007, inventory, net of the LIFO reserve, increased by approximately $25.3 million due to
improving in-stock positions in the basic and consumable product categories as well as slower sales
than projected during the 2007 Holiday season. This increase was offset by a $10.0 million
non-cash reduction in inventory resulting from the below-cost inventory adjustment related to the
planned store closures in the upcoming year. Accounts receivable
increased by approximately $8.1 million due an increase in income tax receivable which reflects overpayment of estimated taxes due
to lower than anticipated sales.
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.
In fiscal 2005, cash was primarily used to increase inventories by approximately $30.9 million, or
10%, during the fiscal year. This increase is primarily attributable to our adding a net of 58 new
stores, upgrading 12 stores and adding a net of 17 new pharmacies, as well as supporting the
increase in comparable store sales. Accounts payable and accrued expenses increased by $12.7
million due primarily to increase in inventory and higher accrued payroll expenses. Income taxes
payable increased by
32
approximately $6.2 million due to the increase in the effective tax rate and no estimated payments
made in 2005.
Capital expenditures in 2007 totaled $31.4 million compared to $26.5 million in 2006 and $27.8
million in 2005. 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. The 2005 capital expenditures included approximately $18.3 million for new stores
and pharmacies, $7.1 million for upgrading existing stores and $2.4 million for technology,
corporate and other capital expenditures. Cash used for investing activities also includes $1.7
million in 2007, $3.4 million in 2006, and $3.2 million in 2005 for the acquisition of prescription
lists and other pharmacy related items and $1.1 million in 2007 and $0.3 million in 2006 from
insurance proceeds related to fixed assets reimbursements.
In 2008, the Company is planning capital expenditures totaling approximately $18.3 million.
Expenditures are planned totaling $11.3 million for new and existing stores and pharmacies.
Planned expenditures also include approximately $1.0 million for technology upgrades, and
approximately $4.0 million for distribution center equipment and capital maintenance. Technology
upgrades in 2008 will be made in the areas of direct store delivery systems, stores POS systems,
and pharmacy systems. In addition the Company plans expenditures of approximately $2.0 million in
2008 for the acquisition of prescription lists and other pharmacy related items.
Cash and cash equivalents were $10.3 million at the end of 2007 compared to $2.5 million at the end
of 2006 and $3.1 million at the end of 2005. 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 2007 the Company repurchased 426,500 shares for $4.4 million.
On October 30, 2007, the Company and Regions Bank entered into an amendment of their 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 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
33
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 2007, 2006 and 2005.
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 February 2,
2008, which excludes the effect of imputed interest:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
|
|
|
|
Payments due by period |
|
|
Contractual Obligations |
|
Total |
|
< 1 yr |
|
1-3 yrs |
|
3-5 yrs |
|
>5 yrs |
Capital Lease obligations (1)
|
|
$ |
129 |
|
|
$ |
129 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Revolving loan (2)
|
|
|
31,860 |
|
|
|
|
|
|
|
31,860 |
|
|
|
|
|
|
|
|
Operating leases (3)
|
|
|
195,275 |
|
|
|
47,523 |
|
|
|
72,021 |
|
|
|
44,582 |
|
|
|
31,149 |
|
Equipment leases (4)
|
|
|
8,081 |
|
|
|
1,988 |
|
|
|
3,963 |
|
|
|
2,070 |
|
|
|
60 |
|
Inventory purchase obligations (5)
|
|
|
137,043 |
|
|
|
137,043 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement benefits (6)
|
|
|
539 |
|
|
|
40 |
|
|
|
88 |
|
|
|
94 |
|
|
|
317 |
|
Mortgage Loans on land & buildings(7)
|
|
|
5,177 |
|
|
|
164 |
|
|
|
839 |
|
|
|
328 |
|
|
|
3,846 |
|
|
|
|
|
Total Contractual Obligations
|
|
$ |
378,104 |
|
|
$ |
186,887 |
|
|
$ |
108,771 |
|
|
$ |
47,074 |
|
|
$ |
35,372 |
|
|
|
|
|
|
|
* |
|
On February 2, 2008, a liability for unrecognized tax benefits for $8.352 million has been
excluded from this table as the timing of payment cannot be reasonably estimated. |
|
(1) |
|
Capital lease obligations include related interest. |
|
(2) |
|
Revolving loan represents principle maturity for the Companys revolving credit agreement and
includes estimated interest of $1.225 million on $30.635 million of debt at 4.0% for 1 year. |
|
(3) |
|
Operating leases are described in Note 5 to the Consolidated Financial Statements. |
|
(4) |
|
Equipment leases representing cooler program and other equipment operating leases. |
|
34
|
|
|
(5) |
|
Inventory purchase obligations represent open purchase orders
and any outstanding purchase commitments as of February 2, 2008. |
|
(6) |
|
Postretirement benefits are described in Note 9 to the Consolidated Financial Statements. |
|
(7) |
|
Mortgage loans for purchased land and buildings. |
As discussed in Note 9 to the Consolidated Financial Statements, the Company had commitments
approximating $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
$17.1 million at February 2, 2008 utilized as collateral for their 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 $.585 million for the year ended February 2, 2008. Total
future commitments under related party leases are $7.078 million.
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 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 (FSP) No. FAS 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 is in the process of determining the effect, if any, that the adoption of SFAS No. 157 will
have on its results of operations or financial position.
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. We are currently reviewing the impact of SFAS No. 159, if
any, on our Consolidated Financial Statements and expect to complete this evaluation in 2008.
In March 2007, the Emerging Issues Task Force (EITF) reached a consensus on issue number 06-10,
Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment
Split-Dollar Life Insurance Arrangements, (EITF 06-10). EITF 06-10 provides guidance to help
companies determine whether a liability for the postretirement benefit associated with a collateral
assignment split-dollar life insurance arrangement should be recorded in accordance with either
SFAS No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions (if, in
35
substance, a postretirement benefit plan exists), or Accounting Principles Board Opinion No. 12 (if
the arrangement is, in substance, an individual deferred compensation contract). EITF 06-10 also
provides guidance on how a company should recognize and measure the asset in a collateral
assignment split-dollar life insurance contract. EITF 06-10 is effective for fiscal years beginning
after December 15, 2007, although early adoption is permitted. The Company has evaluated EITF 06-10
and has determined that it will have no impact on its results of operations or financial position.
In May 2007, the FASB issued FASB Staff Position No. FIN 48-1, Definition of Settlement in FASB
Interpretation No. 48 (FSP
FIN 48-1). FSP FIN 48-1 amends FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, to provide guidance on how an enterprise should
determine whether a tax position is effectively settled for the purposes of recognizing previously
unrecognized tax benefits. The Company adopted FIN 48-1 as of February 4, 2007 and is now required
to apply the guidance provided in FSP FIN 48-1. The application of FSP FIN 48-1 has not had a
material effect on the Companys financial position, results of operations, or cash flows.
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 is 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. Early application of EITF 06-11 is 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 is in the process of
determining the effect, if any, that the adoption of EITF 06-11 will have on its results of
operations or financial position.
In December 2007, the FASB issued FASB Statement No. 141 (R), Business Combinations (FAS 141(R)),
which establishes accounting principles and disclosure requirements for all transactions in which a
company obtains control over another business. Statement 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 is in the process of determining the effect, if any, that the adoption of FAS 141 (R) will
have on 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. Statement 160 establishes new accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of
a subsidiary. Statement 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 is in
the process of determining the effect, if any, that the adoption of FASB No. 160 will have on its
results of operations or financial position.
ITEM 7a: Quantitative and Qualitative Disclosure about Market Risk
The Company has no holdings of derivative financial or commodity instruments as of February
2, 2008. 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.
36
ITEM
8: Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Freds Inc.
Memphis, Tennessee
We have audited the accompanying consolidated balance sheets of Freds Inc., as of February 2, 2008
and February 3, 2007 and the related consolidated statements of income and comprehensive income,
changes in stockholders equity, and cash flows for each of the three years in the period ended
February 2, 2008. 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
February 2, 2008 and February 3, 2007,
and the results of its operations and its cash flows for each of the three years in the period
ended February 2, 2008, in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 1 to the consolidated financial statements, in the year ended February 2, 2008
the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for
Uncertainty in Income Taxes and in the year ended February 3, 2007, the Company adopted Statements
of Financial Accounting Standards No. 123 (Revised 2004), Share-Based Payment, Statements of
Financial Accounting 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. internal control over financial reporting as of February 2,
2008, 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, 2008 expressed an unqualified opinion thereon.
BDO
Seidman, LLP
Memphis, Tennessee
April 16, 2008
37
Freds, Inc.
