Fred's Inc. Annual Report 2002

FY2002 Annual Report · Fred's Inc.

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2002 ANNUAL REPORT

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

About the Company

Fred’s, Inc., founded in 1947, operates 414 discount general merchandise stores in 14 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.

103

Number of Company-Owned and
Franchised Stores by State

Fred’s new distribution center in Dublin, Georgia. Opened April 2003.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Financial Highlights

(in thousands, except per share amounts)

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

Net Sales
(in millions)

Comparable Store Sales

Net Income Per Share-
Diluted

Year Ended

February 1,
2003

February 2,
2002

$1,103,418
42,677
28,216
1.08
26,167

$ 138,453
345,848
2,510
250,770

$ 910,831
31,751
19,629
.81
24,197

$ 138,379
284,059
1,320
218,907

1.0%

0.6%

1
0
6
$

6
6
6
$

1
8
7
$

1
1
9
$

3
0
1
,
1
$

%
6
.
5

%
2
.
5

%
2
.
9

%
5
.
0
1

%
2
.
1
1

9
3
.
$

7
4
.
$

5
6
.
$

1
8
.
$

8
0
.
1
$

Number of
Company-Owned Stores
(end of period)

Sales Per Square Foot

Selling Space (Square Footage)
(in millions)

Stores

Pharmacies

3
8
2

0
8
1

3
9
2

2
8
1

0
2
3

8
9
1

3
5
3

2
0
2

4
1
4

6
1
2

1
7
1
$

4
7
1
$

9
8
1
$

7
9
1
$

6
0
2
$

0
8
6
,
3

6
6
9
,
3

6
4
3
,
4

2
9
8
,
4

5
8
7
,
5

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Letter to Shareholders

“Our market strategy is one that uniquely combines low prices,

convenient store settings, friendly service and a wide selection of merchandise,

including prescription drugs in more than half our stores.”

What a dynamic and interesting year
2002 was for Fred’s – the most
successful in our company’s history
and unquestionably the most
challenging! Quarter by quarter,
Fred’s exceeded sales and financial
targets that we considered aggressive
at the time. These impressive results
were even more remarkable when
viewed in terms of our strong
historical performance over the past
five years.

For fiscal 2002, which ended on
February 1, 2003, our sales broke
through the billion-dollar mark for
the first time ever, increasing 21% to
$1.103 billion, up from $911 million
in fiscal 2001. Comparable store
sales for 2002 increased 11.2% over
2001 – our second straight year of
double-digit comparable store sales
growth. Net income for 2002
increased 44% to $28.2 million
from $19.6 million in 2001, while
earnings per diluted share rose 33%
to $1.08 from $0.81 in 2001.

In terms of sales, market share gains
and financial performance, Fred’s
delivered better-than-anticipated
results in 2002. Perhaps more relevant
to you, our shareholders, is that even
with these solid trends in sales and
earnings, our management team still
believes that the best is yet to come.

A Strong Niche
This ongoing growth and prosperity,
amid one of the most challenging
economic environments in some time,
has much to do with our market niche
and the business model we have
created. While many retail segments
have been hard hit by the nation’s
current economic woes, Fred’s has
gained market share. Our model is
built on providing basic merchandise
that our customers need every day,
promoted by using compelling periodic
circulars that highlight the exceptional
value pricing and exciting special
merchandise purchases that we offer.

Our market strategy is one that
uniquely combines low prices,
convenient store settings, friendly
service and a wide selection of
merchandise, including prescription
drugs in more than half our stores.
It’s an offering that differentiates us in
the marketplace, apart from the huge
mega stores that appeal to destination
shoppers who don’t mind investing
considerable time and effort to
navigate the “big box.” With an in-
store pharmacy, Fred’s also is a more
complete package than the dollar
stores that provide only limited
merchandise selections or the chain
drugstores that don’t offer everyday
low pricing and, thus, cannot fully
serve the customer who wants to
save both time and money.

Our success is more than coincidence,
luck, or just being in the right place
at the right time. It is a hard-won
accomplishment that comes from
remaining keenly focused on what
you do, why it works, and how to
keep winning customers. The
perspective of history – knowing
where Fred’s stood just five years ago
and seeing just how far the Company
has come during the intervening
time – provides useful insight into
the key drivers of our performance
since 1998 and helps explain why
management remains confident and
excited about Fred’s future.

Now and Then
In fiscal 1998, Fred’s had 283
Company-owned stores in 10 states,
having just added 22 stores that year,
net of store closings. Of the total
open at that time, 180 stores had
pharmacies. We had just recently
completed a significant upgrade of
our sole distribution center in
Memphis and predicted that, with
these improvements, our distribution
center would support perhaps up to
425 stores, thus providing significant
capacity for future growth.

Our stores in 1998 comprised almost
3.7 million square feet of retail space
and generated just over $600 million
in sales. Comparable store sales for
the year were 5.6% and sales per square

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Letter to Shareholders

“A closer review of the changes that have occurred at Fred’s over the past five years

reveals several fundamental, powerful, Company-specific initiatives that have helped Fred’s generate

increasing operating momentum and accelerated earnings.”

foot rose 8% to $171. Earnings per
diluted share for the year totaled
$0.39 on a split-adjusted basis.

at our original Memphis center and
greatly enhancing the supply logistics
of our chain.

Dusting off our annual report from
1998, we said we were generally
pleased with the Company’s
accomplishments that year, given the
stress of having to complete a major
retrofit of our sole distribution
center. We were confident that
better years were ahead if we could
maintain our discipline and continue
to refine our merchandise mix.
What a contrast we witnessed in the
Company’s performance over the
next five years with those steps taken!

Sales for 2002 were 84% higher than
those in 1998, while our profitability
expanded at an even faster pace of
220%. Our market region now
stretches over four new states, and
we have increased our retail base
almost 50% to 414 stores, including
216 with pharmacies. Our retail
selling space has jumped 57% in five
years to almost 5.8 million feet.
Comparable store sales have gone
from acceptable to exceptional, while
sales per square foot have expanded
more than 20% to $206 in 2002.
And we broke ground on our second
distribution center in Dublin, Georgia,
which will support our recent and
planned expansion to the east and
south, augmenting available capacity

Meanwhile, the Company has
trimmed long-term debt to a
fraction of what it was in 1998,
down to about 1.0% of equity from
8.6% in 1998. This was no small
feat considering the $35 million in
capital expenditures associated with
our new distribution center, of
which about $24 million was
expended in 2002, as well as the
substantial investments we continue
to make to expand our chain and
remodel select stores. Stockholders’
equity, on the other hand, has
increased 83% since 1998, reaching
more than $250 million by the end
of 2002. This fact is made more
significant knowing that Fred’s has
returned almost $13 million in cash
dividends to shareholders over the
past five years.

Supporting Initiatives
A closer review of the changes that
have occurred at Fred’s over the past
five years reveals several fundamental,
powerful, Company-specific
initiatives that have helped Fred’s
generate increasing operating
momentum and accelerated earnings.
One of the most important involves
our merchandising strategy. Since
1999, our President, John Reier, has

guided our merchants in developing
and enhancing a merchandise mix
that is more attuned to our
customers’ needs, and in capitalizing
on opportunistic buys that draw
customers to our stores and boost
gross margin. With store operations
focusing on better-planned and
better-presented merchandise up and
down our aisles, we have seen our
traffic and average transaction
increase year after year.

Our pharmacy department also
continues to leverage upon itself,
figuring prominently in Fred’s
sales growth. Pharmacy sales, which
comprised about one-third of total
sales in 2002, continue to provide
a strong competitive edge for us
by expanding Fred’s convenience
quotient. And, at a time when
Americans are taking more
prescription medications than ever
before, our pharmacies provide
increasing rationale for repeat visits
and add-on purchases.

