Fred's Inc. Annual Report 2000

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FY2000 Annual Report · Fred's Inc.

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We are exciting selections.
We are great prices.
We are convenient pharmacies.
We are friendly service.

We Are Fred’s.

2 0 0 0 A N N U A L R E P O R T

about the company

Fred's, Inc., founded in 1947, operates 320 discount general merchandise stores in 11

southeastern states. The Company also markets goods and services to 26 franchised

stores. Fred's stores stock more than 12,000 frequently purchased items that address

the everyday needs of its customers, including nationally recognized brand name

products, proprietary Fred's label products, and lower-priced, off-brand products.

The Company is headquartered in Memphis, Tennessee.

Number of Company-owned and Franchised Stores by State

financial highlights

(in thousands, except per share amounts)

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Operating Data
Net sales
Operating income
Net income
Net income per share - diluted
Weighted average shares outstanding - diluted

Balance Sheet Data
Working capital
Total assets
Long-term debt (including capital leases)
Shareholders' equity
Long-term debt to equity

53 Weeks
Ended
February 3,
2001

$ 781,249
25,720
14,849
1.22
12,197

52 Weeks
Ended
January 29,
2000

$ 665,777
18,943
10,702
.89
12,072

$ 110,529
254,795
31,705
159,687

$ 79,707
240,222
11,761
145,913

19.9%

8.1%

Net Sales
(in millions)

Comparable Store Sales

Per Share Performance

$781

$666

$601

2.2%

$492

$418

5.2%

5.6%

9.2%

8.3%

$1.22

$.89

$.73

$.83

$1.11

$.50

$1.96

$1.91

$3.28

$2.55

Earnings before interest,
taxes,depreciation and
amortization (EBITDA)

Diluted net income

Number of Stores
(end of period)

Selling Space (Square Footage)
(in thousands)

Sales Per Square Foot

198

182

180

141

101

213

293

283

261

346

Stores

Pharmacies

4,346

3,966

3,680

3,362

2,862

$189

$174

$171

$159

$149

to our shareholders:

2 0 0 0 A N N U A L R E P O R T

To attain our goals for the year 2000, we

I think it's important to understand these

knew that Fred's would have to reach new

accomplishments in a historical context.

heights in all of the critical measurement

The gain we achieved in 2000 reflected a

standards. We set a high hurdle for

welcomed acceleration to a level well

ourselves in 2000, hoping to increase

above the Company's average growth rate

earnings at least 30%, on top of the strong

for the last five years and was substantially

growth we registered in 1999, and expand

ahead of industry performance. Likewise,

selling space by at least 10% – all while

our comparable store sales increase for the

reducing our debt 10%. I'm pleased to tell

year was

the strongest single-year

you that Fred's accomplished all of that,

performance since Fred's became a

and more, in 2000. It was a very good year!

publicly held company in 1992.

Net sales in 2000 rose

17% to a record $781.2

million

from $665.8

million

in 1999 and

reflected both vigorous

new store additions and

higher comparable sales

per store.

Fiscal 2000

Fred's earnings growth in

2000

was

equally

impressive as net income

increased 39% to $14.8

million or $1.22 per diluted

share versus $10.7 million or

$0.89 per diluted share in

1999.

This improvement

also was a 53-week year for Fred's, which

demonstrated increased sales leverage in

contributed slightly to the increase for

our selling, general and administrative

the year. Adjusting for the extra week in

expenses,

particularly

pharmacy

2000, sales for the year would have

department and corporate expenses,

increased 15%.

which more than offset the slight decline in

gross margins that occurred as a result of a

Comparable store sales, a widely used

shift in our sales mix and because of

barometer for a retailer's health, jumped

increased promotional activities to drive

9.2% in 2000. A 5.8% increase in customer

customer traffic.

transactions and a 3.4%

increase

average customer purchases helped fuel

We also are proud to note that Fred's

this remarkable growth.

balance

sheet has mirrored

the

improvements we have registered in sales

We are exciting
We are exciting

selections.
selections.

We are convenient
We are convenient
pharmacies.
pharmacies.

2 0 0 0 A N N U A L R E P O R T

and earnings.

In 2000, we improved

decade has come from a combination of

inventory turnover,

increased working

acquisitions, store expansion, and, most

capital, and reduced total debt 19% to

significantly, from an increasing customer

approximately $34 million. During the

base.

The pharmacy department has

year, we also replaced our existing

served as the cornerstone of our strategy

revolving bank debt, which provided a

to make our stores more relevant to the

total lending limit of $30 million including

needs of our customers, producing solid

seasonal overline capacity, with a new

comparable store sales growth and

revolver that has a total capacity of $40

offering an extra dimension to shopping at

million. Moreover, we extended

its

Fred's that is not found in the other dollar-

maturity to April 2003.

store competitors.

With this overview of the

Company's performance

year,

believe

the

following details about

operational and financial

highlights for 2000 will be

more enlightening.

Interestingly, we believe

our pharmacy, distribution

and

merchandising

strategies present a clear

distinction over other

pharmacy chains that are

now seeking to reinvent

themselves

value

Pharmacy Department

shopping destinations. Seasoned retailers

In keeping with our store expansion, our

know there are two essential elements to

pharmacy department has continued to

the retail business – price and distribution.

post strong growth. With pharmacies in

With a building footprint that has a

198 stores at year's end, up from 182 stores

minimal stocking area, these chains are

at the end of 1999, this department now

limited in the types and quantity of

accounts for almost one-third of our

merchandise they can offer. Make no

annual sales. Fred's is now one of the larger

mistake, we continue to regard these

pharmacy operations in the Southeast –

competitors as formidable, but their

the largest in some of our markets.

distribution techniques are not well suited

to support the volume that everyday value

The growth we have achieved in our

pricing requires.

pharmacy department over the past

2 0 0 0 A N N U A L R E P O R T

As part of a 50-year-old company, our

they can navigate our stores comfortably.

pharmacy department has long benefited

We have reduced rack height and moved

from some of the factors that currently are

away from round garment racks in favor of

reshaping

the modern

American

stands that show our apparel better and

consumer, including the so-called “Graying

help customers find it more easily. Any

of America” phenomenon and

the

long-time customer will tell you that our

increasing demand for new prescription

stores are brighter than ever, easier to

medicines. We remain confident that there

shop, and offer a more satisfying shopping

are many attractive opportunities awaiting

experience than ever before. The results of

us in the health care field.

these initiatives were reflected in our

Merchandising

overall sales growth for the year, our higher

sales per square foot of selling space, and

In last year's report we discussed the

our increasing transactions and average

significant strides Fred's

has made

its

merchandising programs.

John Reier, our President,

believes the old adage

about

real

estate,

emphasizing

“location,

purchase amounts.

The most obvious way our

customers

ratify

these

steps, of course,

is by

voting with their pocket

books – and with this vote

they continue to reinforce

location, location,” has implications for our

our belief in the changes we have made,

merchandising strategy.

For Fred's,

rewarding us with a 9.2% comparable store

however,

the

three basic

rules are

sales gain in 2000.

“presentation, presentation, presentation.”

In many ways, presentation is the key to our

Store Growth

success. Our initial steps were intended to

One of

the key drivers of Fred's

eliminate under-performing merchandise

performance – past, present and future – is

items and categories, use store size and

our continued investment in new stores

selection to our advantage, make our

and pharmacies. This key strategy has

stores more user-friendly, and, above all,

worked in tandem with our ongoing

maintain a keen focus on the customer. We

program of remodeling and refurbishing

have provided more space for shoppers so

older stores. During 2000, we accelerated

We are great
We are great
prices.
prices.

We are friendly
We are friendly

service.
service.