Consolidated Balance Sheets
(in thousands, except for number of shares)
|
|
|
|
|
|
|
|
|
|
|
February 2, |
|
|
February 3, |
|
|
|
2008 |
|
|
2007 |
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
10,266 |
|
|
$ |
2,475 |
|
Inventories |
|
|
320,268 |
|
|
|
304,969 |
|
Receivables, less allowance for doubtful accounts of $879 and
$719, respectively |
|
|
30,972 |
|
|
|
29,097 |
|
Other non trade receivables |
|
|
20,536 |
|
|
|
18,953 |
|
Prepaid expenses and other current assets |
|
|
11,792 |
|
|
|
12,224 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
393,834 |
|
|
|
367,718 |
|
|
|
|
|
|
|
|
|
|
Property and equipment, at depreciated cost |
|
|
145,985 |
|
|
|
138,031 |
|
Equipment under capital leases, less accumulated amortization of
$4,836, and $4,578, respectively |
|
|
132 |
|
|
|
390 |
|
Other noncurrent assets, net |
|
|
10,621 |
|
|
|
9,570 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
550,572 |
|
|
$ |
515,709 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND SHAREHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
70,416 |
|
|
$ |
64,349 |
|
Current portion of indebtedness |
|
|
159 |
|
|
|
385 |
|
Current portion of capital lease obligations |
|
|
126 |
|
|
|
352 |
|
Accrued expenses and other |
|
|
39,469 |
|
|
|
42,159 |
|
Deferred income taxes |
|
|
13,151 |
|
|
|
16,396 |
|
Income taxes payable |
|
|
|
|
|
|
4,188 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
123,321 |
|
|
|
127,829 |
|
|
|
|
|
|
|
|
|
|
Long-term portion of indebtedness |
|
|
35,653 |
|
|
|
2,216 |
|
Deferred income taxes |
|
|
6,698 |
|
|
|
12,425 |
|
Long-term portion of capital lease obligations |
|
|
|
|
|
|
115 |
|
Other non-current liabilities |
|
|
12,841 |
|
|
|
3,856 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
178,513 |
|
|
|
146,441 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments and contingencies (Notes 2,5 and 9) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders equity: |
|
|
|
|
|
|
|
|
Preferred stock, nonvoting, no par value, 10,000,000 shares
authorized, none outstanding |
|
|
|
|
|
|
|
|
Preferred stock, Series A junior participating nonvoting,
no par value, 224,594 shares authorized, none outstanding |
|
|
|
|
|
|
|
|
Common stock, Class A voting, no par value, 60,000,000 shares
authorized, 39,880,836 shares and 40,068,953 shares
issued & outstanding, respectively |
|
|
135,335 |
|
|
|
135,803 |
|
Common stock, Class B nonvoting, no par value, 11,500,000
shares authorized, none outstanding |
|
|
|
|
|
|
|
|
Retained earnings |
|
|
235,684 |
|
|
|
232,382 |
|
Accumulated other comprehensive income |
|
|
1,040 |
|
|
|
1,083 |
|
|
|
|
|
|
|
|
Total shareholders equity |
|
|
372,059 |
|
|
|
369,268 |
|
|
|
|
|
|
|
|
Total liabilities and shareholders equity |
|
$ |
550,572 |
|
|
$ |
515,709 |
|
|
|
|
|
|
|
|
See accompanying notes to Consolidated Financial Statements.
Freds, Inc.
Consolidated Statements of Income and Comprehensive Income
(in thousands, except per shares amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended |
|
|
|
February 2, |
|
|
February 3, |
|
|
January 28, |
|
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
Net sales |
|
$ |
1,780,923 |
|
|
$ |
1,767,239 |
|
|
$ |
1,589,342 |
|
Cost of goods sold |
|
|
1,290,680 |
|
|
|
1,272,320 |
|
|
|
1,141,105 |
|
|
|
|
|
|
|
|
|
|
|
Gross profit |
|
|
490,243 |
|
|
|
494,919 |
|
|
|
448,237 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
28,614 |
|
|
|
29,102 |
|
|
|
27,755 |
|
Selling, general and administrative expenses |
|
|
445,172 |
|
|
|
424,868 |
|
|
|
380,401 |
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
16,457 |
|
|
|
40,949 |
|
|
|
40,081 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
|
(567 |
) |
|
|
(68 |
) |
|
|
(176 |
) |
Interest expense |
|
|
1,360 |
|
|
|
804 |
|
|
|
1,002 |
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
15,664 |
|
|
|
40,213 |
|
|
|
39,255 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income taxes |
|
|
4,946 |
|
|
|
13,467 |
|
|
|
13,161 |
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
10,718 |
|
|
$ |
26,746 |
|
|
$ |
26,094 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
.27 |
|
|
$ |
.67 |
|
|
$ |
.66 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
.27 |
|
|
$ |
.67 |
|
|
$ |
.66 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
39,771 |
|
|
|
39,770 |
|
|
|
39,632 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
39,882 |
|
|
|
39,858 |
|
|
|
39,772 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
10,718 |
|
|
$ |
26,746 |
|
|
$ |
26,094 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income, net of tax: |
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement plan adjustment |
|
|
(43 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
$ |
10,675 |
|
|
$ |
26,746 |
|
|
$ |
26,094 |
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to Consolidated Financial Statements.
Freds, Inc.
Consolidated Statements of Changes in Shareholders Equity
(in thousands, except per share and share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other |
|
|
|
|
|
|
Common Stock |
|
|
Retained |
|
|
Unearned |
|
|
Comprehensive |
|
|
|
|
|
|
Shares |
|
|
Amount |
|
|
Earnings |
|
|
Compensation |
|
|
Income |
|
|
Total |
|
Balance, January 29, 2005 |
|
|
39,692,091 |
|
|
$ |
132,511 |
|
|
$ |
184,732 |
|
|
$ |
(2,697 |
) |
|
$ |
|
|
|
$ |
314,546 |
|
Cash dividends paid ($.08 per share) |
|
|
|
|
|
|
|
|
|
|
(3,183 |
) |
|
|
|
|
|
|
|
|
|
|
(3,183 |
) |
Restricted stock grants, cancellations and
withholdings, net |
|
|
(4,540 |
) |
|
|
78 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
78 |
|
Issuance of shares under
employee stock purchase plan |
|
|
32,583 |
|
|
|
469 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
469 |
|
Amortization of unearned compensation |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
431 |
|
|
|
|
|
|
|
431 |
|
Exercises of stock options |
|
|
140,054 |
|
|
|
1,026 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,026 |
|
Income tax benefit on exercise of stock
options |
|
|
|
|
|
|
134 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
134 |
|
Net income |
|
|
|
|
|
|
|
|
|
|
26,094 |
|
|
|
|
|
|
|
|
|
|
|
26,094 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to Consolidated Financial Statements.
40
Freds, Inc.
Consolidated Statements of Cash Flows
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Years Ended |
|
|
|
February 2, |
|
|
February 3, |
|
|
January 28, |
|
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
10,718 |
|
|
$ |
26,746 |
|
|
$ |
26,094 |
|
Adjustments to reconcile net income to net cash flows
from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization |
|
|
28,614 |
|
|
|
29,102 |
|
|
|
27,755 |
|
Net (gain) loss on asset disposition and impairments |
|
|
(335 |
) |
|
|
594 |
|
|
|
|
|
Provision for store closures and asset impairments |
|
|
14,559 |
|
|
|
1,792 |
|
|
|
|
|
Stock-based compensation |
|
|
2,116 |
|
|
|
2,199 |
|
|
|
431 |
|
Provision for uncollectible receivables |
|
|
160 |
|
|
|
21 |
|
|
|
69 |
|
LIFO reserve increase |
|
|
1,657 |
|
|
|
1,571 |
|
|
|
2,493 |
|
Deferred income tax expense (benefit) |
|
|
(6,604 |
) |
|
|
(547 |
) |
|
|
3,632 |
|
Issuance (net of cancellation) of restricted stock |
|
|
|
|
|
|
|
|
|
|
78 |
|
Income tax benefit upon exercise of stock options |
|
|
10 |
|
|
|
(55 |
) |
|
|
134 |
|
Provision for post retirement medical |
|
|
(43 |
) |
|
|
|
|
|
|
|
|
(Increase) decrease in operating assets: |
|
|
|
|
|
|
|
|
|
|
|
|
Receivables |
|
|
(8,067 |
) |
|
|
(17,481 |
) |
|
|
(1,550 |
) |
Insurance receivables |
|
|
1,537 |
|
|
|
2,713 |
|
|
|
|
|
Inventories |
|
|
(26,981 |
) |
|
|
(3,681 |
) |
|
|
(30,928 |
) |
Other assets |
|
|
432 |
|
|
|
(1,434 |
) |
|
|
(1,011 |
) |
Increase (decrease) in operating liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
Accounts payable and accrued expenses |
|
|
3,377 |
|
|
|
(3,433 |
) |
|
|
12,730 |
|
Income taxes payable |
|
|
(3,508 |
) |
|
|
(2,550 |
) |
|
|
6,196 |
|
Other noncurrent liabilities |
|
|
1,699 |
|
|
|
(234 |
) |
|
|
2,339 |
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
19,341 |
|
|
|
35,323 |
|
|
|
48,462 |
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
|
(31,289 |
) |
|
|
(26,534 |
) |
|
|
(27,757 |
) |
Proceeds from asset dispositions |
|
|
463 |
|
|
|
138 |
|
|
|
|
|
Insurance recoveries for replacement assets |
|
|
1,094 |
|
|
|
282 |
|
|
|
|
|
Asset acquisition(primarily intangibles) |
|
|
(1,663 |
) |
|
|
(3,439 |
) |
|
|
(3,154 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(31,395 |
) |
|
|
(29,553 |
) |
|
|
(30,911 |
) |
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Payments of indebtedness and capital lease obligations |
|
|
(1,656 |
) |
|
|
(1,367 |
) |
|
|
(694 |
) |
Proceeds from revolving line of credit |
|
|
344,755 |
|
|
|
208,450 |
|
|
|
264,020 |
|
Payments on revolving line of credit |
|
|
(316,293 |
) |
|
|
(211,983 |
) |
|
|
(281,412 |
) |
Excess tax benefits from stock-based compensation |
|
|
(10 |
) |
|
|
55 |
|
|
|
|
|
Proceeds from exercise of stock options and issuances under
employee stock purchase plan |
|
|
624 |
|
|
|
1,597 |
|
|
|
1,498 |
|
Repurchase of shares |
|
|
(4,371 |
) |
|
|
|
|
|
|
|
|
Dividends paid |
|
|
(3,204 |
) |
|
|
(3,192 |
) |
|
|
(3,183 |
) |
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
19,845 |
|
|
|
(6,440 |
) |
|
|
(19,771 |
) |
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents |
|
|
7,791 |
|
|
|
(670 |
) |
|
|
(2,220 |
) |
Cash and cash equivalents: |
|
|
|
|
|
|
|
|
|
|
|
|
Beginning of year |
|
|
2,475 |
|
|
|
3,145 |
|
|
|
5,365 |
|
|
|
|
|
|
|
|
|
|
|
End of year |
|
$ |
10,266 |
|
|
$ |
2,475 |
|
|
$ |
3,145 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosures of cash flow information: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid |
|
$ |
1,269 |
|
|
$ |
818 |
|
|
$ |
985 |
|
Income taxes paid |
|
$ |
18,200 |
|
|
$ |
16,781 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Assets acquired through issuance of mortgage loan |
|
$ |
6,065 |
|
|
$ |
100 |
|
|
$ |
1,058 |
|
Common stock issued for purchase of real estate |
|
$ |
1,173 |
|
|
$ |
|
|
|
$ |
|
|
See accompanying notes to Consolidated Financial Statements.