Additionally, the new Fred’s store
prototype has played an integral role
in our ability to expand sales and
increase market share. Fred’s
prototypical store has continued to
evolve and incorporate improved
layouts, fixtures and amenities that
welcome our customers and make
their visits more convenient and

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Letter to Shareholders

“Just as in 1998, when we initiated the bold moves that enhanced our ability

to grow and helped ensure that we could sustain that growth, we think the steps taken in 2002

should serve as a catalyst for the next five years.”

management and information
technology personnel, as we remain
focused on our most important
assets – our human resources.

In summary, 2002 was an important
year, leveraging an extraordinary
five-year period of growth for Fred’s.
Just as in 1998, when we initiated
the bold moves that enhanced our
ability to grow and helped ensure
that we could sustain that growth,
we think the steps taken in 2002
should serve as a catalyst for the next
five years. This explains
management’s optimism that the
best years are still ahead and that
they have the potential to be even
more rewarding for Fred’s and its
shareholders.

Michael J. Hayes
Chief Executive Officer

enjoyable. We have been delighted
by the performance of new stores
based on this prototype – sales
ramp-up faster, they achieve higher
sales per square foot, and the use of
the new prototype helps us drive
down store opening costs.

All of these strategies have enabled
us to fulfill our longstanding
objective – improving operating
margin. With keen merchandising
and sourcing strategies, we have
witnessed relatively stable gross
margins through the years. Couple
this with our ability to control costs
and leverage operating expenses over
a growing sales base, and you can see
why Fred’s has been able to increase
operating margin 63% between
1998 and 2002.

Focus on the Future
We are gratified by the Company’s
performance in 2002. It marks the
culmination of many initiatives over
the past five years to build both
quality and value for our customers.
Yet we are most excited by what this
progress means for Fred’s over the
next five years.

Our optimism stems partly from the
hard work we have dedicated to
building an infrastructure that can
sustain our ambitious plans for the
future. One key piece of this is the

new, state-of-the-art distribution
center referred to earlier, which is
fully operational at this writing.
This new 600,000-square-foot center
significantly expands our capabilities
to support a growing store base,
positioning Fred’s to serve a growing
presence in Alabama, Georgia,
Florida, North Carolina, and South
Carolina, as well as its expected
growth into new markets in the
future. We devoted a great deal of
time and attention to planning the
opening and operation of this new
facility and are very pleased with the
manner in which these activities are
proceeding, with initial receiving and
shipping activities ramping up
smoothly – on plan and on budget.
Consequently, we believe this new
capacity will provide the framework
for a new era of planned and
controlled expansion.

Simultaneous with our expanded
distribution capabilities, we have
continued to make considerable
investments in systems. We have
initiated a program to enhance all of
our store-level operating systems to
provide even faster, more accurate
communications between our
corporate offices and our retail
locations. In lockstep with these
efforts, we also continue to enhance
our infrastructure, highlighted by
additions to logistics, store

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Selected Financial Data

(dollars 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:3

Basic
Diluted

Cash dividend paid per share3

Selected Operating Data:
Operating income as a percentage of sales
Increase in comparable store sales 4
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

2002

2001

20001

1999

19982

$ 1,103,418
42,677
42,474
14,258
28,216

$ 910,831
31,751
30,140
10,511
19,629

$ 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

1.11
1.08
.12

.83
.81
.12

.66
.65
.12

.48
.47
.12

3.9%
11.2%
414

3.5%
10.5%
353

3.3%
9.2%5
320

2.9%
5.2%
293

.40
.39
.12

2.4%
5.6%
283

$ 345,848
905
2,510
250,770

$ 284,059
1,240
1,320
218,907

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

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

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

1 Results for 2000 include 53 weeks.
2 Results for 1998 include the effect of the 1998 adoption of LIFO for pharmacy inventories.
3 Adjusted for the 5-for-4 stock split effected on June 18, 2001 and the 3-for-2 stock split effected on February 1, 2002.
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.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Management’s Discussion and Analysis

C R I T I C A L A C C O U N T I N G P O L I C I E S

The preparation of Fred’s financial statements requires management to make estimates and judgments in the reporting of

assets, liabilities, revenues, expenses and related disclosures of contingent assets and liabilities. Our estimates are based on
historical experience and on other assumptions that we believe applicable under the circumstances, the results of which form the
basis for making judgments about the values of assets and liabilities that are not readily apparent from other sources. While we
believe that the historical experience and other factors considered provide a meaningful basis for the accounting policies applied
in the consolidated financial statements, the Company cannot guarantee that the estimates and assumptions will be accurate
under different conditions and/or assumptions. A summary of our critical accounting policies and related estimates and
judgments, can be found in Note 1 and the most critical accounting policies are as follows:

I N V E N T O R I E S

Warehouse inventories are stated at the lower of cost or market using the FIFO (first-in, first-out) method. Retail
inventories are stated at the lower of cost or market as determined by the retail inventory method. Under the retail inventory
method (“RIM”), the valuation of inventories at cost and the resulting gross margin are calculated by applying a calculated cost-
to-retail ratio to the retail value of inventories. RIM is an averaging method that has been widely used in the retail industry due
to its practicality. Also, it is recognized that the use of the RIM will result in valuing inventories at lower of cost or market if
markdowns are currently taken as a reduction of the retail value of inventories. Inherent in the RIM calculation are certain
significant management judgments and estimates including, among others, initial markups, markdowns, and shrinkage, which
significantly impact the ending inventory valuation at cost as well as resulting gross margin. These significant estimates, coupled
with the fact that the RIM is an averaging process, can, under certain circumstances, produce distorted or inaccurate cost figures.
Management believes that the Company’s RIM provides an inventory valuation which reasonably approximates cost and results
in carrying inventory at the lower of cost or market. For pharmacy inventories, which are $27.8 million and $24.7 million at
February 1, 2003 and February 2, 2002, respectively, cost was determined using the LIFO (last-in, first-out) method. The
current cost of inventories exceeded the LIFO cost by approximately $6.1 million at February 1, 2003 and $4.6 million at
February 2, 2002. The LIFO reserve increased by $1.5 million, $.6 million and $.8 million at February 1, 2003, February 2,
2002 and February 3, 2001, respectively.

P R O P E R T Y A N D E Q U I P M E N T

Property and equipment are stated at cost, and depreciation is computed using the straight-line method over their estimated
useful lives. Leasehold costs and improvements which are included in buildings 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, fixtures, 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.

I N S U R A N C E R E S E R V E S

The Company is largely self-insured for workers compensation, general liability and medical insurance. The Company’s
liability for self-insurance is determined based on known claims and estimates for incurred but not reported claims. If future
claim trends deviate from recent historical patterns, the Company may be required to record additional expense or expense
reductions which could be material to the Company’s results of operations.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Management’s Discussion and Analysis

The following table provides a comparison of Fred’s financial results for the past three years. In this table, categories of

income and expense are expressed as a percentage of sales.

R E S U L T S O F O P E R A T I O N 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

2002
100.0%
72.4
27.6
23.7
3.9
0.0
3.9
1.3
2.6%

2001
100.0%
72.6
27.4
23.9
3.5
0.2
3.3
1.1
2.2%

2000
100.0%
72.5
27.5
24.2
3.3
0.4
2.9
1.0
1.9%

F I S C A L 2 0 0 2 C O M P A R E D T O F I S C A L 2 0 0 1

Sales

Net sales increased 21.1% ($192.6 million) in 2002. Approximately $95.0 million of the increase was attributable to a net
addition of 61 new stores, upgraded stores, and a net addition of 14 pharmacies during 2002, together with the sales of 33 store
locations and 7 pharmacies that were opened or upgraded during 2001 and contributed a full year of sales in 2002. During
2002, the Company closed one pharmacy location. Comparable store sales, consisting of sales from stores that have been open
for more than one year, increased 11.2% in 2002.