2 0 0 0 A N N U A L R E P O R T

this program with the opening of 32 stores,

program of remodels, completing 20 to 30

which net of the four stores we closed

in 2001 and focusing this program on the

during the year, increased the number of

second half of the year.

company-owned and operated stores to

320 by year's end (excluding our 26

Conclusion

franchised stores).

These new stores

Going

forward,

Fred's

future

helped us increase our total selling space

brighter

than ever.

Today's

retail

10% to approximately 4.4 million square

shopper will continue to make shopping

feet in 2000. Additionally, we did extensive

decisions that are increasingly based on

remodeling of 10 stores in 2000.

In both

convenience and price - two factors

cases, the results were

on the high side of our

expectations, reaffirming

the long-term benefits

of our development

strategies.

In the coming year, we

that form the foundation

of Fred's merchandising

strategy. Our goals and

expectations for 2001 are to

build on our successes and

set new highs in both sales

and profit. The stage has

been set

for continued

plan to maintain these solid trends in store

success at Fred's, and we are ready.

growth and increased selling space. In the

first half of 2001, our focus will be on new

store openings, and we intend to open

Michael J. Hayes

approximately 30 to 36 stores based on the

Chief Executive Officer

improved availability of retail locations.

the second half of the year, we plan to

monitor the overall economic and retail

climate as we consider additional

opportunities for new stores, and we will

remain opportunistic in committing capital

beyond the stores we now have on the

drawing boards. Our goal remains to

increase our selling space 11% to 13% in

2001. We also plan to continue our

2 0 0 0 A N N U A L R E P O R T

selected financial data

(in thousands, except per share amounts)

Statement of Income Data:
Net sales
Operating income
Income before income taxes
Provision for income taxes
Net income
Net income per share:

Basic
Diluted

Selected Operating Data:
Operating income as a percentage of sales
Increase in comparable store sales 4
Company-owned stores open at end of period

Balance Sheet Data (at period end):
Total assets
Short-term debt (including capital leases)
Long-term debt (including capital leases)
Shareholders' equity

20001

1999

19982

1997

1996

$ 781,249
25,720
22,494
7,645
14,849

$ 665,777
18,943
16,439
5,737
10,702

$ 600,902
14,711
13,605
4,775
8,830

$ 492,236
15,511
15,660
5,873
9,787

$ 418,297
6,7793
6,508
702
5,806

1.24
1.22

3.3%
9.2%5
320

.90
.89

2.9%
5.2%
293

.75
.73

2.4%
5.6%
283

.84
.83

3.2%
8.3%
261

.50
.50

1.6%3
2.2%
213

$ 254,795
2,678
31,705
159,687

$ 240,222
30,736
11,761
145,913

$ 220,757
11,914
11,821
136,983

$ 195,407
214
1,368
129,359

$ 161,148
1,641
138
119,579

1 Results for 2000 include 53 weeks.
2 Results for 1998 include the effect of the 1998 adoption of LIFO for pharmacy inventories.
3 After $3,289 of restructuring and other charges.
4 A store is first included in the comparable store sales calculation after the end of the twelfth month following the store's

grand opening month.

5 The increase in comparable store sales for 2000 is computed on the same 53-week period for 1999.

management’s discussion
and analysis

2 0 0 0 A N N U A L R E P O R T

Results of Operations

The following table provides a comparison of Fred's financial results for the past three years. In this table, categories of income
and expense are expressed as a percentage of net sales.

Net sales
Cost of goods sold
Gross profit
Selling, general and administrative expenses
Operating income
Interest expense, net
Income before taxes
Income taxes
Net income

2000

1999

1998 (1)

100.0%
72.5
27.5
24.2
3.3
.4
2.9
1.0
1.9%

100.0%
71.8
28.2
25.3
2.9
.4
2.5
.9
1.6%

100.0%
72.6
27.4
24.9
2.5
.2
2.3
.8
1.5%

(1) Results of 1998 include the effect of the 1998 adoption of LIFO for Pharmacy inventories ($3,108,000).

Fiscal 2000 Compared to Fiscal 1999

Sales
Net sales increased 17.3% ($115 million) in 2000. Approximately $57 million of the increase was attributable to the addition
of 31 new or upgraded stores, and 16 pharmacies during 2000, together with the sales of 20 store locations and 2 pharmacies
that were opened or upgraded during 1999 and contributed a full year of sales in 2000. During 2000, the Company also closed
4 store locations. Comparable store sales based on a 53-week comparison, consisting of sales from stores that have been open
for more than one year, increased 9.2% in 2000.

The Company's front store (non-pharmacy) sales increased approximately 15% over 1999 front store sales. Front store sales
growth benefited from the above mentioned store additions, and solid performances in categories such as home furnishings,
floor coverings, bath, small appliances, giftware, ladies intimate, ladies accessories, men’s and boy’s apparel, ethnic products,
beverages, food and snacks, and tobacco. Lawn and garden sales decreased due to reduced emphasis of large lawn and
garden equipment that carried lower margins and required additional labor outside the stores.

Fred's pharmacy sales grew to 33% of total sales in 2000 from 31% of total sales in 1999 and continues to rank as the largest
sales category within the Company. The total sales in this department, including the Company's mail order operation,
increased 25% over 1999, with third party prescription sales representing approximately 83% of total pharmacy sales,
compared with 77% of total pharmacy sales in 1999. The Company's pharmacy sales growth continued to benefit from an
ongoing program of purchasing prescription files from independent pharmacies, the addition of pharmacy departments in
existing store locations, and inflation caused by drug manufacturer increases.

Sales to Fred's 26 franchised locations increased approximately $1 million in 2000 and represented 4% of the Company's total
sales, as compared to 5% in 1999. It is anticipated that this category of business will decline as a percentage of total Company
sales since the Company has not added and does not intend to add any additional franchisees.

Gross Margin
Gross margin as a percentage of sales was 27.5% in 2000 compared to 28.2% in 1999. The decrease in gross margin is primarily
attributed to the changes in sales mix and promotional activities to increase customer traffic.

2 0 0 0 A N N U A L R E P O R T

management’s discussion
and analysis

Selling, General and Administrative Expenses
Selling, general and administrative expenses were 24.2% of net sales in 2000 compared with 25.3% of net sales in 1999. Labor
expenses improved in the stores and pharmacies as a result of the strong sales coupled with store productivity initiatives.
Advertising expense improved as a percentage of sales by reducing the cost of advertising circulars while maintaining the
same number of circulars issued during the year. Other expenses such as store supplies and distribution center equipment
rental also improved as a result of cost control efforts.

Operating Income
Operating income increased approximately $6.8 million or 35.8% to $25.7 million in 2000 from $18.9 million in 1999.
Operating income as a percentage of sales increased to 3.3% in 2000 from 2.9% in 1999, due to the above-mentioned reasons.

Interest Expense, Net
Interest expense for 2000 totaled $3.2 million compared to net interest expense of $2.5 million in 1999.

The interest expense for 2000 reflects higher average revolver borrowings for inventory purchases, caused by significantly
improved in-stock positions over 1999 and inventory for the new stores opened throughout the year. Higher interest rates
during 2000 were also a factor in the higher expense.

Income Taxes
The effective income tax rate decreased to 34.0% in 2000 from 34.9% in 1999, due to changes made in the Company's
organizational structure during the fourth quarter of 1998 and the implementation of a federal program to generate
employment related tax credits, which resulted in a reduction in the Company's liability for taxes.

At February 3, 2001, the Company had certain net operating loss carryforwards which were acquired in reorganizations and
certain purchase transactions and are available to reduce income taxes, subject to usage limitations. These carryforwards total
approximately $43.8 million for state income tax purposes, which expire during the period 2002 through 2022.
If certain
substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of
carryforwards which can be utilized.