41
Notes to Consolidated Financial Statements
(in thousands, except share and per share amounts)
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 February 2, 2008, the Company had 692 retail stores and 296 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.
Fiscal year. The Company utilizes a 52 53 week accounting period which ends on the Saturday
closest to January 31. Fiscal years 2007, 2006, and 2005, as used herein, refer to the years
ended February 2, 2008, February 3, 2007, and January 28, 2006, respectively. The fiscal year
2006 had 53 weeks and the fiscal years 2007 and 2005 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 $4,052 at February 2, 2008 and
$6,480 at February 3, 2007.
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
42
conditions, they approximate the carrying value of the inventory at net realizable value (market
value). Therefore, after applying the cost to retail ratio, the cost
value of our inventory is stated at the lower of cost or market as is prescribed by U.S. GAAP.
Because the approximation of net realizable value (market value) under the retail inventory method
is based on estimates such as markups, markdowns and inventory losses (shrink), there exists an
inherent uncertainty in the final determination of inventory cost and gross margin. In order to
mitigate that uncertainty, the Company has a formal review by product class which considers such
variables as current market trends, seasonality, weather patterns and age of merchandise to ensure
that markdowns are taken currently, or a markdown reserve is established to cover future
anticipated markdowns. This review also considers current pricing trends and inflation to ensure
that markups are taken if necessary. The estimation of inventory losses (shrink)is a significant
element in approximating the carrying value of inventory at net realizable value, and as such the
following paragraph describes our estimation method as well as the steps we take to mitigate the
risk that this estimate in the determination of the cost value of inventory.
The Company calculates inventory losses (shrink) based on actual inventory losses occurring as a
result of physical inventory counts during each fiscal period and estimated inventory losses
occurring between yearly physical inventory counts. The estimate for shrink occurring in the
interim period between physical counts is calculated on a store- specific basis and is based on
history, as well as performance on the most recent physical count. It is calculated by multiplying
each 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 $31.1 million and $36.4 million at
February 2, 2008 and February 3, 2007, 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 $15.4 million at February 2, 2008 and $13.8 million at February 3, 2007. The LIFO
reserve increased by approximately $1.6 million, $1.6 million, and $2.5 million, during 2007, 2006,
and 2005, respectively.
The Company has historically included an estimate of inbound freight and certain general and
administrative expenses in merchandise inventory as prescribed by Generally Accepted Accounting
Principles. 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
43
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 February 2, 2008 is $21.9
million, with the corresponding amount of $19.8 million at February 3, 2007.
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.
For the year ended February 3, 2007, the Company recorded a year end below-cost inventory
adjustment of approximately $2.1 million included in cost of goods sold in the consolidated
statements of income to reflect the impact of the Companys plans to liquidate the boys and girls
apparel departments and to record a markdown related to the closure of approximately 20 stores
which occurred in fiscal 2007.
Property and equipment. Property and equipment are carried at cost. Depreciation is recorded
using the straight-line method over the estimated useful lives of the assets. Improvements to
leased premises are depreciated using the straight-line method over the shorter of the initial
term of the lease or the useful life of the improvement. Leasehold improvements added late in
the lease term are depreciated over the shorter of the remaining term of the lease (including
the upcoming renewal option, if the renewal is reasonably assured) or the useful life of the
improvement, whichever is lesser. Gains or losses on the sale of assets are recorded at
disposal. The following average estimated useful lives are generally applied:
|
|
|
|
|
|
|
Estimated Useful Lives |
Building and building improvements |
|
8 - 30 years |
Furniture, fixtures and equipment |
|
3 - 10 years |
Leasehold improvements |
|
3 - 10 years or term of lease, if shorter |
Automobiles and vehicles |
|
3 - 5 years |
Airplane |
|
9 years |
Assets under capital leases 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, 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 as of February 2, 2008 and February 3, 2007 was approximately $1.1
million and $1.4 million, respectively, 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, electric work, entrances (front and back) and
other work as required. Leasehold improvements are recorded at their gross costs
44
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.
Vendor rebates and allowances. The Company receives vendor rebates for achieving certain purchase
or sales volume and receives vendor allowances to fund certain expenses. 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.
For vendor funding arrangements that were entered into prior to December 31, 2002 and have not
been modified subsequently, the Company recognizes a reduction to selling, general and
administrative expenses or cost of goods sold when the vendor allowance is earned.
During the quarter ended October 29, 2005, the Company renewed its contract with its primary
pharmaceutical wholesaler, AmerisourceBergen Corporation. The renewal of this contract impacted the
Companys financial statements because of the application of the provisions of EITF 02-16. The
effect on the financial statements, which occurred during the third quarter, was a deferral of the
associated rebates against cost of sales of $2.2 million pretax (estimated at $0.03 per diluted
share, after tax). This
45
change in timing had no effect on cash flow for the quarter. While the
contract was not due to mature until January 31, 2006, the renewal terms were positive to overall
earnings and the Company has benefited through better pricing.
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 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):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Period in which the |
|
|
|
|
|
|
Misstatement Originated (1) |
|
|
|
|
|
|
Cumulative |
|
|
|
|
|
|
|
|
|
|
Adjustment |
|
|
|
Prior to |
|
|
|
|
|
|
|
|
|
|
recorded as of |
|
|
|
January 31 |
|
|
January 29 |
|
|
January 28 |
|
|
February 3 |
|
|
|
2004 |
|
|
2005 |
|
|
2006 |
|
|
2007 |
|
Other non trade receivables (2) |
|
$ |
674 |
|
|
$ |
485 |
|
|
$ |
623 |
|
|
$ |
1,782 |
|
Income taxes payable (3) |
|
|
(226 |
) |
|
|
(162 |
) |
|
|
(209 |
) |
|
|
(597 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Impact on net income (4) |
|
$ |
448 |
|
|
$ |
323 |
|
|
$ |
414 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retained earnings (5) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
1,185 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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.
46
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 2007, 2006, and 2005, were
$27.6 million, $27.4 million, and $22.3 million, respectively. Gross advertising expenses were
reduced by vendor cooperative advertising allowances of $1.5 million, $1.1 million, and $.5 million for
2007, 2006, and 2005, 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.
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 February 2, 2008. 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 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 2007, 2006, and
2005 was $2,008, $2,019, and $1,891, respectively.
Other intangible assets. Other identifiable intangible assets, which are included in other
noncurrent assets, primarily represent customer lists associated with acquired pharmacies and are
being amortized on a straight-line basis over five years. Intangibles, net of accumulated
amortization, totaled $6,139 at February 2, 2008, and $6,975 at February 3, 2007. Accumulated
amortization at February 2, 2008 and February 3, 2007 totaled $13,089 and $10,675 respectively.
Amortization expense for 2007, 2006, and 2005, was $2,414, $2,663, and $2,180, respectively.