The Company’s front store (non-pharmacy) sales increased approximately 24.2% over 2001 front store sales. Front store

sales growth benefited from the above mentioned store additions and improvements, and solid sales increases in categories such
as ladies and plus size apparel, ladies accessories, footwear, bedding and windows, home furnishings, floor coverings, giftware,
small appliances, photo supplies, electronics, tobacco and auto.

Fred’s pharmacy sales were 33.2% of total sales in 2002 from 34.4% of total sales in 2001 and continue to rank as the
largest sales category within the Company. The total sales in this department, including the Company’s mail order operation,
increased 17.1% over 2001, with third party prescription sales representing approximately 85% of total pharmacy sales, no
change from the prior year. 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 $1.8 million in 2002 and represented 3.2% of the

Company’s total sales, as compared to 3.7% in 2001. 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 as a percentage of sales increased to 27.6% in 2002 compared to 27.4% in 2001. The increase in gross
margin is a result of product mix in the general merchandise categories and increased margins in the pharmacy department due
in part to the shift to more generic medications.

Gross Margin

Selling, General and Administrative Expenses
Selling, general and administrative expenses were 23.7% of net sales in 2002 compared with 23.9% of net sales in 2001.

Labor expenses as a percent of sales improved in the stores and pharmacies as a result of strong sales coupled with store
productivity initiatives. Expenses in the stores and pharmacies improved by .4% as a percent of net sales. Increases offsetting
these improvements were in insurance, distribution and transportation expenses. Insurance expense rose in 2002 due to

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Management’s Discussion and Analysis

premium increases for insurance coverage, as well as increasing reserves associated with business growth. Distribution and
transportation expenses increased as a percent of sales due to the distances required to service newer stores which opened in the
area of the new distribution center in Dublin, Georgia which is scheduled to open in 2003.

Operating Income
Operating income increased approximately $10.9 million or 34.4% to $42.7 million in 2002 from $31.8 million in 2001.

Operating income as a percentage of sales increased to 3.9% in 2002 from 3.5% in 2001, due to the above-mentioned
improvements in gross margins and selling, general and administrative expense control.

Interest expense for 2002 totaled $.2 million (less than .1% of sales) compared to net interest expense of $1.6 million (.2%

of sales) in 2001. The significant reduction results from the funds raised from our public offering in September 2001 and
March 2002 coupled with cash flows from operations, effective working capital management throughout the year and
controlling capital expenditures.

Interest Expense, Net

Income Taxes

The effective income tax rate decreased to 33.6% in 2002 from 34.9% in 2001, primarily due to state income tax planning

that allowed utilization of $.8 million of state operating losses that were previously reserved.

As a result of certain changes in methods of accounting for income tax purposes, net operating loss carryforwards increased

in certain states during 2002. These state net operating loss carryforwards are available to reduce state income taxes in future
years. These carryforwards total approximately $63.7 million for state income tax purposes and expire at various times during
the period 2003 through 2022. If certain substantial changes in the Company’s ownership should occur, there would be an
annual limitation on the amount of carryforwards that can be utilized.

Net income for 2002 was $28.2 million (or $1.08 per diluted share) or approximately 43.8% higher than the $19.6 million

(or $.81 per diluted share) reported in 2001.

Net Income

F I S C A L 2 0 0 1 C O M P A R E D T O F I S C A L 2 0 0 0

Sales
Net sales increased 16.6% ($129.6 million) in 2001. Approximately $54.0 million of the increase was attributable to the

addition of 33 new or upgraded stores, and 7 pharmacies during 2001, together with the sales of 31 store locations and 16
pharmacies that were opened or upgraded during 2000 and contributed a full year of sales in 2001. During 2001, the Company
closed 3 pharmacy locations. Comparable store sales, consisting of sales from stores that have been open for more than one year,
increased 10.5% in 2001.

The Company’s front store (non-pharmacy) sales increased approximately 15.5% over 2000 front store sales. Front store

sales growth benefited from the above mentioned store additions and improvements, and solid sales increases in categories such
as home furnishings, floor coverings, bath, giftware, small appliances, photo finishing, girl’s apparel, missy ready-to-wear, infants
and toddler apparel, beverages, food and snacks.

Fred’s pharmacy sales grew to 34.4% of total sales in 2001 from 33% of total sales in 2000 and continue to rank as the

largest sales category within the Company. The total sales in this department, including the Company’s mail order operation,
increased 21.2% over 2000, with third party prescription sales representing approximately 85% of total pharmacy sales,
compared with 83% of total pharmacy sales in 2000. 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 $.8 million in 2001 and represented 3.7% of the Company’s

total sales, as compared to 4.0% in 2000. 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.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Management’s Discussion and Analysis

Gross margin as a percentage of sales was 27.4% in 2001 compared to 27.5% in 2000. The decrease in gross margin is a result
of margin reduction in the pharmacy department partially offset by margin improvements in general merchandise departments.

Gross Margin

Selling, General and Administrative Expenses
Selling, general and administrative expenses were 23.9% of net sales in 2001 compared with 24.2% of net sales in 2000.

Labor expenses improved in the stores and pharmacies as a result of the strong sales coupled with store productivity initiatives.
Distribution center labor expense also improved as a percentage of volume processed. Corporate communications expense
improved as a result of installing new technology that reduced expenses.

Operating Income
Operating income increased approximately $6.0 million or 23.5% to $31.8 million in 2001 from $25.7 million in 2000.

Operating income as a percentage of sales increased to 3.5% in 2001 from 3.3% in 2000, due to the above-mentioned reasons.

Interest Expense, Net
Interest expense for 2001 totaled $1.6 million or .2% of sales compared to net interest expense of $3.2 million or .4% of

sales in 2000. The significant reduction results from the funds raised from our public offering of 1,585,000 company shares in
September 2001(unadjusted for 3-for-2 stock split completed February 1, 2002), lower interest rates, and improved inventory
turnover and expense control.

The effective income tax rate increased to 34.9% in 2001 from 34.0% in 2000, due to increased income levels which

eliminated the benefit of graduated tax rates.

At February 2, 2002, the Company had 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 totaled
approximately $43.9 million for state income tax purposes, and expire at various times during the period 2003 through 2023.

Income Taxes

Net income for 2001 was $19.6 million (or $ .81 per diluted share) or approximately 32.2% higher than the $14.8 million

(or $.65 per diluted share) reported in 2000.

Net Income

L I Q U I D I T Y A N D C A P I T A L R E S O U R C E S

Fred’s primary sources of working capital have traditionally been cash flow from operations and borrowings under its credit

facility. In March 2002 the Company raised proceeds of $3.5 million from the offering of 98,756 Company shares. In
September 2001 the Company raised proceeds of $38.2 million from a secondary offering of 1,585,000 Company shares
(unadjusted for 3-for-2 stock split completed February 1, 2002). The Company had working capital of $138.5 million, $138.4
million, and $110.5 million at year-end 2002, 2001 and 2000, 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 2002 and 2001 were approximately the same primarily resulting from inventory purchased for new store
openings scheduled for the first quarter of 2003. The Company plans to open 30 new stores during the first quarter of 2003.
Net cash flow provided by operating activities totaled $43.7 million in 2002, $26.4 million in 2001, and $27.1 million

in 2000.