Net Income
Net income for 2000 was $14.8 million (or $1.22 per diluted share) or approximately 39% higher than the $10.7 million (or $.89
per diluted share) reported in 1999.

Fiscal 1999 Compared to Fiscal 1998

Sales
Net sales increased 10.8% ($65 million) in 1999. Approximately $37 million of the increase was attributable to the addition and
upgrade of 25 store locations and 2 pharmacies during 1999, together with the sales of 29 stores and pharmacies that were
opened or upgraded during 1998 and contributed a full year of sales in 1999. During 1999, the Company also closed 10 store
locations. Comparable store sales, consisting of sales from stores that have been open for more than one year, increased 5.2%
in 1999.

The Company's front store (non-pharmacy) sales increased approximately 6% over 1998 front store sales. Front store sales
growth benefited from the above mentioned store additions, as solid performances in categories such as home furnishings,
footwear, ladies accessories, plus size and girls apparel, and trim-a-home were mostly offset by weaker performances in missy
and ladies intimate apparel, hardware and several of the Company’s basic hardlines departments.

Fred's pharmacy sales grew from 27% of total sales in 1998 to 31% of total sales in 1999, and continues to rank as the largest
sales category within the Company. The total sales in this department, including the Company's mail order operation,

management’s discussion
and analysis

2 0 0 0 A N N U A L R E P O R T

increased 27% over 1998, with third party prescription sales representing approximately 77% of total pharmacy sales,
compared with 71% of total pharmacy sales in 1998. The Company's pharmacy sales growth continued to benefit from an
ongoing program of purchasing prescription files from independent pharmacies, the addition of pharmacy departments in
existing store locations, and inflation caused by drug manufacturer increases.

Sales to Fred's 26 franchised locations decreased approximately $3 million in 1999 and represented 5% of the Company's total
It is anticipated that this category of business will continue to
sales compared with approximately 6% of 1998 total sales.
decline as a percentage of total Company sales since the Company has not added and does not intend to add any additional
franchisees.

Gross Margin
Gross margin as a percentage of sales was 28.2% in 1999 compared to 27.4% in 1998. Gross margin benefited from reduced
levels of markdowns as a percentage of sales, higher initial purchase margins resulting from greater volumes of import and
opportunistic purchases, a lesser percentage of franchise sales, which carry substantially lower margins than retail sales, and a
reduced level of inflation in pharmacy costs.

Selling, General and Administrative Expenses
Selling, general and administrative expenses were 25.3% of net sales in 1999 compared with 24.9% of net sales in 1998. Higher
rental costs as a percentage of sales due to a greater percentage of company stores being leased and slightly higher rent costs
associated with the Company's build-to-suit prototype store, an increase in repairs and maintenance expense resulting from
store improvement programs implemented during 1999, and higher depreciation expense associated with capital investments
made over the past 12 to 18 months contributed to most of the higher expense ratio in 1999. These increases were partially
offset by the elimination of mailing costs associated with two major advertising circulars during 1999.

Operating Income
Operating income increased approximately $4.2 million or 28.8% to $18.9 million in 1999 from $14.7 million in 1998.
Operating income as a percentage of sales, increased to 2.9% in 1999 from 2.5% in 1998, due to the above mentioned reasons.

Interest Expense, Net
Interest expense for 1999 totaled $2.5 million compared to net interest expense of $1.1 million in 1998 (interest expense of
$1.2 million less interest income of $.1 million).

The interest expense for 1999 reflects higher average revolver borrowings for inventory purchases, caused by significantly
improved in-stock positions over 1998 and duplicate inventories in several remerchandised inventory categories, and the
accelerated repayment of approximately $7.5 million in accounts payable, originally due in February, as a result of a change
made in the company's pharmacy drug wholesaler in December of 1999. The company also experienced full year interest costs
on term loan borrowings to finance the distribution center modernization and acquisition of a new mainframe computer.

Income Taxes
The effective income tax rate decreased to 34.9% in 1999 from 35.1% in 1998, due primarily to changes made in the Company's
organizational structure during the fourth quarter of 1998, which resulted in a reduction in the Company's liability for taxes.

At January 29, 2000, the Company had certain net operating loss carryforwards which were acquired in reorganizations and
certain purchase transactions and are available to reduce income taxes, subject to usage limitations. These carryforwards total
approximately $36.7 million for state income tax purposes, which expire during the period 2001 through 2021.
If certain
substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of
carryforwards which can be utilized.

2 0 0 0 A N N U A L R E P O R T

management’s discussion
and analysis

Net Income
Net income for 1999 was $10.7 million (or $.89 per diluted share) or approximately 22% higher than the $8.8 million (or $.73
per diluted share) reported in 1998.

Liquidity and Capital Resources

Fred's primary sources of working capital are cash flow from operations and borrowings under its current facility. The
Company had working capital of $110.5 million, $79.7 million and $72.8 million at year end 2000, 1999 and 1998, respectively.
Working capital fluctuates in relation to profitability, seasonal inventory levels, net of trade accounts payable, and the level of
store openings and closings.

On April 3, 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement to replace the existing
$15 million unsecured revolving credit commitment that has generally been used to finance inventory levels at specified
periods. The expanded credit capacity is necessary to accommodate the Company's continued growth and shifting seasonal
inventory needs. This $40 million credit commitment was supplemented with a $5 million seasonal overline, for a total
revolving borrowing capacity of $45 million. The credit commitment expires on April 3, 2003 and bears interest at 1.5% below
prime rate or a LIBOR-based rate (weighted average interest rate of 7.4% on 2000 outstanding borrowings). All other
provisions of the new agreement are essentially the same as the prior agreement.

At February 3, 2001, approximately $22.6 million of inventories were financed with outstanding borrowings under the
Company's revolver. The reduction in borrowings from the prior year results from the Company’s focus on inventory
management and the accelerated payment made in the prior year as explained below.

At January 29, 2000, approximately $28.2 million of inventories were financed with outstanding borrowings under the
Company's revolver. Higher year-end revolver borrowings resulted from significantly improved in-stock positions compared
to 1998, duplicate inventories in several re-merchandised inventory categories, and the accelerated repayment of
approximately $7.5 million in accounts payable, originally due in February, as a result of a change made in the Company's
pharmacy drug wholesaler in December 1999.

In May 1998, the Company entered into a seven-year unsecured term loan of $12 million to finance the modernization and
automation of the Company's distribution center and corporate facilities. The Loan Agreement bears interest of 6.82% per
annum and matures on November 1, 2005. At year-end 2000, the outstanding principal balance on the term loan was
approximately $8.8 million compared with $10.3 million at year-end 1999.

In April 1999, the Company entered into a four-year unsecured term loan of $2.3 million to finance the replacement of the
Company's mainframe computer system. The Loan Agreement bears interest at 6.15% per annum and matures on April 15,
2003. At year-end 2000, the outstanding principal balance on the term loan was approximately $1.3 million compared with
$1.8 million at year-end 1999.