Estimated amortization expense for each of the next 5 years is as follows: 2008 $2,328, 2009 -
$1,881, 2010 $1,235, 2011 $530, and 2012- $165.
Financial instruments. At February 2, 2008, 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
47
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 $8.2 million and $8.6 million on February 2, 2008 and February 3, 2007,
respectively. Changes in the reserve during fiscal 2007 were attributable to additional reserve
requirements of $38.3 million netted with reserve utilization of $37.7 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.
Prior to January 28, 2006, the Company accounted for share-based payments using the
intrinsic-value-based recognition method prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, (APB 25). As stock options were granted at an
exercise price equal to the market value of the underlying common stock on the date of grant, no
stock option compensation expense was reflected in net income prior to adopting SFAS 123(R).
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. For periods prior
to 2006, the Company in its proforma disclosures under SFAS 123, recognized forfeitures as they
occurred.
The following represents total stock based compensation expense (a component of selling, general
and administrative expenses) recognized in the consolidated financial statements (in thousands):
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Stock option expense |
|
$ |
1,312 |
|
|
$ |
1,408 |
|
Restricted stock expense |
|
|
591 |
|
|
|
512 |
|
ESPP expense |
|
|
213 |
|
|
|
279 |
|
|
|
|
|
|
|
|
Total stock-based compensation |
|
|
2,116 |
|
|
|
2,199 |
|
|
|
|
|
|
|
|
|
|
Income tax benefit on stock-based compensation |
|
$ |
340 |
|
|
$ |
210 |
|
48
As a result of adopting SFAS 123(R), the Companys income before income taxes and net income for
fiscal year 2006, were $1.7 million and $1.7 million lower, respectively, than if it had continued
to account for share-based compensation under APB 25. Basic and diluted earnings per share for
fiscal year 2006 were $.04 and $.04 lower respectively, than if the Company had continued to account for share-based compensation under APB
25.
The following table illustrates the effect on 2005 net income and earnings per share as if the
Company had applied the fair value recognition provisions of SFAS No. 123(R) to stock based
employee compensation.
|
|
|
|
|
(Amounts in thousands, except per share data) |
|
2005 |
|
Net income, as reported |
|
$ |
26,094 |
|
Less SFAS No. 123 pro forma compensation expense, net of income taxes |
|
|
(794 |
) |
|
|
|
|
|
SFAS No. 123 pro forma Net income |
|
$ |
25,300 |
|
|
|
|
|
|
|
|
|
|
Basic earnings per share |
|
|
|
|
As reported |
|
$ |
0.66 |
|
Pro forma |
|
|
0.64 |
|
|
|
|
|
|
Diluted earnings per share |
|
|
|
|
As reported |
|
|
0.66 |
|
Pro forma |
|
|
0.64 |
|
Amounts for the year ended February 2, 2008 and February 3, 2007 are not presented in this table
because those amounts were recorded in accordance with SFAS No. 123 (R) and are recognized in the
Consolidated Financial Statements.
The amounts in this table have been adjusted from the amounts reported in our Annual Report on Form
10-K for the fiscal year ended January 28, 2006 to be calculated following the same method that has
been utilized under SFAS No. 123(R). The total impact of the change was to increase the
incremental stock option expense per SFAS No. 123(R), net of taxes by $.4 million.
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.
49
The fair value of each option granted is estimated on the date of grant using the BSM with the
following weighted average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Pro |
|
|
|
|
|
|
|
|
|
|
Forma) |
|
|
2007 |
|
2006 |
|
2005 |
Stock Options |
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility |
|
|
42.8 |
% |
|
|
41.4 |
% |
|
|
46.6 |
% |
Risk-free interest rate |
|
|
4.1 |
% |
|
|
4.8 |
% |
|
|
4.3 |
% |
Expected option life (in years) |
|
|
5.8 |
|
|
|
5.9 |
|
|
|
5.3 |
|
Expected dividend yield |
|
|
0.4 |
% |
|
|
0.4 |
% |
|
|
0.5 |
% |
Weighted average fair value at grant date |
|
$ |
4.68 |
|
|
$ |
6.01 |
|
|
$ |
7.35 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee Stock Purchase Plan |
|
|
|
|
|
|
|
|
|
|
|
|
Expected volatility |
|
|
37.2 |
% |
|
|
38.7 |
% |
|
|
41.4 |
% |
Risk-free interest rate |
|
|
4.7 |
% |
|
|
4.8 |
% |
|
|
4.3 |
% |
Expected option life (in years) |
|
|
0.63 |
|
|
|
0.63 |
|
|
|
0.5 |
|
Expected dividend yield |
|
|
0.38 |
% |
|
|
0.3 |
% |
|
|
0.2 |
% |
Weighted average fair value at grant date |
|
$ |
3.31 |
|
|
$ |
4.31 |
|
|
$ |
3.37 |
|
The following is a summary of the methodology applied to develop each assumption:
Expected Volatility This is a measure of the amount by which a price has fluctuated or is
expected to fluctuate. The Company uses actual historical changes in the market value of our stock
to calculate expected price volatility because management believes that this is the best indicator
of future volatility. The Company calculates weekly market value changes from the date of grant
over a past period representative of the expected life of the options to determine volatility. An
increase in the expected volatility will increase compensation expense.
Risk-free Interest Rate This is the yield of a U.S. Treasury zero-coupon bond issue
effective at the grant date with a remaining term equal to the expected life of the option. An
increase in the risk-free interest rate will increase compensation expense.
Expected Lives This is the period of time over which the options granted are expected to
remain outstanding and is based on historical experience. Options granted have a maximum term of
seven and one-half years. An increase in the expected life will increase compensation expense.
Dividend Yield This is based on the historical yield for a period equivalent to the
expected life of the option. An increase in the dividend yield will decrease compensation expense.
Forfeiture Rate This is the estimated percentage of options granted that are expected to
be forfeited or cancelled before becoming fully vested. This estimate is based on historical
experience. An increase in the forfeiture rate will decrease compensation expense.
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
50
Companys deferred income tax assets and liabilities. 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.
Business segments. The Company operates in a single reportable operating segment.
Comprehensive income. Comprehensive income consists of two components, net income and other
comprehensive income (loss). Other comprehensive income (loss) refers to gains and losses that
under generally accepted accounting principles are recorded as an element of stockholders equity
but are excluded from net income. The 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,
Employee Benefit Plans, in the Notes to Consolidated Financial Statements for further discussion.
Reclassifications. Certain prior year amounts have been reclassified to conform to the 2007
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 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 (FSP) No. FAS 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 is in the process of determining the effect, if any, that the
adoption of SFAS No. 157 will have on its results of operations or financial position.
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. We are currently reviewing the impact of SFAS No. 159, if
any, on our Consolidated Financial Statements and expect to complete this evaluation in 2008.
In March 2007, the Emerging Issues Task Force (EITF) reached a consensus on issue number 06-10,
Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment
Split-Dollar Life Insurance Arrangements, (EITF 06-10). EITF 06-10 provides guidance to help
companies determine whether a liability for the postretirement benefit associated with a collateral
assignment split-dollar life insurance arrangement should be recorded in accordance with either
SFAS No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions (if, in
substance, a postretirement benefit plan exists), or Accounting Principles Board Opinion No. 12 (if
the arrangement is, in substance, an individual deferred compensation contract). EITF 06-10 also
provides guidance on how a company should recognize and measure the asset in a collateral
assignment split-dollar life
51
insurance contract. EITF 06-10 is effective for fiscal years beginning
after December 15, 2007, although early adoption is permitted. The Company has evaluated EITF 06-10
and has determined that it will have no impact on its results of operations or financial position.
In May 2007, the FASB issued FASB Staff Position No. FIN 48-1, Definition of Settlement in FASB
Interpretation No. 48 (FSP FIN 48-1). FSP FIN 48-1 amends FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes, to provide guidance on how an enterprise should
determine whether a tax position is effectively settled for the purposes of recognizing previously
unrecognized tax benefits. The Company adopted FIN 48-1 as of February 4, 2007 and is now required
to apply the guidance provided in FSP FIN 48-1. The application of FSP FIN 48-1 has not had a
material effect on the Companys financial position, results of operations, or cash flows.
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 is 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. Early application of EITF 06-11 is 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 is in the process of
determining the effect, if any, that the adoption of EITF 06-11 will have on its results of
operations or financial position.
In December 2007, the FASB issued FASB Statement No. 141 (R), Business Combinations (FAS 141(R)),
which establishes accounting principles and disclosure requirements for all transactions in which a
company obtains control over another business. Statement 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 is in the process of determining the effect, if any, that the adoption of FAS 141 (R) will
have on 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. Statement 160 establishes new accounting and
reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of
a subsidiary. Statement 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 is in
the process of determining the effect, if any, that the adoption of FASB No. 160 will have on its
results of operations or financial position.