In fiscal 2002, cash was primarily used to increase inventories by approximately $31.4 million during the fiscal year. This

increase is primarily attributable to our adding a net of 61 new stores, upgrading 30 stores and adding a net of 14 new
pharmacies, as well as supporting the improved comparable store sales. Accounts payable and accrued liabilities increased by
$20.0 million due primarily to higher inventory purchases. Income taxes payable decreased by approximately $6.8 million and
the net deferred income tax asset increased by approximately $12.3 million primarily as a result of certain changes in method of

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Management’s Discussion and Analysis

accounting for income tax purposes. The majority of the adjustment from the accounting method changes is due to a change in
method of accounting for inventory in retail stores from the retail inventory method to the cost method.

In fiscal 2001, cash was primarily used to increase inventories by approximately $14.3 million during the fiscal year. This
increase is primarily attributable to our adding 33 new stores, upgrading 6 stores and adding a net of 4 new pharmacies, as well
as supporting the improved comparable store sales. Accounts payable and accrued liabilities increased by $3.5 million due
primarily to higher inventory purchases. Income taxes payable decreased by approximately $2.4 million as a result of required
income tax payments. Fiscal 2000 cash was primarily used to increase inventories by approximately $8.7 million during the
fiscal year. Also, accounts receivable increased $4.6 million due to increased pharmacy sales involving third party carriers.
Accounts payable and accrued liabilities increased by $5.1 million due primarily to higher inventory purchases. Income taxes
payable increased as a result of tax strategies put in place in prior years that had a favorable effect in 2000.

Capital expenditures in 2002 totaled $50.8 million compared with $17.4 million in 2001 and $15.8 million in 2000. The

2002 capital expenditures included approximately $23.9 million for the new distribution center being constructed in Dublin,
Georgia. This new facility is expected to be opened in April, 2003. Expenditures totaling approximately $24.2 million were
associated with upgraded, remodeled, or new stores and pharmacies. Approximately $2.7 million in expenditures related to
technology upgrades, distribution center equipment, freight equipment, and capital maintenance. The 2001 capital expenditures
included approximately $13.5 million of expenditures associated with upgraded, remodeled, or new stores and pharmacies and
approximately $3.9 million in expenditures related to technology upgrades, distribution center equipment, freight equipment,
and capital maintenance. The 2000 capital expenditures included approximately $12.2 million of expenditures associated with
upgraded, remodeled, or new stores and pharmacies. Approximately $3.6 million in expenditures related to technology
upgrades, distribution center equipment, freight equipment, and capital maintenance. Cash used for investing activities also
includes $1.8 million in 2002, $1.0 million in 2001, and $2.8 million in 2000 for the acquisition of customer lists and other
pharmacy related items.

In 2003, the Company is planning capital expenditures totaling approximately $34.1 million, including $11.1 million
remaining on construction of the new distribution center being constructed in Dublin, Georgia. This new facility is expected to
open in April 2003. Expenditures are planned totaling $20.5 million for the upgrades, remodels, or new stores and pharmacies.
Planned expenditures of $2.5 million relate to technology upgrades, distribution center equipment and capital maintenance. The
Company also plans expenditures of $1.8 million in 2003 for the acquisition of customer lists and other pharmacy related items.

Cash and cash equivalents were $8.2 million at the end of 2002 compared to $15.9 million at year-end 2001. Short-term

investment objectives are to maximize yields while minimizing company risk and maintaining liquidity. Accordingly, limitations
are placed on amounts and types of investments.

In April 2000, the Company and a bank entered into a new Revolving Loan and Credit Agreement. 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 the prime rate or a LIBOR-based rate (weighted average interest rate of 2.9% on 2002 outstanding borrowings). The
credit capacity is used to accommodate the Company’s continued growth and seasonal inventory needs. Under the most
restrictive covenants of the Agreement, we are required to maintain specific shareholders’ equity and net income levels. We are
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 credit commitment, as amended on April 30, 2002 extends to March 31,
2004. There were no borrowings outstanding under this agreement at either February 1, 2003 or February 2, 2002.

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 2002, the outstanding principal balance on the term loan was approximately $ .1 million compared with $.7
million at year-end 2001.

On March 6, 2002, the Company filed a Registration Statement on Form S-3 registering 500,000 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. On March 22, 2002 the Company raised proceeds of $3.5 million from
the offering of 98,756 shares.

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.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Management’s Discussion and Analysis

The Company has no off-balance sheet financing arrangements.

O F F - B A L A N C E S H E E T A R R A N G E M E N T S

E F F E C T S O F I N F L A T I O N A N D C H A N G I N G P R I C E S

The Company believes that inflation and/or deflation had a minimal impact on its overall operations during fiscal years

2002, 2001 and 2000.

C O N T R A C T U A L O B L I G A T I O N S A N D C O M M E R C I A L C O M M I T M E N T S

As discussed in Note 6 of 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 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 future minimum rental payments under all operating and capital leases as of February 1, 2003 are
$106.3 million and $3.1 million, respectively.

(Dollars in thousands)
Contractual Obligations
Term Loans
Capital Lease Obligations
Operating Leases
Financing Obligations
Total Contractual Obligations

Total

141
3,117
106,269
157
$109,684

2003

141
728
24,750
36
$ 25,655

Payments due by period
2005

2006

2004

–
703
21,814
17
$ 22,534

–
665
18,879
18
$ 19,562

–
543
15,014
19
$ 15,576

2007

–
352
10,405
21
$ 10,778

>2007

–
126
15,407
46
$ 15,579

As discussed in Note 10 of the consolidated financial statements, the Company had commitments approximating $10.4

million at February 1, 2003 on issued letters of credit which support purchase orders for merchandise. Additionally, the
Company had outstanding letters of credit aggregating $7.9 million at February 1, 2003 utilized as collateral for their risk
management programs.

The Company is financing 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 ($18,485) against the related liability and neither is reflected on the consolidated balance sheet.

R E C E N T A C C O U N T I N G P R O N O U N C E M E N T S

In June 2001, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 142, Goodwill and Other

Intangible Assets. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed
annually for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized
over their useful lives. The Company will continue to amortize intangible assets in accordance with existing policy and
accordingly the adoption of SFAS No. 142 did not have a material impact on the Company’s financial position or results of
operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS

No. 144 is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. The
Company adopted this statement on February 3, 2002. This statement addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. It supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of. The adoption of SFAS No. 144 did not have a material impact on the Company’s
financial position or results of operations.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Management’s Discussion and Analysis

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB

Statement No. 13, and Technical Corrections. SFAS No. 145 rescinds both SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and the amendment to SFAS No. 4, SFAS No. 64, Extinguishments of Debt Made to Satisfy Sinking-
Fund Requirements. Generally, under SFAS No. 145, gains and losses from debt extinguishments will no longer be classified as
extraordinary items. The Company adopted the provisions of SFAS No. 145 on February 2, 2003 and believes the adoption of
SFAS No. 145 will not have a material effect on the Company’s financial position or results of operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No.
146 nullifies EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring) (“EITF 94-3”). SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is incurred, whereas EITF 94-3 had recognized the
liability at the commitment date to an exit plan. The Company was required to adopt the provisions of SFAS No. 146 effective
for exit or disposal activities initiated after December 31, 2002. The adoption of SFAS No. 146 did not have a material impact
on the Company’s financial position or results of operations.