Cash provided by operations was $27.1 million in 2000 compared to cash used in operations of ($.8) million in 1999 and cash
provided by operations of $.7 million in 1998. Year-end 2000 inventory levels were better managed to improve turnover and
reduce duplicate inventories in several product categories. Also, income taxes payable increased as a result of tax strategies
put in place in prior years that had a favorable effect in 2000. Year-end 1999 inventory levels were impacted by improved in-
stock positions and duplicate inventories compared to 1998, and accounts payable were impacted by the accelerated
repayment of $7.5 million of payables. Year-end 1998 accounts payable levels were adversely impacted as a result of
merchandise processing delays, and were supplemented with short-term borrowings at year-end.

management’s discussion
and analysis

2 0 0 0 A N N U A L R E P O R T

Capital expenditures in 2000 totaled $15.8 million compared with $14.0 million in 1999 and $21.3 million in 1998. The 2000
capital expenditures included approximately $12.2 million of expenditures associated with upgraded or new stores and
pharmacies. Approximately $3.6 million in expenditures related to technology upgrades, distribution center equipment,
freight equipment, and capital maintenance. The 1999 capital expenditures included approximately $2.3 million of
expenditures associated with replacement of the Company's mainframe computer system, and approximately $11.7 million of
expenditures associated with new stores and pharmacies, store and pharmacy upgrades, distribution center equipment and
annual capital maintenance. The 1998 capital expenditures included $12.0 million of expenditures associated with the
Company's modernization and automation of its distribution center, $4.7 million of expenditures associated with new stores
and pharmacies, and $4.6 million for store and pharmacy upgrades and annual capital maintenance. Cash used for investing
activities also includes $2.8 million in 2000, $.8 million in 1999, and $2.0 million in 1998 for the acquisition of customer lists and
other pharmacy related items.

The Company believes that sufficient capital resources are available in both the short-term and long-term through currently
available cash, cash generated from future operations and, if necessary, the ability to obtain additional financing.

Recent Accounting Pronouncements

In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the
effective date of FASB Statement No. 133, which deferred the effective date provisions of SFAS No. 133 for the company to the
first quarter of 2001. The Company does not believe this new standard will have an impact on its financial statements since it
currently has no derivative instruments.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 “Revenue Recognition in
Financial Statements” (SAB 101). SAB 101 identifies various revenue recognition issues, several of which are common within
the retail industry including treatment of revenue recognition on layaway sales. In the fourth quarter of 2000, the Company
revised its revenue recognition for layaway sales to defer revenue recognition until all terms of the sale have been satisfied and
the customer takes delivery of the merchandise. Under the prior method of accounting, net sales were recognized at the time
the customer put the merchandise into layaway. The effects of this change on prior quarters in 2000 and the proforma effect
on 1999 are reflected in Note 12. The effects of this change on the fourth quarter of 2000 was an increase in net sales, gross
profit, net income per share (basic and diluted) of $1,932,000, $482,000, $318,000 and $.02, respectively. Annual financial
results were not affected.

Cautionary Statement Regarding Forward-looking Information

Statements, other than those based on historical facts that the Company expects or anticipates may occur in the future are
forward-looking statements which are based upon a number of assumptions concerning future conditions that may ultimately
prove to be inaccurate. Actual events and results may materially differ from anticipated results described in such statements.
The Company's ability to achieve such results is subject to certain risks and uncertainties, including, but not limited to,
economic and weather conditions which affect buying patterns of the Company's customers, changes in consumer spending
and the Company's ability to anticipate buying patterns and implement appropriate inventory strategies, continued
availability of capital and financing, competitive factors, changes in reimbursement practices for pharmaceuticals,
governmental regulation, and other factors affecting business beyond the Company's control. Consequently, all of the
forward-looking statements are qualified by these cautionary statements and there can be no assurance that the results or
developments anticipated by the Company will be realized or that they will have the expected effects on the Company or its
business or operations.

2 0 0 0 A N N U A L R E P O R T

consolidated statements
of income

( i n t h o u s a n d s , e x c e p t p e r s h a r e a m o u n t s )

Net sales
Cost of goods sold

Gross profit

Selling, general and administrative expenses

Operating income

Interest expense, net

Income before taxes

Income taxes
Net income

Net income per share

Basic
Diluted

Weighted average shares outstanding

Basic
Diluted

February 3,
2001
$ 781,249
566,115
215,134

For the Years Ended
January 29,
2000
$ 665,777
478,138
187,639

January 30,
1999
$ 600,902
436,523
164,379

189,414
25,720

3,226
22,494

168,696
18,943

2,504
16,439

7,645
$ 14,849

5,737
$ 10,702

$
$

1.24
1.22

$
$

0.90
0.89

149,668
14,711

1,106
13,605

4,775
8,830

0.75
0.73

$
$

11,937
12,197

11,827
12,072

11,798
12,078

S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s .

consolidated balance sheets

( i n t h o u s a n d s , e x c e p t n u m b e r o f s h a r e s )

2 0 0 0 A N N U A L R E P O R T

ASSETS
Current assets:

Cash and cash equivalents

Receivables, less allowance for doubtful accounts of $516
($452 at January 29, 2000)

Inventories
Deferred income taxes
Other current assets

Total current assets

Property and equipment, at depreciated cost
Equipment under capital leases, less accumulated amortization of

$1,305 ($856 at January 29, 2000)

Deferred income taxes
Other noncurrent assets, net

Total assets

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:

Accounts payable
Current portion of indebtedness
Current portion of capital lease obligations
Accrued liabilities
Income taxes payable

Total current liabilities

Long-term portion of indebtedness
Capital lease obligations
Other noncurrent liabilities
Total liabilities

Commitments and contingencies (Notes 6 and 10)

Shareholders' equity:

Common stock, Class A voting, no par value, 12,068,518 shares

issued and outstanding (11,988,276 shares at January 29, 2000)

Retained earnings
Deferred compensation on restricted stock incentive plan

Total shareholders' equity

February 3,
2001

January 29,
2000

2,569

3,036

15,430
149,602
2,022
2,306
171,929

76,360

1,387
98
5,021
$ 254,795

40,432
2,175
503
14,012
4,278
61,400

30,475
1,230
2,003
95,108

10,911
141,612
3,002
1,865
160,426

73,459

1,835
866
3,636
$ 240,222

$ 39,653
30,306
430
9,680
650
80,719

10,027
1,734
1,829
94,309

68,557
91,342
(212)
159,687
$ 254,795

67,326
78,902
(315)
145,913
$ 240,222

S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s .

2 0 0 0 A N N U A L R E P O R T

consolidated statements of
changes in stockholders’ equity

( i n t h o u s a n d s , e x c e p t s h a r e d a t a )

Balance, January 31, 1998
Cash dividends paid ($.20 per share)
Repurchase of shares
Issuance of restricted stock
Cancellation of restricted stock
Exercises of stock options
Amortization of deferred compensation
on restricted stock incentive plan
Tax benefit on exercise of stock options
Net income
Balance, January 30, 1999

Cash dividends paid ($.20 per share)
Issuance of restricted stock
Cancellation of restricted stock
Other issuances
Exercises of stock options
Amortization of deferred compensation
on restricted stock incentive plan
Tax benefit on exercise of stock options
Net income
Balance, January 29, 2000

Cash dividends paid ($.20 per share)
Issuance of restricted stock
Cancellation of restricted stock
Exercises of stock options
Amortization of deferred compensation
on restricted stock incentive plan
Tax benefit on exercise of stock options
Net income
Balance, February 3, 2001

Common Stock

Shares
11,866,789

Amount
$ 65,700

Retained
Earnings
$ 64,147
(2,381)

Deferred
Compensation
$ (488)

(30)
46,182
(5,500)
39,331

752
(38)
329

208

11,946,772

$ 66,951

9,900
(5,700)
1,714
35,590

124
(118)
30
296

11,988,276

$ 67,326

3,800
(29,072)
105,514

57
(218)
1,079

313

8,830
$ 70,596

(2,396)

10,702
$ 78,902

(2,409)

(362)
38

248

$ (564)

(124)
118

255

$ (315)

(57)
15

145

12,068,518

$ 68,557

14,849
$ 91,342

$ (212)

Total
$ 129,359
(2,381)
-
390
-
329

248
208
8,830
$ 136,983

(2,396)

30
296

255
43
10,702
$ 145,913

(2,406)

(203)
1,079

145
313
14,849
$ 159,690

S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s .