52
Note 2 Detail of Certain Balance Sheet Accounts
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Property and equipment, at cost: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Buildings and building improvements |
|
$ |
88,459 |
|
|
$ |
76,623 |
|
Leasehold improvements |
|
|
50,859 |
|
|
|
45,097 |
|
Automobiles and vehicles |
|
|
5,500 |
|
|
|
6,429 |
|
Airplane |
|
|
4,697 |
|
|
|
4,697 |
|
Furniture, fixtures and equipment |
|
|
224,734 |
|
|
|
216,448 |
|
|
|
|
|
|
|
|
|
|
|
374,249 |
|
|
|
349,294 |
|
Less accumulated depreciation and amortization |
|
|
(235,281 |
) |
|
|
(215,879 |
) |
|
|
|
|
|
|
|
|
|
|
138,968 |
|
|
|
133,415 |
|
Construction in progress |
|
|
1,034 |
|
|
|
353 |
|
Land |
|
|
5,983 |
|
|
|
4,263 |
|
|
|
|
|
|
|
|
Total property and equipment, at depreciated cost |
|
$ |
145,985 |
|
|
$ |
138,031 |
|
|
|
|
|
|
|
|
Depreciation expense totaled $25,942, $26,064, and $25,094, for 2007, 2006, and 2005, 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.
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Other non trade receivables: |
|
|
|
|
|
|
|
|
Landlord receivables |
|
$ |
59 |
|
|
$ |
1,529 |
|
Vendor receivables |
|
|
13,276 |
|
|
|
14,489 |
|
Income tax receivable |
|
|
4,018 |
|
|
|
28 |
|
Insurance receivable |
|
|
1,058 |
|
|
|
877 |
|
Other |
|
|
2,125 |
|
|
|
2,030 |
|
|
|
|
|
|
|
|
Total non trade receivables |
|
$ |
20,536 |
|
|
$ |
18,953 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Prepaid expenses and other current assets |
|
|
|
|
|
|
|
|
Prepaid advertising |
|
$ |
701 |
|
|
$ |
964 |
|
Prepaid insurance |
|
|
1,630 |
|
|
|
1,451 |
|
Prepaid rent |
|
|
4,424 |
|
|
|
4,458 |
|
Supplies |
|
|
3,866 |
|
|
|
4,134 |
|
Other |
|
|
1,171 |
|
|
|
1,217 |
|
|
|
|
|
|
|
|
Total prepaid expenses and other current assets |
|
$ |
11,792 |
|
|
$ |
12,224 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Accrued expenses and other: |
|
|
|
|
|
|
|
|
Payroll and benefits |
|
$ |
10,573 |
|
|
$ |
12,564 |
|
Sales and use taxes |
|
|
6,333 |
|
|
|
7,906 |
|
Insurance |
|
|
8,186 |
|
|
|
8,604 |
|
Deferred rent |
|
|
4,683 |
|
|
|
5,657 |
|
Other |
|
|
9,694 |
|
|
|
7,428 |
|
|
|
|
|
|
|
|
Total accrued expenses and other |
|
$ |
39,469 |
|
|
$ |
42,159 |
|
|
|
|
|
|
|
|
53
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Other non-current liabilities |
|
|
|
|
|
|
|
|
FIN 48 tax liability (Note 4) |
|
$ |
8,352 |
|
|
$ |
|
|
OPEB liability |
|
|
539 |
|
|
|
591 |
|
Deferred income |
|
|
3,950 |
|
|
|
3,265 |
|
|
|
|
|
|
|
|
Total other non-current liabilities |
|
$ |
12,841 |
|
|
$ |
3,856 |
|
|
|
|
|
|
|
|
NOTE 3 INDEBTEDNESS
On October 30, 2007, the Company and Regions Bank entered into an amendment of their 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.
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 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 February 2, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in thousands) |
|
Payments due by year |
Contractual Obligations |
|
Total |
|
2008 |
|
2009 |
|
2010 |
|
2011 |
|
2012 |
|
Term debt |
|
$ |
1,161 |
|
|
$ |
164 |
|
|
$ |
176 |
|
|
$ |
663 |
|
|
$ |
158 |
|
|
$ |
170 |
|
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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
|
2005 |
|
Current |
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
$ |
10,886 |
|
|
$ |
15,048 |
|
|
$ |
10,666 |
|
State |
|
|
664 |
|
|
|
(1,034 |
) |
|
|
(1,137 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
11,550 |
|
|
|
14,014 |
|
|
|
9,529 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred |
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
|
(5,354 |
) |
|
|
(1,135 |
) |
|
|
3,272 |
|
State |
|
|
(1,250 |
) |
|
|
588 |
|
|
|
360 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(6,604 |
) |
|
|
(547 |
) |
|
|
3,632 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
4,946 |
|
|
$ |
13,467 |
|
|
$ |
13,161 |
|
|
|
|
|
|
|
|
|
|
|
54
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:
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
|
2006 |
|
Deferred income tax assets: |
|
|
|
|
|
|
|
|
Accrual for incentive compensation |
|
$ |
474 |
|
|
$ |
1,529 |
|
Allowance for doubtful accounts |
|
|
455 |
|
|
|
392 |
|
Insurance accruals |
|
|
2,279 |
|
|
|
2,207 |
|
Other accruals |
|
|
312 |
|
|
|
|
|
Net operating loss carryforwards |
|
|
5,119 |
|
|
|
5,043 |
|
Postretirement benefits other than pensions |
|
|
287 |
|
|
|
323 |
|
Reserve for below cost inventory adjustment |
|
|
3,964 |
|
|
|
334 |
|
Federal benefit on state reserves |
|
|
2,656 |
|
|
|
|
|
Amortization of intangibles |
|
|
4,406 |
|
|
|
3,747 |
|
|
|
|
|
|
|
|
Total deferred income tax assets |
|
|
19,952 |
|
|
|
13,575 |
|
Less: valuation allowance |
|
|
(1,695 |
) |
|
|
(1,709 |
) |
|
|
|
|
|
|
|
Deferred income tax assets, net of valuation allowance |
|
|
18,257 |
|
|
|
11,866 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred income tax liabilities: |
|
|
|
|
|
|
|
|
Property, plant, and equipment |
|
|
(17,710 |
) |
|
|
(20,163 |
) |
Inventory valuation |
|
|
(19,928 |
) |
|
|
(19,837 |
) |
Prepaid expenses |
|
|
(468 |
) |
|
|
(687 |
) |
|
|
|
|
|
|
|
Total deferred income tax liability |
|
|
(38,106 |
) |
|
|
(40,687 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net deferred income tax liability |
|
$ |
(19,849 |
) |
|
$ |
(28,821 |
) |
|
|
|
|
|
|
|
The net operating loss carryforwards are available to reduce state income taxes in future years.
These carryforwards total approximately $122.2 million for state income tax purposes and expire at
various times during the period 2008 ($1.5 million) through 2027.
During 2007, the valuation allowance decreased $14, and during 2006, the valuation allowance
increased $821. 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007 |
|
2006 |
|
2005 |
Income tax provision at statutory rate |
|
|
35.0 |
% |
|
|
35.0 |
% |
|
|
35.0 |
% |
Tax credits, principally jobs |
|
|
(9.9 |
) |
|
|
(3.5 |
) |
|
|
(2.6 |
) |
State income taxes, net of federal benefit |
|
|
(0.7 |
) |
|
|
(1.1 |
) |
|
|
(0.6 |
) |
Permanent differences |
|
|
2.2 |
|
|
|
0.9 |
|
|
|
0.5 |
|
Uncertain tax positions |
|
|
5.1 |
|
|
|
0.0 |
|
|
|
0.0 |
|
Change in valuation allowance |
|
|
(0.1 |
) |
|
|
2.2 |
|
|
|
1.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective income tax rate |
|
|
31.6 |
% |
|
|
33.5 |
% |
|
|
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.
55
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 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 4, 2007 |
|
$ |
7.3 |
|
Additions for tax position related to current
year |
|
|
1.5 |
|
Additions for tax position of prior years |
|
|
.4 |
|
Reductions for tax position of prior years |
|
|
(.8 |
) |
Settlements |
|
|
|
|
|
|
|
|
Balance at February 2, 2008 |
|
$ |
8.4 |
|
|
|
|
|
As of February 4, 2007, our liability for unrecognized tax benefits totaled $7.3 million, of which
$0.5 million and $0.3 million were recognized as income tax benefit during the quarterly periods
ending November 3, 2007 and February 2, 2008, respectively, as a result of a lapse in applicable
statute of limitations. As of February 2, 2008, our liability for unrecognized tax benefits
totaled $8.4 million and is recorded in our consolidated balance sheet with Other Liabilities,
all of which, if recognized, would affect our effective tax rate.
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 February 2, 2008, accrued
interest and penalties related to our unrecognized tax benefits totaled $ 1.0 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 2004-2006. 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. 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
56
certain transportation equipment under capital leases. Total rent expense under operating leases was
$54,539, $48,670, and $46,561, for 2007, 2006, and 2005, respectively. Total contingent rentals
included in operating leases above was $1,150, $1,322, and $1,247, for 2007, 2006, and 2005,
respectively.