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and
Disclosure. SFAS No. 148 is an amendment of SFAS No. 123, Accounting for Stock-Based Compensation, and provides
alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation.
SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, Interim Financial Reporting,
to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect
to stock-based employee compensation on reported net income and earnings per share in annual and interim financial
statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options
using the fair value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based
employee compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123
or the intrinsic value method of APB Opinion No. 25, Accounting for Stock Issued to Employees. As allowed by SFAS No. 123,
the Company has elected to continue to utilize the accounting method prescribed by APB Opinion No. 25 and has adopted the
disclosure requirements of SFAS No. 148 as of February 2, 2003. The adoption of SFAS No. 148 did not have a material
impact on the Company’s financial position or results of operations.

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 02-16, Accounting by a
Customer (including a Reseller) for Certain Consideration Received from a Vendor (“EITF 02-16”). 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 vendor’s products or for the promotion of sales of the vendor’s 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. As clarified by the EITF in January 2003, this issue is effective for arrangements with vendors
initiated on or after January 1, 2003. The provisions of this consensus have been applied prospectively. The adoption of EITF
02-16 is not expected to have a material impact on the Company’s financial position or results of operations.

FASB Interpretation No. 46, Accounting for Variable Interest Entities (“FIN 46”), expands upon current guidance relating
to when a company should include in its financial statements the assets, liabilities and activities of a variable interest entity. The
consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply for “older” entities in the first fiscal year or interim period beginning after June 15, 2003,
which would apply for the Company beginning in the third quarter of 2003. The Company is currently evaluating the impact
that the adoption of FIN 46 will have on its financial position and results of operations when adopted in 2003.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Consolidated Statements of Income

(in thousands, except per share amounts)

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 1,
2003
$ 1,103,418
798,441
304,977

For the Years Ended
February 2,
2002
$ 910,831
661,110
249,721

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

262,300
42,677

203
42,474

14,258
28,216

1.11
1.08

$
$

217,970
31,751

1,611
30,140

10,511
19,629

.83
.81

$
$

189,414
25,720

3,226
22,494

7,645
14,849

.66
.65

$
$

25,503
26,167

23,553
24,197

22,382
22,869

See accompanying notes to consolidated financial statements.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Consolidated Balance Sheets

(in thousands, except for number of shares)

ASSETS
Current assets:

Cash and cash equivalents
Receivables, less allowance for doubtful accounts of $975

($657 at February 2, 2002)

Inventories
Deferred income taxes
Other current assets

Total current assets

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

$2,542 ($1,849 at February 2, 2002)

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
Deferred tax liability
Income taxes payable

Total current liabilities

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

Commitments and contingencies (Notes 6 and 10)

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, 25,673,259 shares issued and outstanding
(25,361,112 shares issued and outstanding at February 2, 2002)

Common stock, Class B nonvoting, no par value, 11,500,000

shares authorized, none outstanding

Retained earnings
Deferred compensation on restricted stock incentive plan

Total shareholders’ equity
Total liabilities and shareholders’ equity

See accompanying notes to consolidated financial statements.

February 1,
2003

February 2,
2002

8,209

15,906

18,400
193,506
–
7,775
227,890

15,705
163,560
1,790
2,499
199,460

110,794

78,225

2,425
4,739
$ 345,848

1,533
4,841
$ 284,059

58,489
177
728
19,484
10,559
–
89,437

121
676
2,389
2,455
95,078

43,747
562
678
14,228
–
1,866
61,081

141
696
1,179
2,055
65,152

–

117,209

110,508

–
133,589
(28)
250,770
$ 345,848

–
108,462
(63)
218,907
$ 284,059

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Consolidated Statements of Changes in Shareholders’ Equity

(in thousands, except share and per share amounts)

Balance, January 29, 2000
Cash dividends paid ($.11 per share)
Issuance of restricted stock
Cancellation of restricted stock
Exercises of stock options
Amortization of deferred compensation
on restricted stock incentive plan
Tax benefit on exercise of stock options
Net income
Balance, February 3, 2001
Proceeds from public offering
Cash dividends paid ($.12 per share)
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, February 2, 2002
Cash dividends paid ($.12 per share)
Issuance 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, February 1, 2003

Common Stock

Shares
22,478,017

Amount
$ 67,326

Retained
Earnings
$ 78,902
(2,409)

Deferred
Compensation

(315)

7,125
(54,510)
197,839

57
(218)
1,079

313

22,628,471
2,377,500

$ 68,557
38,156

(15,185)
55,980
314,346

(63)
937
2,165

756

25,361,112

$110,508

750
100,722
210,675

19
3,592
1,684

1,406

14,849
$ 91,342

(2,509)

19,629
$ 108,462
(3,089)

(57)
15

145

(212)

137

(63)

(19)

25,673,259

$ 117,209

28,216
$ 133,589

(28)

Total
$ 145,913
(2,409)
–
(203)
1,079

145
313
14,849
$ 159,687
38,156
(2,509)
(51)
937
2,165

137
756
19,629
$ 218,907
(3,089)
–
3,592
1,684

54
1,406
28,216
$ 250,770

See accompanying notes to consolidated financial statements.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Consolidated Statements of Cash Flows

(in thousands)

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
(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 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 public offering, net of expenses
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

February 1,
2003

For the Years Ended
February 2,
2002

February 3,
2001

$ 28,216

19,629

$ 14,849

21,032
318
1,535
12,329

54
–
1,406

(3,014)
(31,424)
(365)

19,998
(6,778)
400
43,707

(50,835)
–
(1,844)
(52,679)

(855)
–
3,535
1,684
(3,089)
1,275
(7,697)

15,906
8,209

180
7,300

1,585
57

$
$

17,846
142
642
1,026

137
(52)
756

(416)
(14,291)
(194)

3,532
(2,411)
52
26,398

(17,372)
–
(986)
(18,358)

(9,892)
(22,623)
38,156
2,165
(2,509)
5,297
13,337

2,569
15,906

1,775
11,000

691
937

$
$

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

–
–

$
$

See accompanying notes to consolidated financial statements.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

N O T E 1
D E S C R I P T I O N O F B U S I N E S S A N D S U M M A R Y O F

S I G N I F I C A N T A C C O U N T I N G P O L I C I E S

Description of business. The primary business of Fred’s, Inc. and subsidiaries (the “Company”) is the sale of general
merchandise through its 414 retail discount stores located in fourteen states in the Southeastern United States. Two hundred
and sixteen of the Company’s stores have full service pharmacies. 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 2002, 2001 and 2000, as used herein, refer to the years ended February 1, 2003, February 2, 2002, and February 3, 2001,
respectively. Results for 2000 include 53 weeks.

Use of estimates. The preparation of financial statements in accordance with accounting principles generally accepted in the
United States 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 equivalents.

Allowance for doubtful accounts. The Company is reimbursed for drugs sold by its pharmacies by many different payors
including the insurance companies, Medicare and various state Medicaid programs. The Company estimates the allowance on a
payor-specific basis, given its interpretation of the contract terms or applicable regulations. However, the reimbursement rates
are often subject to interpretations that could result in payments that differ from the Company’s estimates. Additionally,
updated regulations and contract negotiations occur frequently, necessitating the Company’s continual review and assessment of
the estimation process.