consolidated statements of
cash flows

( i n t h o u s a n d s )

2 0 0 0 A N N U A L R E P O R T

Cash flows from operating activities:

Net income

Adjustments to reconcile net income to net cash flows

from operating activities:

Depreciation and amortization

Provision for uncollectible receivables
LIFO Reserve
Deferred income taxes
Amortization of deferred compensation on restricted

stock incentive plan

Issuance (net of cancellation) of restricted stock
Tax benefit upon exercise of stock options
Gain on sale of fixed assets
(Increase) decrease in assets:

Receivables
Inventories
Other assets

Increase (decrease) in liabilities:

Accounts payable and accrued liabilities
Income taxes payable
Other noncurrent liabilities

Net cash (used in) provided by operating activities

Cash flows from investing activities:

Capital expenditures
Proceeds from dispositions of property and equipment
Asset acquisition, net of cash acquired (primarily intangibles)

Net cash used in investing activities

Cash flows from financing activities:

Reduction of indebtedness and capital lease obligations
Proceeds from revolving line of credit, net of payments
Proceeds from term loan
Proceeds from exercise of options
Payment of cash for dividends and fractional shares

Net cash provided by (used in) financing activities

Increase (decrease) in cash and cash equivalents
Cash and cash equivalents:

Beginning of year
End of year

Supplemental disclosures of cash flow information:

Interest paid
Income taxes paid

Non cash investing and financing activities:

Assets acquired through capital lease obligations
Common stock issued for acquisition

S e e a c c o m p a n y i n g n o t e s t o c o n s o l i d a t e d f i n a n c i a l s t a t e m e n t s .

February 3,
2001

For the Years Ended
January 29,
2000

January 30,
1999

$ 14,849

$ 10,702

8,830

14,277
64
753
1,747

145
(203)
313
-

(4,583)
(8,743)
(444)

5,110
3,628
174
27,087

(15,801)
493
(2,807)
(18,115)

(2,495)
(5,617)
-
1,079
(2,406)
(9,439)
(467)

3,036
2,569

3,332
2,000

-
-

$
$

11,830
80
100
2,513

255
-
43
(41)

(2,060)
(15,135)
(847)

(8,210)
(176)
159
(787)

(14,043)
215
(805)
(14,633)

(2,139)
18,040
2,249
296
(2,396)
16,050
630

2,406
3,036

2,399
3,810

612
30

$
$

8,939
124
3,108
2,344

248
390
208
-

(1,969)
(14,664)
(2,354)

(3,712)
(890)
175
777

(21,273)
-
(1,993)
(23,266)

(556)
10,200
12,000
329
(2,381)
19,592
(2,897)

5,303
2,406

1,239
2,828

509
-

$
$

2 0 0 0 A N N U A L R E P O R T

notes to consolidated
financial statements

NOTE 1 - DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of business. The primary business of Fred’s, Inc. and subsidiaries (the “Company”) is the sale of general
merchandise through its 320 retail discount stores located in the southeastern United States. In addition, the Company sells
general merchandise to its 26 franchisees.

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 2000, 1999 and 1998, as used herein, refer to the years ended February 3, 2001, January 29, 2000, and January 30, 1999,
respectively.

Use of estimates. The preparation of financial statements in accordance with generally accepted accounting principles
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.

Inventories. Wholesale inventories are stated at the lower of cost or market using the FIFO (first-in, first-out) method. Retail
inventories are stated at the lower of cost or market as determined by the retail inventory method. For pharmacy inventories,
which comprise approximately 19% and 18% of the retail inventories at February 3, 2001 and January 29, 2000, respectively,
cost was determined using the LIFO (last-in, first-out) method. The current cost of inventories exceeded the LIFO cost by
approximately $3,961,000 at February 3, 2001 and $3,208,000 at January 29, 2000.

Property and equipment. Buildings, furniture, fixtures and equipment are stated at cost and depreciation is computed using
the straight-line method over their estimated useful lives. Leasehold costs and improvements are amortized over the lesser of
their estimated useful lives or the remaining lease terms. Average useful lives are as follows: buildings and improvements - 8
to 30 years; furniture and fixtures - 5 to 10 years; and equipment - 3 to 10 years. Amortization on equipment under capital
leases is computed on a straight-line basis over the terms of the leases. Gains or losses on the sale of assets are recorded at
disposal.

Long lived assets. The Company’s policy is to review the recoverability of all long-lived assets annually and whenever events
or changes indicate that the carrying amount of an asset may not be recoverable. Based upon the Company’s review as of
February 3, 2001 and January 29, 2000, no material adjustments to the carrying value of such assets were necessary.

Selling, general and administrative expenses. The Company includes buying, warehousing, transportation and occupancy
costs in selling, general and administrative expenses.

Advertising. The Company charges advertising, including production costs, to expense on the first day of the advertising
period. Advertising expense for 2000, 1999, and 1998 was $10,166,000, $8,926,000, and $9,621,000 respectively.

Preopening costs. The Company charges to expense the preopening costs of new stores as incurred. These costs are primarily
labor to stock the store, preopening advertising, store supplies and other expendable items.

Revenue recognition. The Company markets goods and services through Company owned stores and 26 franchised stores.
Net sales includes sales of merchandise from Company owned stores, net of returns and exclusive of sales taxes. Sales to
franchised stores are recorded when the merchandise is shipped from the Company’s warehouse. Revenues resulting from
In addition, the Company charges the
layaway sales are recorded upon delivery of the merchandise to the customer.

notes to consolidated
financial statements

2 0 0 0 A N N U A L R E P O R T

franchised stores a fee based on a percentage of their purchases from the Company. These fees represent a reimbursement
for use of the Fred’s name and other administrative costs incurred on behalf of the franchised stores. Total franchise income
for 2000, 1999 and 1998 was $1,809,000, $1,761,000 and $1,957,000 respectively.

Other intangible assets. Other identifiable intangible assets which are included in other noncurrent assets primarily
represent amounts associated with acquired pharmacies and are being amortized on a straight line basis over five years. These
intangibles, net of accumulated amortization, totaled $4,945,000 at February 3, 2001, and $3,559,000 at January 29, 2000.
Accumulated amortization for 2000 and 1999 totaled $3,964,000 and $2,543,000, respectively. Amortization expense for 2000,
1999 and 1998 was $1,421,000, $1,307,000 and $1,214,000 respectively.

Cash and cash equivalents. Cash on hand and in banks, together with other highly liquid investments having original
maturities of three months or less, are classified as cash equivalents. Included in accounts payable are outstanding checks in
excess of funds on deposit which totaled $5,823,000 at February 3, 2001 and $14,089,000 at January 29, 2000.

Financial instruments. At February 3, 2001, the Company did not have any outstanding derivative instruments. The recorded
value of the Company’s financial instruments, which include cash and cash equivalents, receivables, accounts payable and
indebtedness, approximates fair value. The following methods and assumptions were used to estimate fair value of each class
of financial instrument: (1) the carrying amounts of current assets and liabilities approximate fair value because of the short
maturity of those instruments and (2) the fair value of the Company’s indebtedness is estimated based on the current
borrowing rates available to the Company for bank loans with similar terms and average maturities.

Business segments. The Company’s only reportable operating segment is its sale of merchandise through its Company
owned stores and to franchised Fred’s locations, which are organized around the products sold and markets served.

Comprehensive income. Comprehensive income does not differ from the consolidated net income presented in the
consolidated statements of income.

Reclassifications. Certain prior year amounts have been reclassified to conform to the 2000 presentation.