Future minimum rental payments under all operating and capital leases as of February 2, 2008 are as
follows:
|
|
|
|
|
|
|
|
|
|
|
Operating |
|
|
Capital |
|
|
|
Leases |
|
|
Leases |
|
|
2008 |
|
$ |
49,511 |
|
|
$ |
129 |
|
2009 |
|
|
41,707 |
|
|
|
|
|
2010 |
|
|
34,277 |
|
|
|
|
|
2011 |
|
|
27,406 |
|
|
|
|
|
2012 |
|
|
19,246 |
|
|
|
|
|
Thereafter |
|
|
31,209 |
|
|
|
|
|
|
|
|
|
|
|
|
Total minimum lease payments |
|
$ |
203,356 |
|
|
|
129 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Imputed interest |
|
|
|
|
|
|
(3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Present value of net minimum lease payments, shown as
current portion of capital lease obligations in Balance Sheet |
|
|
|
|
|
$ |
126 |
|
|
|
|
|
|
|
|
|
The gross amount of property and equipment under capital leases was $4,967 at February 2, 2008 and
February 3, 2007. Accumulated depreciation on property and equipment under capital leases at
February 2, 2008 and February 3, 2007, was $4,836, and $4,578, respectively. Depreciation expense
on assets under capital lease for 2007, 2006, and 2005, was $258, $375, and $481, 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 stores leases of the Company. The total rental
payments related to these leases was $.585 million for the year ended February 2, 2008. Total
future commitments under related party leases are $7.078 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 will become dilutive at the time of exercise and will expire,
if unexercised, in October 2008.
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 January 28, 2006, the Company had 301,866 shares of
Class A common stock available to be issued from the March 6, 2002 Registration Statement. During
the second and third quarter of fiscal 2007, we sold in a private placement an aggregate of 103,053
shares of our Class A common stock to Summit Properties, LLC (Summit) pursuant to the exemptions
from registration provided in Section 4(2) of the Securities Act of 1933, as amended (the Act),
and Rule 506 of Regulation D promulgated thereunder. The shares were issued in connection with our
acquisition of the membership interests of certain Limited Liability Companies and related real
estate rights. The shares have subsequently been registered under the Act. We will not receive
any proceeds from the resale of these shares.
57
The private placement that we made in reliance on the exemptions from registration under Section
4(2) of the Act and Rule 506 of Regulation D thereunder did not involve any public offering of
common stock. In addition, Summit provided us with written representations that it was an
accredited investor within the meaning of Rule 501(e) of Regulation D, that it was a sophisticated
investor and that it had the knowledge and experience necessary to evaluate the risks and merits of
the investment in our common stock. In addition, Summit was solicited on a private and
confidential basis in a manner not involving any general solicitation or advertising in compliance
with Regulation D.
As of February 2, 2008, the Company has 198,813 shares of Class A common stock available to be
issued from the March 6, 2002 Registration 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 February 2, 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 |
|
|
|
|
|
|
|
|
|
|
Purchased as Part of |
|
of Shares That May Yet |
|
|
Total Number of |
|
Average Price |
|
Publicly Announced |
|
Be Purchased Under |
|
|
Shares Purchased |
|
Paid Per Share |
|
Plan or Programs |
|
the Plans or Programs |
August 27, 2007 September 10, 2007 |
|
|
|
|
|
$ |
|
|
|
|
|
|
|
|
4,000.0 |
|
September 11, 2007 October 3, 2007 |
|
|
190.1 |
|
|
$ |
10.25 |
|
|
|
190.1 |
|
|
|
3,809.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
October 4, 2007 November 3, 2007 |
|
|
236.4 |
|
|
$ |
10.24 |
|
|
|
236.4 |
|
|
|
3,573.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
November 4, 2007 February 2, 2008 |
|
|
|
|
|
$ |
|
|
|
|
|
|
|
|
3,573.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
426.5 |
|
|
$ |
10.25 |
|
|
|
426.5 |
|
|
|
|
|
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 2,057,344 shares as of February 2, 2008 (2,326,713
shares as of February 3, 2007) are available to be granted. These options expire five years to
seven and one-half years from the date of grant. Options outstanding at February 2, 2008 expire in
2008 through 2014.
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 during each of the first
four years on the anniversary date
58
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 71,294, 83,104 and
32,583 shares issued during fiscal years 2007, 2006 and 2005, respectively. There are 1,410,928
shares approved to be issued under the 2004 Plan and as of February 2, 2008 there were 1,223,947
shares available.
Stock Options. The following table summarizes stock option activity from January 29, 2005 through
February 2, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
Weighted |
|
Average |
|
Aggregate |
|
|
|
|
|
|
Average |
|
Remaining |
|
Intrinsic |
|
|
|
|
|
|
Exercise |
|
Contractual |
|
Value |
|
|
Options |
|
Price |
|
Life (Years) |
|
(Thousands) |
Outstanding at January 29, 2005 |
|
|
1,221,357 |
|
|
$ |
16.28 |
|
|
|
3.8 |
|
|
$ |
1,894 |
|
Granted |
|
|
241,800 |
|
|
$ |
15.37 |
|
|
|
|
|
|
|
|
|
Forfeited / Cancelled |
|
|
(135,896 |
) |
|
$ |
18.05 |
|
|
|
|
|
|
|
|
|
Exercised |
|
|
(137,242 |
) |
|
$ |
7.37 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at February 2, 2008 |
|
|
1,216,451 |
|
|
$ |
15.40 |
|
|
|
4.6 |
|
|
$ |
0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at February 2, 2008 |
|
|
387,438 |
|
|
$ |
17.26 |
|
|
|
2.9 |
|
|
$ |
0 |
|
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. The total pre-tax intrinsic value of options exercised during the year ended February
3, 2007 was $.1 million. Cash received from the exercise of stock options during the year ended
February 3, 2007 totaled $.7 million and the related tax benefits recognized from the exercise of
stock options totaled $.1 million. There were no options exercised during the year ended February
2, 2008. The total fair value of options vested during the years ended February 2, 2008 and
February 3, 2007 was $1 million and $.7 million, respectively. As of February 2, 2008, total
unrecognized stock-based compensation expense net of estimated forfeitures related to non-vested
stock options was approximately $1.8 million, which is expected to be recognized over a weighted
average period of approximately 3.5 years.
The following table summarizes information about stock options outstanding at February 2, 2008:
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
Options Exercisable |
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average |
|
Weighted |
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Remaining |
|
Average |
|
|
|
|
|
Average |
|
|
|
|
|
|
Contractual |
|
Exercise |
|
|
|
|
|
Exercise |
Range of Exercise Prices |
|
Shares |
|
Life (Years) |
|
Price |
|
Shares |
|
Price |
$10.61 to $14.60 |
|
|
676,311 |
|
|
|
6.3 |
|
|
$ |
12.64 |
|
|
|
142,469 |
|
|
$ |
13.99 |
|
$14.68 to $20.60 |
|
|
485,940 |
|
|
|
2.7 |
|
|
$ |
18.05 |
|
|
|
204,119 |
|
|
$ |
17.96 |
|
$23.05 to $33.49 |
|
|
54,200 |
|
|
|
1.7 |
|
|
$ |
25.98 |
|
|
|
40,850 |
|
|
$ |
25.14 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,216,451 |
|
|
|
4.6 |
|
|
$ |
15.40 |
|
|
|
387,438 |
|
|
$ |
17.26 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 29, 2005 through February 2, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
|
|
|
Average |
|
|
Number |
|
Grant Date |
|
|
of Shares |
|
Fair Value |
Non-vested Restricted Stock at January 29, 2005 |
|
|
183,760 |
|
|
$ |
15.61 |
|
Granted |
|
|
5,750 |
|
|
$ |
14.44 |
|
Forfeited / Cancelled |
|
|
(13,016 |
) |
|
$ |
15.81 |
|
Vested |
|
|
(3,962 |
) |
|
$ |
17.74 |
|
|
|
|
|
|
|
|
|
|
Non-vested Restricted Stock at January 28, 2006 |
|
|
172,532 |
|
|
$ |
15.51 |
|
Granted |
|
|
92,182 |
|
|
$ |
13.93 |
|
Forfeited / Cancelled |
|
|
(25,293 |
) |
|
$ |
15.12 |
|
Vested |
|
|
(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 |
|
Vested |
|
|
(9,679 |
) |
|
$ |
16.59 |
|
|
|
|
|
|
|
|
|
|
Non-vested Restricted Stock at February 2, 2008 |
|
|
285,635 |
|
|
$ |
13.83 |
|
The aggregate pre-tax intrinsic value of restricted stock outstanding as of February 2, 2008 is
$2.8 million with a weighted average remaining contractual life of 6.3 years. The unrecognized
compensation expense net of estimated forfeitures, related to the outstanding restricted stock is
approximately $2.8 million, which is expected to be recognized over a weighted average period of
approximately 5.7 years. The total fair value of restricted stock awards that vested during the
years ended February 2, 2008 and February 3, 2007 was $.2 million and $.1 million, respectively.
60
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.