Inventories. Warehouse inventories are stated at the lower of cost or market using the FIFO (first-in, first-out) method. Retail
inventories are stated at the lower of cost or market as determined by the retail inventory method. Under the retail inventory
method (“RIM”), the valuation of inventories at cost and the resulting gross margin are calculated by applying a calculated cost-
to-retail ratio to the retail value of inventories. RIM is an averaging method that has been widely used in the retail industry due
to its practicality. Also, it is recognized that the use of the RIM will result in valuing inventories at lower of cost or market if
markdowns are currently taken as a reduction of the retail value of inventories. Inherent in the RIM calculation are certain
significant management judgments and estimates including, among others, initial markups, markdowns, and shrinkage, which
significantly impact the ending inventory valuation at cost as well as resulting gross margin. These significant estimates, coupled
with the fact that the RIM is an averaging process, can, under certain circumstances, produce distorted or inaccurate cost figures.
Management believes that the Company’s RIM provides an inventory valuation which reasonably approximates cost and results
in carrying inventory at the lower of cost or market. For pharmacy inventories, which are $27,819 and $24,700 at February 1,
2003 and February 2, 2002, respectively, cost was determined using the LIFO (last-in, first-out) method. The current cost of
inventories exceeded the LIFO cost by $6,138 at February 1, 2003 and $4,603 at February 2, 2002. The LIFO reserve increased
by $1,535, $642, and $753 during 2002, 2001, and 2000, respectively.

Property and equipment. Property and equipment are stated at cost, and depreciation is computed using the straight-line
method over their estimated useful lives. Leasehold costs and improvements which are included in buildings 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, fixtures 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.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

Impairment of long-lived assets. The Company’s policy is to review the carrying value of all long-lived assets annually and
whenever events or changes indicate that the carrying amount of an asset may not be recoverable. The Company adjusts the net
book value of the underlying assets if the sum of expected future cash flows is less than the book value. Assets to be disposed of
are adjusted to the fair value less the cost to sell if less than the book value. Based upon the Company’s review as of February 1,
2003 and February 2, 2002, no material adjustments to the carrying value of such assets were necessary.

Vendor rebates. The Company records vendor rebates for new store allowances, when realized, as a reduction of cost associated
with new stores and/ or remodeled stores. The Company records volume purchase rebates and allowances, when realized, as a
reduction to inventory purchases, at cost, which has the effect of reducing cost of goods sold, as prescribed by 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”).

Selling, general and administrative expenses. The Company includes buying, warehousing, distribution, depreciation 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 2002, 2001, and 2000 was $14,124, $12,079 and $10,166 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 layaway sales are
recorded upon delivery of the merchandise to the customer. In addition, the Company charges the franchised stores a fee based
on a percentage of their purchases from the Company. These fees represent a reimbursement for use of the Fred’s name and
other administrative costs incurred on behalf of the franchised stores and are therefore netted against selling, general and
administrative expenses. Total franchise income for 2002, 2001, and 2000 was $2,016, $1,764, and $1,806 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. During the years
ended February 1, 2003 and February 2, 2002, the Company issued 1,966 and 55,980 shares for pharmacy acquisitions,
respectively. Intangibles, net of accumulated amortization, totaled $4,661 at February 1, 2003, and $4,778 at February 2, 2002.
Accumulated amortization for 2002 and 2001 totaled $7,218 and $5,272, respectively. Amortization expense for 2002, 2001,
and 2000 was $1,945, $1,795, and $1,421, respectively. Estimated amortization expense for each of the next 5 years is as
follows: 2003 - $1,546; 2004 - $1,325; 2005 - $970; 2006 - $485; and 2007 - $165.

Financial instruments. At February 1, 2003, 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.

Insurance reserves. The Company is largely self-insured for workers compensation, general liability and medical insurance. The
Company’s liability for self-insurance is determined based on known claims and estimates for future claims cost and incurred but
not reported claims. If future claim trends deviate from recent historical patterns, the Company may be required to record
additional expense or expense reductions which could be material to the Company’s results of operations.

Deferred rent. The Company records rental expense on a straight-line basis over the base, non-cancelable lease term. Any differences
between the calculated expense and the amounts actually paid are reflected as a liability in accrued liabilities in the accompanying
consolidated balance sheet and totaled approximately $714 and $494 at February 1, 2003 and February 2, 2002, respectively.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

Stock-based compensation. The Company grants stock options having a fixed number of shares and an exercise price equal to
the fair value of the stock on the date of grant to certain executive officers, directors and key employees. The Company accounts
for stock option grants in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees (“APB No. 25”), and related interpretations because the Company believes the alternative fair value accounting
provided for under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for
Stock-Based Compensation – Transition and Disclosure, requires the use of option valuation models that were not developed for
use in valuing employee stock options. Under APB No. 25, compensation expense is generally not recognized for plans in which
the exercise price of the stock options equals the market price of the underlying stock on the date of grant and the number of
shares subject to exercise is fixed. Had compensation cost for the Company’s stock-based compensation plans been determined
based on the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS
No. 123, net income and earnings per share would have been reduced to the pro forma amounts indicated in the following table.

Net income – as reported
Less pro forma effect of stock option grants
Net income – pro forma
Earnings per share – as reported

Basic
Diluted

Earnings per share – pro forma

Basic
Diluted

2002
28,216
456
27,760

1.11
1.08

1.09
1.06

$
$

2001
19,629
567
19,062

0.83
0.81

0.81
0.79

$
$

2000
14,849
589
14,260

0.66
0.65

0.63
0.62

$
$

The Company also periodically awards restricted stock having a fixed number of shares at a purchase price that is set by the

Compensation Committee of the Company’s Board of Directors, which purchase price may be set at zero, to certain executive
officers, directors and key employees. The Company also accounts for restricted stock grants in accordance with APB No. 25
and related interpretations. Under APB No. 25, 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, and recognizes such amount on a
straight-line basis over the period in which the restricted stock award is earned by the recipient. The Company recognized
compensation expense relating to its restricted stock awards of approximately $54, $137, and $145 in 2002, 2001, and 2000,
respectively. (See Note 8 for further disclosure relating to stock incentive plans).

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 Company’s consolidated financial statements or income tax returns. Deferred income tax expense or benefit is
the net change during the year in the Company’s deferred income tax assets and liabilities.

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.

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 2002 presentation.

Recent Accounting Pronouncements. In June 2001, the Financial Accounting Standards Board (the “FASB”) issued SFAS No.
142, Goodwill and Other Intangible Assets. Under the new rules, goodwill and indefinite lived intangible assets are no longer
amortized but are reviewed annually for impairment. Separable intangible assets that are not deemed to have an indefinite life
will continue to be amortized over their useful lives. The Company will continue to amortize intangible assets in accordance

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

with existing policy and accordingly the adoption of SFAS No. 142 did not have a material impact on the Company’s financial
position or results of operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB

In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and
Disclosure. SFAS No. 148 is an amendment of SFAS No. 123, Accounting for Stock-Based Compensation, and provides
alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation.
SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and APB Opinion No. 28, Interim Financial Reporting,to
require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements.
While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair
value method, the disclosure provisions of SFAS No. 148 are applicable to all companies with stock-based employee
compensation, regardless of whether they account for that compensation using the fair value method of SFAS No. 123 or the
intrinsic value method of APB Opinion No. 25, Accounting for Stock Issued to Employees. As allowed by SFAS No. 123, the
Company has elected to continue to utilize the accounting method prescribed by APB Opinion No. 25 and has adopted the
disclosure requirements of SFAS No. 148 as of February 1, 2003. The adoption of SFAS No. 148 did not have a material
impact on the Company’s financial position or results of operations.