Recent accounting pronouncements. In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 “Revenue Recognition in Financial Statements” (SAB 101). SAB 101 identifies various revenue recognition
issues, several of which are common within the retail industry including treatment of revenue recognition on layaway sales. In
the fourth quarter of 2000, the Company revised its revenue recognition for layaway sales to defer revenue recognition until
all terms of the sale have been satisfied and the customer takes delivery of the merchandise. Under the prior method of
accounting, net sales were recognized at the time the customer put the merchandise into layaway. The effects of this change
on prior quarters in 2000 and the proforma effects on 1999 are reflected in Note 12. The effects of this change on the fourth
quarter of 2000 was an increase in net sales, gross profit, net income and net income per share (basic and diluted) of
$1,932,000, $482,000, $318,000 and $.02, respectively. Annual financial results were not affected.

In June 1999, the FASB issued SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities – Deferral of the
effective date of FASB Statement No. 133, which deferred the effective date provisions of SFAS No. 133 for the company to the
first quarter of 2001. The Company does not believe this new standard will have an impact on its financial statements since it
currently has no derivative instruments.

2 0 0 0 A N N U A L R E P O R T

notes to consolidated
financial statements

NOTE 2 - PROPERTY AND EQUIPMENT

Property and equipment, at cost, consist of the following (in thousands):

Buildings and improvements
Furniture, fixtures and equipment

Less accumulated depreciation and amortization

Land

2000
67,068
89,152
156,220
(84,100)
72,120
4,240
76,360

1999
$ 65,660
81,424
147,084
(78,018)
69,066
4,393
$ 73,459

Depreciation expense totaled $12,407,000, $10,168,000 and $7,442,000 for 2000, 1999 and 1998, respectively.

NOTE 3 - ACCRUED LIABILITIES

The components of accrued liabilities are as follows (in thousands):

Payroll and benefits
Sales and use taxes
Insurance
Other

NOTE 4 - INDEBTEDNESS

2000

5,136
2,000
2,497
4,379
14,012

1999

2,992
1,726
2,904
2,058
9,680

On April 3, 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement (the “Agreement”) to
replace the May 15, 1992 Revolving Loan and Credit Agreement, as amended. The Agreement provides the Company with an
unsecured revolving line of credit commitment of up to $40 million and bears interest at 1.5% below prime rate or a LIBOR-
based rate. Under the most restrictive covenants of the Agreement, the Company is required to maintain specified
shareholders’ equity and net income levels.The Company is required to pay a commitment fee to the bank at a rate per annum
equal to .18% on the unutilized portion of the revolving line commitment over the term of the Agreement. The term of the
Agreement extends to April 3, 2003.There were $22,623,000 and $28,240,000 of borrowings outstanding under the Agreement
at February 3, 2001 and January 29, 2000, respectively.

On April 23, 1999, the Company and a bank entered into a Loan Agreement (the “Loan Agreement”). The Loan Agreement
provided the Company with a four-year unsecured term loan of $2.3 million to finance the replacement of the Company’s
mainframe computer system. The Loan Agreement bears interest of 6.15% per annum and matures on April 15, 2003. Under
the most restrictive covenants of the Loan Agreement, the Company is required to maintain specified debt service levels.There
were $1,265,500 and $1,828,000 borrowings outstanding under the Agreement at February 3, 2001 and January 29, 2000,
respectively. The principal maturity under this Agreement for debt outstanding at February 3, 2001 is as follows: $562,500 in
fiscal 2001; $562,500 in fiscal 2002 and $140,500 in fiscal 2003.

notes to consolidated
financial statements

2 0 0 0 A N N U A L R E P O R T

On May 5, 1998, the Company and a bank entered into a Loan Agreement (the “Term Loan Agreement”). The Term Loan
Agreement provided the Company with an unsecured term loan of $12 million to finance the modernization and automation
of the Company’s distribution center and corporate facilities. The Term Loan Agreement bears interest of 6.82% per annum
and matures on November 1, 2005. Under the most restrictive covenants of the Term Loan Agreement, the Company is
required to maintain specified shareholders’ equity and net income levels. Borrowings outstanding under this Term Loan
Agreement totaled $8,762,000 at February 3, 2001 and $10,265,000 at January 29, 2000. The principal maturity under this
Agreement for debt outstanding at February 3, 2001 is as follows: $1,612,742 in fiscal 2001; $1,727,860 in fiscal 2002;
$1,851,199 in fiscal 2003; $1,983,338 in fiscal 2004 and $1,586,503 in fiscal 2005.

Interest expense for 2000, 1999 and 1998 totaled $3,226,000, $2,504,000 and $1,206,000, respectively.

NOTE 5 - INCOME TAXES

Deferred income taxes are provided for the tax effects of temporary differences between the financial reporting basis and
income tax basis of the Company’s assets and liabilities.The provision for income taxes consists of the following (in thousands):

Current

Federal
State

Deferred
Federal
State

2000

1999

1998

5,597
-
5,597

1,423
324
1,747
7,344

3,224
-
3,224

2,116
397
2,513
5,737

2,639
(208)
2,431

1,974
370
2,344
4,775

2 0 0 0 A N N U A L R E P O R T

notes to consolidated
financial statements

Deferred tax assets (liabilities) are comprised of the following(in thousands):

2000

1999

Current deferred tax assets:

Inventory valuation methods
Accrual for inventory shrinkage
Allowance for doubtful accounts
Insurance accruals
Other

Gross current deferred tax assets

Deferred tax asset valuation allowance

Current deferred tax liabilities

Net current deferred tax asset

Noncurrent deferred tax assets:

Net operating loss carryforwards
Postretirement benefits other than pensions
Restructuring costs
Other

Gross noncurrent deferred tax assets

Deferred tax asset valuation allowance

Noncurrent deferred tax liabilities:

Depreciation
Other

Gross noncurrent deferred tax liabilities

Net noncurrent deferred tax asset

465
768
310
1,200
654
2,467
(289)
2,178
(156)
2,022

1,685
760
82
1,769
4,296
(1,267)
3,029

(2,904)
(27)
(2,931)
98

758
672
285
990
749
3,454
(182)
3,272
(270)
3,002

1,421
694
82
1,583
3,780
(1,239)
2,541

(1,648)
(27)
(1,675)
866

The ultimate realization of these assets is dependent upon the generation of future taxable income sufficient to offset the
related deductions and loss carryforwards within the applicable carryforward periods as described below. The valuation
allowance is based upon management’s conclusion that certain tax carryforward items will expire unused. During 2000 and
1999, the valuation allowance increased $264,000 and $393,000, respectively, as the result of the company generating
additional net operating loss carryforwards in certain states.

At February 3, 2001, the Company has certain net operating loss carryforwards which were acquired in reorganizations and
purchase transactions which are available to reduce income taxes, subject to usage limitations. These carryforwards total
approximately $43,784,000 for state income tax purposes, and expire at various times during the period 2002 through 2022. If
certain substantial changes in the Company’s ownership should occur, there would be an annual limitation on the amount of
carryforwards which can be utilized.

A reconciliation of the statutory Federal income tax rate to the effective tax rate is as follows:

Income tax provision at statutory rate
State income taxes, net of federal benefit
Change in valuation allowance
Surtax Exemptions
Other

2000

35.0%
0.9
-
(1.0)
(0.9)
34.0%

1999
35.0%
1.6
-
(1.0)
(0.7)
34.9%

1998
35.0%
0.8
0.7
(1.0)
(0.4)
35.1%

notes to consolidated
financial statements

2 0 0 0 A N N U A L R E P O R T

NOTE 6 - LONG-TERM LEASES

The Company leases certain of its store locations under noncancelable operating leases expiring at various dates through
2031. Many of these leases contain renewal options and require the Company to pay taxes, maintenance, insurance and certain
other operating expenses applicable to the leased properties.
In addition, the Company leases various equipment under
noncancelable operating leases and certain transportation equipment under capital leases. Total rent expense under
operating leases was $17,465,000, $15,329,000 and $13,618,000 for 2000, 1999 and 1998, respectively. Amortization expense
on assets under capital lease for 2000, 1999 and 1998 was $449,000, $355,000 and $283,000, respectively.