NOTE 8 NET INCOME PER SHARE
Basic earnings per share excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common shares outstanding for
the period. Diluted earnings per share reflects the potential dilution that could occur if
options to issue common stock were exercised into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Restricted stock is 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended |
|
|
|
February 2, 2008 |
|
|
January 28, 2006 |
|
|
January 29, 2005 |
|
|
|
|
|
|
|
|
|
|
|
Per |
|
|
|
|
|
|
|
|
|
|
Per |
|
|
|
|
|
|
|
|
|
|
Per |
|
|
|
|
|
|
|
|
|
|
|
Share |
|
|
|
|
|
|
|
|
|
|
Share |
|
|
|
|
|
|
|
|
|
|
Share |
|
|
|
Income |
|
|
Shares |
|
|
Amount |
|
|
Income |
|
|
Shares |
|
|
Amount |
|
|
Income |
|
|
Shares |
|
|
Amount |
|
|
Basic EPS |
|
$ |
10,718 |
|
|
|
39,771 |
|
|
$ |
.27 |
|
|
$ |
26,746 |
|
|
|
39,770 |
|
|
$ |
.67 |
|
|
$ |
26,094 |
|
|
|
39,632 |
|
|
$ |
.66 |
|
Effect of Dilutive
Securities |
|
|
|
|
|
|
111 |
|
|
|
|
|
|
|
|
|
|
|
88 |
|
|
|
|
|
|
|
|
|
|
|
140 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted EPS |
|
$ |
10,718 |
|
|
|
39,882 |
|
|
$ |
.27 |
|
|
$ |
26,746 |
|
|
|
39,858 |
|
|
$ |
.67 |
|
|
$ |
26,094 |
|
|
|
39,772 |
|
|
$ |
.66 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
1,216,451, 1,097,064, and 89,404 such options outstanding at February 2, 2008, February 3, 2007,
and January 28, 2006.
NOTE 9 COMMITMENTS AND CONTINGENCIES
Commitments. The Company had commitments approximating $14.3 million at February 2, 2008 and $9.7
million at February 3, 2007 on issued letters of credit, which support purchase orders for
merchandise. Additionally, the Company had outstanding letters of credit aggregating approximately
$17.1 million at February 2, 2008 and $15.7 million at February 3, 2007 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 one year 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 2007, 2006, and 2005, were $251, $160, and $142,
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. The Companys change in benefit obligation based upon an actuarial valuation
is as follows:
61
|
|
|
|
|
|
|
|
|
|
|
February 2, |
|
|
February 3, |
|
|
|
2008 |
|
|
2007 |
|
Benefit obligation at beginning of year |
|
$ |
591 |
|
|
$ |
731 |
|
Service cost |
|
|
33 |
|
|
|
39 |
|
Interest cost |
|
|
30 |
|
|
|
31 |
|
Actuarial (gain) |
|
|
(82 |
) |
|
|
(165 |
) |
Benefits paid |
|
|
(33 |
) |
|
|
(45 |
) |
|
|
|
|
|
|
|
Benefit obligation at end of year |
|
$ |
539 |
|
|
$ |
591 |
|
|
|
|
|
|
|
|
The medical care cost trend used in determining this obligation is 7.5% effective December 1, 2006,
decreasing annually before leveling at 5.0% in 2012. 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 |
|
|
February 2, |
|
February 3, |
|
|
2008 |
|
2007 |
Effect of health care trend rate: |
|
|
|
|
|
|
|
|
1% increase effect on accumulated benefit obligations |
|
$ |
47 |
|
|
$ |
55 |
|
1% increase effect on periodic cost |
|
|
7 |
|
|
|
9 |
|
1% decrease effect on accumulated benefit obligations |
|
|
(42 |
) |
|
|
(50 |
) |
1% decrease effect on periodic cost |
|
|
(6 |
) |
|
|
(8 |
) |
The discount rate used in calculating the obligation was 6.25% in 2007 and 5.75% in 2006.
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-orunder 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.
The following table summarizes the effects from the adoption of SFAS No. 158 on individual line
items in the Companys Consolidated Balance Sheet at February 3, 2007.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Before |
|
|
|
|
|
|
After |
|
|
|
Implementation of |
|
|
Changes due to |
|
|
Implementation of |
|
|
|
SFAS No. 158 |
|
|
SFAS No. 158 |
|
|
SFAS No. 158 |
|
Long term deferred income taxes |
|
$ |
11,879 |
|
|
$ |
546 |
|
|
$ |
12,425 |
|
Other noncurrent liabilities |
|
|
5,485 |
|
|
|
(1,629 |
) |
|
|
3,856 |
|
|
|
|
|
|
|
|
|
|
|
Total liabilities |
|
$ |
147,524 |
|
|
$ |
(1,083 |
) |
|
$ |
146,441 |
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income, net of tax |
|
|
|
|
|
|
1,083 |
|
|
|
1,083 |
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity |
|
$ |
368,185 |
|
|
$ |
1,083 |
|
|
$ |
369,268 |
|
|
|
|
|
|
|
|
|
|
|
The annual net postretirement cost is as follows:
62
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended |
|
|
|
February 2, |
|
|
February 3, |
|
|
January 28, |
|
|
|
2008 |
|
|
2007 |
|
|
2006 |
|
Service cost |
|
$ |
33 |
|
|
$ |
39 |
|
|
$ |
41 |
|
Interest cost |
|
|
30 |
|
|
|
31 |
|
|
|
39 |
|
Amortization of prior service cost |
|
|
(14 |
) |
|
|
(13 |
) |
|
|
(13 |
) |
Amortization of unrecognized prior service cost |
|
|
(97 |
) |
|
|
(98 |
) |
|
|
(90 |
) |
|
|
|
|
|
|
|
|
|
|
Net periodic postretirement benefit cost |
|
$ |
(48 |
) |
|
$ |
(41 |
) |
|
$ |
(23 |
) |
|
|
|
|
|
|
|
|
|
|
The Companys policy is to fund claims as incurred.
Information about the expected cash flows for the postretirement medical plan follows:
|
|
|
|
|
Expected Benefit Payments |
|
Postretirement |
(net of retiree contributions) |
|
Medical Plan |
2008 |
|
$ |
40 |
|
2009 |
|
|
43 |
|
2010 |
|
|
45 |
|
2011 |
|
|
45 |
|
2012 |
|
|
49 |
|
2013 - 2017 |
|
|
288 |
|
Clarification of Adoption of SFAS No. 158 with Regard to the Companys Defined Benefit Plans:
In 2006, upon the adoption of SFAS No. 158, the Company recorded the impact of the standard in its
entirety in Other Comprehensive Income, an amount after tax of $1.083 million. During 2007,
additional guidance was issued as it relates to the adoption of SFAS No. 158, and it clarified that
the impact of the initial adoption would not be included in Other Comprehensive Income, but rather
would be a direct adjustment to Accumulated Other Comprehensive Income. As a result of this
guidance, the Consolidated Statement of Comprehensive Income has been adjusted to show the impact
only under previous pension accounting guidance (an amount of approximately $0.086 million).
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 ongoing and data continues to be reviewed. Following the
close of the discovery period in this case, the Company will have an opportunity to seek
decertification of the class, and the Company expects to file such a decertification and other
motions.
63
In addition to the matter described above, the Company is party to other 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
energies 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 February 2, 2008, 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 |
|
|
February 2, |
|
February 3, |
|
January 28, |
|
|
2008 |
|
2007 |
|
2006 |
Pharmaceuticals |
|
|
32.2 |
% |
|
|
31.9 |
% |
|
|
31.3 |
% |
Household Goods |
|
|
24.8 |
% |
|
|
24.7 |
% |
|
|
24.8 |
% |
Apparel and Linens |
|
|
9.9 |
% |
|
|
11.7 |
% |
|
|
12.7 |
% |
Food and Tobacco Products |
|
|
14.2 |
% |
|
|
13.0 |
% |
|
|
12.5 |
% |
Health and Beauty Aids |
|
|
8.0 |
% |
|
|
8.0 |
% |
|
|
8.0 |
% |
Paper and Cleaning Supplies |
|
|
8.8 |
% |
|
|
8.6 |
% |
|
|
8.5 |
% |
Sales to Franchised Freds Stores |
|
|
2.1 |
% |
|
|
2.1 |
% |
|
|
2.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Sales Mix |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
100.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Note 11 QUARTERLY FINANCIAL DATA (UNAUDITED)
The Companys unaudited quarterly financial information for the fiscal years ended
February 2, 2008 and February 3, 2007 is reported below:
64
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First |
|
Second |
|
Third |
|
Fourth |
|
|
Quarter |
|
Quarter |
|
Quarter |
|
Quarter |
Year Ended February 2, 2008 |
|
13 weeks |
|
13 weeks |
|
13 weeks |
|
13 weeks |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss) per share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
0.19 |
|
|
|
0.08 |
|
|
|
0.12 |
|
|
|
(0.11 |
) |
Diluted |
|
|
0.19 |
|
|
|
0.08 |
|
|
|
0.12 |
|
|
|
(0.11 |
) |
Cash dividends paid per share |
|
|
0.02 |
|
|
|
0.02 |
|
|
|
0.02 |
|
|
|
0.02 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended February 3, 2007 |
|
13 weeks |
|
13 weeks |
|
13 weeks |
|
14 weeks |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
416,878 |
|
|
$ |
406,925 |
|
|
$ |
407,872 |
|
|
$ |
535,564 |
|
Gross profit |
|
|
119,844 |
|
|
|
115,044 |
|
|
|
119,498 |
|
|
|
140,533 |
|
Net income |
|
|
7,298 |
|
|
|
4,323 |
|
|
|
5,953 |
|
|
|
9,172 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
0.18 |
|
|
|
0.11 |
|
|
|
0.15 |
|
|
|
0.23 |
|
Diluted |
|
|
0.18 |
|
|
|
0.11 |
|
|
|
0.15 |
|
|
|
0.23 |
|
Cash dividends paid per share |
|
|
0.02 |
|
|
|
0.02 |
|
|
|
0.02 |
|
|
|
0.02 |
|
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
Exchange Act of 1934, as amended (the Exchange Act)). Based on that evaluation, the
Chief Executive Officer and the Chief Financial Officer, concluded that, as of the date
of their evaluation, the Companys disclosure controls and procedures are effective in
timely alerting them to material information required to be included in the Companys
periodic SEC reports, subject to the effectiveness of the Companys internal control
over financial reporting. Consistent with the suggestion of the Securities and Exchange
Commission, the Company has formed a Disclosure Committee consisting of key Company
personnel designed to review the accuracy and completeness of all disclosures made by
the Company.