FASB Interpretation No. 46, Accounting for Variable Interest Entities (“FIN 46”), expands upon current guidance relating
to when a company should include in its financial statements the assets, liabilities and activities of a variable interest entity. The
consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The
consolidation requirements apply for “older” entities in the first fiscal year or interim period beginning after June 15, 2003,
which would apply for the Company beginning in the third quarter of 2003. The Company believes the adoption of FIN 46 in
2003 will not have a material effect on the Company’s financial position or results of operations.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

N O T E 2
P R O P E R T Y A N D E Q U I P M E N T

Property and equipment, at cost, consist of the following:

Buildings and improvements
Furniture, fixtures and equipment

Less accumulated depreciation and amortization

Construction in progress
Land

Total property and equipment, at depreciated cost

2002
75,779
125,723
201,502
(117,312)
84,190
22,308
4,296
$ 110,794

Depreciation expense totaled $18,394, $15,507 and $12,407 for 2002, 2001 and 2000, respectively.

The components of accrued liabilities are as follows:

N O T E 3
A C C R U E D L I A B I L I T I E S

Payroll and benefits
Sales and use taxes
Insurance
Other

Total accrued liabilities

2002

6,900
3,320
5,036
4,228
19,484

2001
68,922
102,075
170,997
(99,121)
71,876
2,109
4,240
78,225

2001

6,727
2,694
1,753
3,054
14,228

N O T E 4
I N D E B T E D N E S S

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 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 $187,731 at February 1, 2003) 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 March 31, 2004. There were no borrowings outstanding
under the Agreement at February 1, 2003 or February 2, 2002.

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
$141 and $703 borrowings outstanding under the loan Agreement at February 1, 2003 and February 2, 2002, respectively.

The Company has other miscellaneous financing obligations totaling $157, which relate primarily to business acquisitions.

The Company’s indebtedness under miscellaneous financing matures as follows: 2003 - $36; 2004 - $17; 2005 - $18; 2006 -
$19; 2007 - $21; and $46 thereafter.

The Company is financing 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. The
Company has offset the investment in the bonds ($18,485) against the related liability and neither is reflected on the
consolidated balance sheet.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

The provision for income taxes consists of the following:

N O T E 5
I N C O M E T A X E S

Current

Federal
Deferred
Federal
State

2002

2001

2000

1,929

9,485

5,642

12,824
(495)
12,329
14,258

907
119
1,026
10,511

1,679
324
2,003
7,645

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax

liabilities are presented below:

Current deferred tax assets:

Accrual for inventory shrinkage
Allowance for doubtful accounts
Insurance accruals
Net operating loss carryforwards
Postretirement benefits other than pensions
Restructuring costs
Amortization of intangibles
Other

Total deferred tax assets

Less: valuation allowance

Deferred tax assets, net of valuation allowance
Deferred tax liabilities:

Property, plant, and equipment
Inventory valuation
Other

Total deferred tax liability
Net deferred tax asset (liability)

2002

2001

235
333
1,467
2,474
960
59
2,209
–
7,737
(700)
7,037

(5,939)
(12,305)
(28)
(18,272)
$ (11,235)

1,060
357
933
1,532
799
73
1,768
76
6,598
(1,532)
5,066

(3,598)
(347)
(27)
(3,972)
1,094

A net current deferred tax liability in the amount of $10.6 million primarily resulted from a change in method of
accounting for inventory in retail stores from the retail inventory method to the cost method for income tax purposes.

The net operating loss carryforwards are available to reduce state income taxes in future years. These carryforwards total
approximately $63.7 million for state income tax purposes and expire at various times during the period 2003 through 2022.

During 2002, the valuation allowance decreased $832, and during 2001, the valuation allowance decreased $24. 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 tax asset after giving consideration to the valuation allowance.

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
Permanent differences
Change in valuation allowance
Other

2002
35.0%
1.4
(1.0)
(2.0)
0.2
33.6%

2001
35.0%
0.1
–
(0.1)
(0.1)
34.9%

2000
35.0%
0.9
–
–
(1.9)
34.0%

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

N O T E 6
L O N G - T E R M L E A S E S

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 under
noncancelable operating leases and certain transportation equipment under capital leases. Total rent expense under operating
leases was $26,844, $22,207 and $17,465 for 2002, 2001 and 2000, respectively. Total contingent rentals included in operating
leases above was $786, $409 and $370 for 2002, 2001 and 2000, respectively. Amortization expense on assets under capital lease
for 2002, 2001 and 2000 was $693, $544 and $449, respectively.

Future minimum rental payments under all operating and capital leases as of February 1, 2003 are as follows:

2003
2004
2005
2006
2007
Thereafter
Total minimum lease payments
Imputed interest
Present value of net minimum lease payments, including

$728 classified as current portion of capital lease obligations

Operating
Leases

24,750
21,814
18,879
15,014
10,405
15,407
$ 106,269

Capital
Leases

1,020
917
808
626
385
129
3,885
(768)

3,117

N O T E 7
S H A R E H O L D E R S ’ E Q U I T Y

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

On May 24, 2001, the Company announced a five-for-four stock split of its common stock, Class A voting, no par value.

The new shares, one additional share for each four shares held by stockholders, were distributed on June 18, 2001 to
stockholders of record on June 4, 2001. All share and per share amounts included in the accompanying financial statements
have been adjusted to reflect this stock split.

In October 2001, the Company completed a secondary stock offering of 1,585,000 company shares (unadjusted for 3-for-2

stock split completed on February 1, 2002) raising net proceeds to the Company of $38.2 million dollars.

On January 15, 2002, the Company announced a three-for-two stock split of its common stock, Class A voting, no par
value. The new shares, one additional share for each two shares held by stockholders, were distributed on February 1, 2002 to
stockholders of record on January 25, 2002. All share and per share amounts included in the accompanying financial statements
have been adjusted to reflect this stock split.

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

N O T E 8
E M P L O Y E E B E N E F I T P L A N S

Incentive stock option plan. The Company has a long-term incentive plan under which an aggregate of 2,430,651 shares may
be granted. These options expire five years from the date of grant. Options outstanding at February 1, 2003 expire in 2003
through 2007.

Under the plan, stock option grants are made to key employees including executive officers, as well as other employees, as
prescribed by the Compensation Committee (the “Committee”) of the Board of Directors. The number of options granted is
directly linked to the employee’s job classification. Options, which include non-qualified stock options and incentive stock
options, are rights to purchase a specified number of shares of Fred’s Common Stock at a price fixed by the Committee. The
exercise price for stock options issued under the plan that qualify as incentive stock options within the meaning of Section
422(b) of the Code shall not be less than 100% of the fair value as of the date of grant. The option exercise price may be
satisfied in cash or by exchanging shares of Fred’s Common Stock owned by the optionee, or a combination of cash and shares.
Options have a maximum term of ten years from the date of grant. Options granted under the plan generally become
exercisable one-third on the first anniversary, one-third on the second anniversary, and one-third on the third anniversary. The
plan also provides for annual stock grants to non-employee directors according to a non-discretionary formula. The number of
shares granted is dependent upon current director compensation levels at the fair value of the stock on the grant date.

A summary of activity in the plan follows:

Outstanding at beginning of year
Granted
Forfeited/canceled
Exercised
Outstanding at end of year
Exercisable at end of year

2002

2001

2000

Weighted
Average
Exercise
Price
$ 8.65
20.94
7.93
7.99
11.57
10.24

Options
924,035
174,982
(83,143)
(210,675)
805,199
439,059

Weighted
Average
Exercise
Price
$ 8.16
9.39
9.22
6.82
8.65
8.32

Weighted
Average
Exercise
Price
$ 7.01
8.03
5.88
4.63
8.16
5.67

Options
1,056,475
647,824
(264,046)
(197,838)
1,242,415
288,871

Options
1,242,415
288,219
(292,253)
(314,346)
924,035
356,068

The weighted average remaining contractual life of all outstanding options was 2.3 years at February 1, 2003.