Future minimum rental payments under all operating and capital leases as of February 3, 2001 are as follows:

2001
2002
2003
2004
2005
Thereafter
Total minimum lease payments

Imputed interest

Present value of net minimum lease payments, including

$503 classified as current portion of capital lease obligations

Operating
Leases

Capital
Leases

(in thousands)

16,055
14,189
11,505
8,491
6,121
11,426
67,787

741
741
364
255
142
0
2,243

(510)

1,733

NOTE 7 - SHAREHOLDERS’ EQUITY

The Company has 30 million shares of Class A voting common stock authorized. The Company’s authorized capital also
In addition, the
consists of 11.5 million shares of Class B nonvoting common stock, of which no shares have been issued.
Company has authorized 10 million shares of preferred stock, of which no shares have been issued.

Effective October 12, 1998 the Company adopted a Shareholders Rights Plan which granted a dividend of one preferred share
purchase right (“the Right”) for each common share outstanding at that date. Each Right represents the right to purchase one-
hundredth of a preferred share of stock at a preset price to be exercised when any one individual, firm, corporation or other
entity acquires 15% or more of the Company’s common stock. The Rights will become dilutive at the time of exercise and will
expire, if unexercised, on October 12, 2008.

NOTE 8 - EMPLOYEE BENEFIT PLANS

Incentive stock option plan. The Company has a long-term incentive plan under which an aggregate of 1,168,750 shares may
be granted. These options expire five years from the date of grant. Options outstanding at February 3, 2001 expire in 2001
through 2005.

2 0 0 0 A N N U A L R E P O R T

notes to consolidated
financial statements

A summary of activity in the plan follows:

2000

1999

1998

Weighted
Average
Exercise
Price
$ 13.13
15.04
11.02

8.67
15.29
10.62

Weighted
Average
Exercise
Price
$ 13.40
11.82
14.79
11.33
8.38
13.13
9.1

Weighted
Average
Exercise
Price
$ 8.55
25.61
12.46
-
8.42
13.4
9.85

Options
411,298
150,695
(32,523)
-
(39,331)
490,139
152,483

Options
490,139
136,750
(26,101)
(1,744)
(35,590)
563,454
169,313

Options
563,454
345,507
(140,825)
-
(105,514)
662,622
154,065

Outstanding at beginning of year
Granted
Canceled
Expired
Exercised
Outstanding at end of year
Exercisable at end of year

The weighted average remaining contractual life of all outstanding options was 3.2 years at February 3, 2001.

The following table summarizes information about stock options outstanding at February 3, 2001:

Range of
Exercise Prices
$ 5.90 to $ 7.20
$ 11.50 to $16.19
$ 20.00 to $25.88

Number
Outstanding at
February 3, 2001
70,634
483,113
108,875
662,622

Options Outstanding
Weighted
Average
Remaining
Contractual
Life
(in Years)

1
3.8
2.1

Options Exercisable

Weighted
Average
Exercise
Price
$ 7.04
$ 14.19
$ 25.52

Number
Exercisable at
February 3, 2001
69,084
80,881
4,100
154,065

Weighted
Average
Exercise
Price
$ 7.03
$12.94
$25.50

The Company applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees and related
interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based
compensation. Had compensation cost for the Company’s stock option plan been determined based on the fair value at the grant
date for awards in 2000, 1999, and 1998 consistent with the method prescribed by SFAS No. 123, Accounting for Stock-Based
Compensation, the Company’s operating results for 2000, 1999, and 1998 would have been reduced to the pro forma amounts
indicated below:

Net income

As reported
Pro forma

Basic earnings per share

As reported
Pro forma

Diluted earnings per share

As reported
Pro forma

2001

1999
2000
(in thousands, except per share data)

$ 14,849
14,260

$ 10,702
10,363

8,830
8,322

1.24
1.19

1.22
1.17

0.9
0.88

0.89
0.86

0.75
0.71

0.73
0.69

notes to consolidated
financial statements

2 0 0 0 A N N U A L R E P O R T

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions using grants in 2000, 1999 and 1998, respectively:

Average expected life (years)
Average expected volatility
Risk-free interest rates
Dividend yield

2000
3
39.00%
5.60%
1.30%

1999
3
43.30%
4.80%
1.50%

1998
3
41.50%
5.50%
1.30%

The weighted average grant-date fair value of options granted during 2000, 1999,and 1998 was $3.90, $4.17, and $7.85 respectively.

Restricted stock. During 2000, 1999, and 1998, the Company issued (cancelled) a net of (25,272), 4,200, and 40,682 restricted
shares,respectively. Compensation expense related to the shares issued is recognized over the period for which restrictions apply.

Employee stock ownership plan. The Company has a non-contributory employee stock ownership plan for the benefit of
qualifying employees who have completed one year of service and attained the age of 18. Benefits are fully vested upon
completion of seven years of service. The Company has not made any contributions to the plan since 1996.

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 Company’s Board of Directors. Participants are 100% vested in their contributions and earnings thereon. Contributions
by the Company and earnings thereon are fully vested upon completion of seven years of service. The Company’s
contributions for the years ended February 3, 2001, January 29, 2000 and January 30, 1999 were $100,000, $96,000 and $83,000,
respectively.

Postretirement benefits. The Company provides certain health care benefits to its full-time employees that retire between
the ages of 58 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 Company’s change in benefit obligation based upon an actuarial
valuation is as follows:

Benefit obligation at beginning of year
Service cost
Interest cost
Participant contributions
Amendments
Actuarial (gain) loss
Benefits paid
Benefit obligation at end of year

February 3,
2001

1,377
132
116
-
-
68
(76)
1,617

For the Years Ended
January 29,
2000
(in thousands)

1,252
127
91
-
-
(17)
(76)
1,377

January 30,
1999

1,132
103
85
4
-
(67)
(5)
1,252

2 0 0 0 A N N U A L R E P O R T

notes to consolidated
financial statements

A reconciliation of the Plan’s funded status to accrued benefit cost follows:

Funded status
Unrecognized net actuarial gain
Unrecognized prior service cost
Accrued benefit costs

February 3,
2001

January 29,
2000
(in thousands)

January 30,
1999

$ (1,617)
(322)
(5)
$ (1,944)

$ (1,377)
(406)
(6)
$ (1,789)

$ (1,252)
(405)
(6)
$ (1,663)

The medical care cost trend used in determining this obligation is 10.0% effective February 1, 1997, decreasing annually before
leveling at 6.0% in 2003. This trend rate has a significant effect on the amounts reported. To illustrate, increasing the health
care cost trend by 1% would increase the accumulated postretirement benefit obligation by $238,000. The discount rate used
in calculating the obligation was 7.5% in 2000, 7.75% in 1999 and 6.75% in 1998.

The annual net postretirement cost is as follows:

February 3,
2001

132
116
(17)
1
232

For the Years Ended
January 29,
2000
(in thousands)

127
91
(17)
1
202

January 30,
1999

103
85
(21)
1
168

Service cost
Interest cost
Amortization of net gain from prior periods
Amortization of unrecognized prior service cost
Net periodic postretirement benefit cost

The Company’s policy is to fund claims as incurred.