(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.
All internal control systems, no matter how well designed, have inherent limitations.
Therefore, even those systems determined to be effective can
65
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 February 2, 2008. 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
February 2, 2008.
Our assessment of the effectiveness of internal control over financial reporting as of
February 2, 2008 has been audited by BDO Seidman, LLP, the independent registered public
accounting firm who also audited our Consolidated Financial Statements. BDO Seidmans
attestation report on our assessment of internal control over financial reporting is
included herein.
(c) Attestation Report of Independent Registered Public Accounting Firm on Internal
Control Over Financial Reporting.
(d) Changes in Internal Control over Financial Reporting. There have been no
changes during the quarter ended February 2, 2008 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.
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
February 2, 2008, 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, Item 9A.b Managements 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.
66
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 February 2, 2008, 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 February 2, 2008 and
February 3, 2007, 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
February 2, 2008 and our report dated April 16, 2008 expressed an unqualified opinion thereon.
BDO
Seidman, LLP
Memphis, Tennessee
April 16, 2008
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 |
|
Positions and Offices |
|
Michael J. Hayes (1)
|
|
|
66 |
|
|
Director, Chairman of the Board, Chief Executive Officer |
John R. Eisenman (1)
|
|
|
66 |
|
|
Director |
Roger T. Knox (1)
|
|
|
70 |
|
|
Director |
John Reier (1)
|
|
|
68 |
|
|
Director, Vice Chairman of the Board |
Thomas H. Tashjian(1)
|
|
|
53 |
|
|
Director |
B. Mary McNabb (1)
|
|
|
59 |
|
|
Director |
Michael T. McMillan (1)
|
|
|
48 |
|
|
Director |
Bruce A. Efird
|
|
|
48 |
|
|
President |
Jerry A. Shore
|
|
|
55 |
|
|
Executive Vice President and Chief Financial Officer |
Dennis K Curtis
|
|
|
48 |
|
|
Executive Vice-President General Merchandise Manager |
John A. Casey
|
|
|
61 |
|
|
Executive Vice President Pharmacy Acquisitions |
Rick A. Chambers
|
|
|
44 |
|
|
Executive Vice President Pharmacy Operations |
Charles S. Vail
|
|
|
65 |
|
|
Corporate Secretary, Senior Vice President Legal Services and
General Counsel |
67
(1) Seven directors, constituting the entire Board of Directors, are to be elected
at the 2008 Annual Meeting to serve one year or until their successors are elected.
Michael J. Hayes was elected a director of the Company in January 1987. Mr.
Hayes served as Managing Director of the Company from October 1989 until March 2002
when he was elected Chairman of the Board. He has been Chief Executive Officer
since October 1989. 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 Hancock Fabrics, Inc.
John D. Reier is a Director and Vice Chairman of the Board. On January 4,
2008, Mr. Reier retired from Freds Inc. following the transition to a new Company
President, which occurred in September 2007 when Freds named Bruce A. Efird to that
position. Mr. Reier joined the Company in May of 1999 as President and was elected
a Director of the Company in August 2000. Prior to joining the company, Mr. Reier
was President and Chief Executive Officer of Sunnys Great Outdoors Stores, Inc.
from 1997 to 1999, and was President, Chief Operating Officer, Senior Vice President
of Merchandising, and General Merchandise Manager at Family Dollar Stores, Inc. from
1987 to 1997.
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. She is
currently Chief Executive Officer for Kids Outlet in California, a position she has
held since January 2007. She has served as a member of the Board of Directors of C-ME
(Cyber Merchants Exchange), a public company, 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. Mr. Efird was
Executive Vice President-Merchandising for Meijer, Inc., a leading
68
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.
The remainder of the information required by this item is incorporated herein by
reference to the proxy statement for our 2008 Annual Meeting.
ITEM 11: Executive Compensation
Information required by this item is incorporated herein by reference to the
proxy statement for our 2008 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 2008 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 2008 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 2008 Annual Meeting.
69
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 |
|
|
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]. |
|
|
|
|
|
|
|
|
|
|
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]. |
70
|
|
|
|
|
|
|
|
|
|
***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 |
|
|
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]. |
|
|
|
|
|
|
|
|
|
|
**21.1 |
|
|
Subsidiaries of Registrant |
|
|
|
|
|
|
|
|
|
|
**23.1 |
|
|
Consent of BDO Seidman LLP |
|
|
|
|
|
|
|
|
|
|
**31.1 |
|
|
Certification of Chief Executive Officer pursuant to Exchange Rule
13a-14(a) of the Securities Exchange Act. |
|
|
|
|
|
|
|
|
|
|
**31.2 |
|
|
Certification of Chief Financial Officer pursuant to Exchange Rule
13a-14(a) of the Securities Exchange Act. |
71
|
** |
|
32. Certification of Chief Financial Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350. |
|
|
(b) |
|
Reports on Form 8-K |
None.
|
|
|
* |
|
Management Compensatory Plan |
|
** |
|
Filed herewith |
|
*** |
|
(SEC File No. under the Securities Exchange Act of 1934 is 00-19288) |
72
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Freds Inc.
Memphis, Tennessee
The audits referred to in our report dated April 16, 2008 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 schedules, 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, 2008
73
Schedule II Valuation and Qualifying Accounts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions |
|
|
|
|
|
|
|
|
|
Balance at |
|
|
Charged to |
|
|
Deductions |
|
|
Balance |
|
|
|
beginning |
|
|
Costs and |
|
|
and Reclass |
|
|
at end of |
|
Description |
|
of Period |
|
|
Expenses |
|
|
Adjustments |
|
|
Period |
|
Deducted from applicable assets: (in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended January 28, 2006 |
|
$ |
629 |
|
|
$ |
193 |
|
|
$ |
124 |
|
|
$ |
698 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended February 3, 2007 |
|
$ |
698 |
|
|
$ |
69 |
|
|
$ |
48 |
|
|
$ |
719 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended February 2, 2008 |
|
$ |
719 |
|
|
$ |
255 |
|
|
$ |
95 |
|
|
$ |
879 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory valuation reserves: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended January 28, 2006 |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended February 3, 2007 |
|
$ |
|
|
|
$ |
2,119 |
|
|
$ |
|
|
|
$ |
2,119 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended February 2, 2008 |
|
$ |
2,119 |
|
|
$ |
10,025 |
|
|
$ |
2,119 |
|
|
$ |
10,025 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
74
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 17th day of April, 2008.
|
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FREDS, INC.
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By: |
/s/ Michael J. Hayes
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Michael J. Hayes, Chief Executive Officer |
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By: |
/s/ Jerry A. Shore
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Jerry A. Shore, Executive Vice |
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President and Chief Financial Officer |
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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 17th day of April, 2008.
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Signature |
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Title |
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/s/ Michael J. Hayes
Michael J. Hayes
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Director, Chairman of the Board, Chief Executive
Officer (Principal Executive Officer) |
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/s/ Jerry A. Shore
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Executive Vice President and Chief Financial |
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Jerry A. Shore
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Officer (Principal Accounting and Financial Officer) |
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/s/ Roger T. Knox
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Director |
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Roger T. Knox |
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/s/ John R. Eisenman
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Director |
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John R. Eisenman |
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/s/ John D. Reier
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Director and Vice-Chairman of the Board |
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John D. Reier |
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/s/ Thomas H. Tashjian
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Director |
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Thomas H. Tashjian |
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/s/ B. Mary McNabb
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Director |
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B. Mary McNabb |
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/s/ Michael T. McMillan
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Director |
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Michael T. McMillan |
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