NOTE 9 - 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 securities or other contracts to issue common stock were exercised or converted 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.

notes to consolidated
financial statements

2 0 0 0 A N N U A L R E P O R T

A reconciliation of basic earnings per share to diluted earnings per share follows (in thousands, except per share data):

February 3, 2001

Years Ended
January 29, 2000

January 31, 1999

Income
$ 14,849

Shares
11,937

Per
Share
Amount
$ 1.24

Income
$ 10,702

Shares
11,827

Per
Share
Income
Amount
$ 0.90 $ 8,830

78
182
12,197

$ 1.22

$ 10,702

108
137
12,072

$ 0.89 $ 8,830

Basic EPS
Effect of Dilutive

Securities

Restricted stock
Stock options

Diluted EPS

$ 14,849

Per
Share
Amount
$ 0.75

$ 0.73

Shares
11,798

79
201
12,078

NOTE 10 - COMMITMENTS AND CONTINGENCIES

Commitments. At February 3, 2001, the Company had commitments approximating $5,082,000 on issued letters of credit
which support purchase orders for merchandise. Additionally, the Company had outstanding letters of credit aggregating
$2,552,000 utilized as collateral for their risk management programs.

Litigation. The Company is a party to several pending legal proceedings and claims 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 results of
operations, cash flows, or the financial condition of the Company.

NOTE 11 - OTHER EXPENSES

During the fourth quarter of 1996, the Company recorded a $2,860,000 accrual for the closure of certain underperforming
stores and the repositioning of certain merchandise categories. This charge included an accrual for closed facility lease
obligations of $1,156,000. The remaining lease obligation at February 3, 2001 represents remaining future base payments
required on one location that has been closed.

The 2000 activity in this reserve is as follows:

Lease obligations

$ 400

$ 215

$ (129)

$ 86

January 30,
1999

January 29,
2000

Payments

February 3,
2001

(in thousands)

2 0 0 0 A N N U A L R E P O R T

notes to consolidated
financial statements

NOTE 12 – QUARTERLY FINANCIAL DATA (UNAUDITED)

Year Ended February 3, 2001 - restated (1) (2)
Net sales
Gross profit
Net income
Net income per share

Basic
Diluted

Cash dividends paid per share

Year Ended January 29, 2000 - pro forma (3)
Net sales
Gross profit
Net income
Net income per share

Basic
Diluted

Cash dividends paid per share

Year Ended January 29, 2000 - as reported
Net sales
Gross profit
Net income
Net income per share

Basic
Diluted

Cash dividends paid per share

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

(in thousands, except per share data)

$ 176,132
48,990
3,345

$ 180,353
49,060
1,654

$ 180,141
51,850
3,829

$ 244,623
65,234
6,021

0.28
0.28
0.05

0.14
0.14
0.05

0.32
0.31
0.05

0.5
0.49
0.05

$ 154,226
44,135
2,766

$ 155,792
43,775
920

$ 156,741 $ 199,018
52,949
4,339

46,780
2,677

0.23
0.23
0.05

0.08
0.08
0.05

0.22
0.22
0.05

0.37
0.36
0.05

$ 154,934
44,319
2,886

$ 156,498
43,952
1,037

$ 158,049 $ 196,296
52,251
3,883

47,117
2,896

0.24
0.24
0.05

0.09
0.09
0.05

0.24
0.24
0.05

0.33
0.32
0.05

(1)

(2)

Based upon a 53 week year.

As discussed in “Recent Accounting Pronouncements” in Note 1, the above information has been restated to reflect the
impact of the Company implementing the interpretations in SAB 101 related to layaway sales during the fourth quarter of
2000. In the quarters in the year ended February 3, 2001, the effects of this restated on previously reported net sales,
gross profit, net income and net income per share (basic & diluted) was a decrease of $528,000, $132,000, $87,000 and $.01,
respectively, for the 1st quarter; a decrease of $453,000, $111,000, $73,000 and $.00, respectively, for the 2nd quarter; and
a decrease of $951,000, $239,000, $158,000 and $.01, respectively, for the 3rd quarter.

(3)

For informational purposes only, 1999 quarterly results have been restated on proforma basis as if the effects of SAB 101
on layaway sales had been applied to the 1999 quarterly reports.

report of independent
accountants

To the Board of Directors and Shareholders of Fred’s, Inc.

2 0 0 0 A N N U A L R E P O R T

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of changes

in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of Fred’s, Inc. and its

subsidiaries at February 3, 2001 and January 29, 2000, and the results of their operations and their cash flows for each of the

three years in the period ended February 3, 2001, in conformity with accounting principles generally accepted in the United

States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to

express an opinion on these financial statements based on our audits. We conducted our audits of these statements in

accordance with auditing standards generally accepted in the United States of America, which 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, and evaluating the overall financial

statement presentation. We believe that our audits provide a reasonable basis for our opinion expressed above.

April 4, 2001

2 0 0 0 A N N U A L R E P O R T

directors and officers

Executive Officers

Michael J. Hayes
Chief Executive Officer

David A. Gardner
Managing Director

John D. Reier
President

John A. Casey
Executive Vice President – Pharmacy Operations

Jerry A. Shore
Executive Vice President and Chief Financial Officer

Charles A. Brunjes
Senior Vice President of Store Operations

Charles S. Vail
Corporate Secretary, Vice President – Legal Services
and General Counsel

Board of Directors

Michael J. Hayes
Chief Executive Officer
Fred's, Inc.

David A. Gardner
Managing Director
Fred's, Inc.
President
Gardner Capital Corporation
(a real estate and venture capital investment firm)

John R. Eisenman
Real Estate Investments
REMAX Island Realty, Inc.
Former President of Sally's, Inc.
(a restaurant chain)
Former commercial real estate developer

Roger T. Knox
Chief Executive Officer and President
Memphis Zoological Society
Former Chairman of the Board and
Chief Executive Officer
Goldsmith's Department Stores
(retailing)

John D. Reier
President
Fred's Inc.

Thomas J. Tashjian
Private Investor

corporate information

Corporate Offices
Fred's, Inc.
4300 New Getwell Road
Memphis, Tennessee 38118
(901) 365-8880

Transfer Agent
Union Planters National Bank
Memphis, Tennessee

Independent Accountants
PricewaterhouseCoopers LLP
Memphis, Tennessee

Securities Counsel
Baker, Donelson, Bearman & Caldwell
Memphis, Tennessee

Annual Report on Form 10-K
A copy of the Company's Annual Report on Form 10-K
for the year ended February 3, 2001, as filed with the
Securities and Exchange Commission, may be obtained by
shareholders of record without charge upon written
request to Jerry A. Shore, Executive Vice President and
Chief Financial Officer.

Annual Meeting of Shareholders
The 2001 annual meeting of shareholders will be held
at 10:00 a.m. local time on Wednesday, June 6, 2001, at
the Memphis Marriott Hotel, 2625 Thousand Oaks
Boulevard, Memphis, Tennessee. Shareholders of record
as of April 20, 2001, are invited to attend this meeting.

Stock Market Information
The Company's common stock trades on the Nasdaq Stock
Market under the symbol FRED (CUSIP No. 356108-10-0). At
April 20, 2001, the Company had an estimated 5,400
shareholders, including beneficial owners holding shares in
nominee or street name.

The table below sets forth the high and low stock prices,
together with cash dividends paid per share, for each fiscal
quarter in the past two fiscal years:

High

Low

Dividends
Per Share

1999
First
Second
Third
Fourth

2000
First
Second
Third
Fourth

SIC 5331

$ 15.00
$ 17.63
$ 18.00
$ 17.63

$ 16.00
$ 21.06
$ 25.00
$ 23.69

$ 9.75
$ 10.31
$ 10.69
$ 11.50

$ 14.13
$ 15.00
$ 18.75
$ 17.13

$ 0.05
$ 0.05
$ 0.05
$ 0.05

4300 New Getwell Road
Memphis, Tennessee 38118