The following table summarizes information about stock options outstanding at February 1, 2003:

Range of
Exercise Prices
$ 3.84 to $ 8.47
$ 10.61 to $18.53
$ 20.91 to $37.05

Number
Outstanding at
February 1, 2003
551,103
184,721
69,375
805,199

Options Outstanding
Weighted
Average
Remaining
Contractual
Life
(in Years)
1.9
2.8
4.5

Weighted
Average
Exercise
Price
$ 7.62
$ 16.85
$ 28.89

Options Exercisable

Number
Exercisable at
February 1, 2003
326,320
89,273
23,466
439,059

Weighted
Average
Exercise
Price
$ 7.35
$15.62
$30.03

Pro forma information regarding net income and earnings per share, as disclosed in Note 1, has been determined as if the
Company had accounted for its employee stock-based compensation plans under the fair value method of SFAS No. 123. The
fair value of options granted during 2002, 2001, and 2000 was $10.03, $6.90 and $2.08, respectively. The fair value of each

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

stock option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following
assumptions:

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

2002
3.0
46.1%
2.1%
0.5%

2001
3.0
41.9%
2.6%
1.6%

2000
3.0
39.0%
5.6%
1.3%

The Black-Scholes option 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. Because the Company’s employee stock options have characteristics significantly different from those of
traded options, and because changes in the subjective assumptions can materially affect the fair value estimate, in management’s
opinion, the existing models do not necessarily provide reliable single measure of the fair value of its employee stock options.

Restricted Stock. During 2002, 2001, and 2000, the Company issued (forfeited/cancelled) a net of 750, (15,185), and (47,385)
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 and the plan owns
242,023 shares of Company stock.

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 2002, 2001,
and 2000 were $176, $117 and $100, respectively.

Postretirement benefits. The Company provides certain health care benefits to its full-time employees who 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
Actuarial (gain) loss
Benefits paid
Benefit obligation at end of year

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

February 1,
2003

February 2,
2002

1,786
213
152
–
378
(28)
2,501

1,617
140
123
1
(74)
(21)
1,786

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

February 1,
2003
(2,501)
(2)
(4)
52
(2,455)

February 2,
2002
(1,786)
(380)
(5)
116
(2,055)

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

The medical care cost trend used in determining this obligation is 11.0% effective December 1, 2001, decreasing annually
before leveling at 5.0% in 2011. 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 $343. The discount rate used
in calculating the obligation was 7.0% in 2002 and 7.25% in 2001.

The annual net postretirement cost is as follows:

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.

February 1,
2003

For the Years Ended
February 2,
2002

February 3,
2001

213
152
–
1
366

140
123
(17)
1
247

132
116
(17)
1
232

N O T E 9
N E T I N C O M E P E R S H A R E

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.

A reconciliation of basic earnings per share to diluted earnings per share follows:

February 1, 2003

For the Years Ended
February 2, 2002

February 3, 2001

Basic EPS
Effect of dilutive securities

Income
$ 28,216

Diluted EPS

$ 28,216

Per
Share
Amount
$ 1.11

Income
$ 19,629

$ 1.08

$ 19,629

Shares
25,503
664
26,167

Per
Share
Amount
$ .83

Income
$ 14,849

$ .81

$ 14,849

Per
Share
Amount
$ .66

$ .65

Shares
22,382
487
22,869

Shares
23,553
644
24,197

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 56,625 such options outstanding at February 1, 2003 and there were no such options
outstanding at February 2, 2002.

N O T E 1 0
C O M M I T M E N T S A N D C O N T I N G E N C I E S

Commitments. The Company had commitments approximating $10,434 at February 1, 2003 and $9,133 at February 2, 2002 on
issued letters of credit, which support purchase orders for merchandise. Additionally, the Company had outstanding letters of credit
aggregating $7,871 at February 1, 2003 and $6,838 at February 2, 2002 utilized as collateral for its risk management programs.

Litigation. The Company is a party to several pending legal proceedings and claims arising in the normal course of business.
Although the outcome of the proceedings and claims cannot be determined with certainty, management of the Company is of the
opinion that it is unlikely that these proceedings and claims will have a material adverse effect on the results of operations, cash

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Notes to Consolidated Financial Statements

(in thousands, except share and per share amounts)

flows, or the financial condition of the Company. However, litigation involves an element of uncertainty. Future developments
could cause these actions or claims to have a material adverse effect on the results of operations, cash flows, or the financial
condition of the Company.

N O T E 1 1
S A L E S M I X

The Company manages its business on the basis of one reportable segment. See Note 1 for a brief description of the
Company’s business. As of February 1, 2003, all of the Company’s operations were located within the United States. The
following data is presented in accordance with SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information.

The Company’s sales mix by major category during the last 3 years is as follows:

Pharmaceuticals
Household Goods
Apparel and Linens
Food and Tobacco Products
Health and Beauty Aids
Paper and Cleaning Supplies
Sales to Franchised Fred’s Stores

Totals

Year Ended February 1, 2003
Net sales
Gross profit
Net income
Net income per share

Basic
Diluted

Cash dividends paid per share

Year Ended February 2, 2002
Net sales
Gross profit
Net income

Net income per share

Basic
Diluted

Cash dividends paid per share

2002
33.2%
23.0%
13.6%
9.6%
9.0%
8.4%
3.2%

100.0%

2001
34.4%
22.4%
12.3%
9.5%
9.4%
8.3%
3.7%
100.0%

2000
32.7%
20.4%
13.8%
9.4%
11.0%
8.3%
4.4%
100.0%

N O T E 1 2
Q U A R T E R L Y F I N A N C I A L D A T A ( U N A U D I T E D )

First
Quarter

Second
Quarter

Third
Quarter

Fourth
Quarter

$ 258,427
69,425
6,275

$ 256,470
69,638
3,667

$ 263,197
75,994
7,408

$ 325,324
89,920
10,866

0.25
0.24
0.03

0.14
0.14
0.03

0.29
0.28
0.03

0.42
0.42
0.03

$ 207,359
57,758
4,159

$ 210,278
56,781
2,114

$ 219,242
62,038
5,128

$ 273,952
73,144
8,228

0.18
0.18
0.03

0.09
0.09
0.03

0.22
0.22
0.03

0.34
0.32
0.03

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Report of Independent Auditors

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

We have audited the accompanying consolidated balance sheet of Fred’s, Inc. and subsidiaries as of February 1, 2003, and

the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended. 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 audit. The consolidated financial statements of Fred’s, Inc. and subsidiaries for the years ended
February 2, 2002 and February 3, 2001, were audited by other auditors whose report dated March 15, 2002, expressed an
unqualified opinion on those statements.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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. An audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable
basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial
position of Fred’s, Inc. and subsidiaries at February 1, 2003, and the consolidated results of their operations and their cash flows
for the year then ended in conformity with accounting principles generally accepted in the United States.

Memphis, Tennessee
March 7, 2003

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Directors and Officers

Board of Directors

Michael J. Hayes
Chairman and Chief Executive Officer
Fred’s, Inc.

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
President Emeritus
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

Executive Officers

Michael J. Hayes
Chief Executive Officer

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 –
Store Operations

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

F R E D ’ S 2 0 0 2 A N N U A L R E P O R T

Corporate Information

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

Transfer Agent
American Stock Transfer &
Trust Company
59 Maiden Lane
New York, New York 10038
(800) 937-5449

Independent Auditors
Ernst & Young LLP
Memphis, Tennessee

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

Annual Report on Form 10-K
Shareholders of record may obtain a copy of the
Company’s Annual Report on Form 10-K for the year
ended February 1, 2003, as filed with the Securities and
Exchange Commission, without charge upon written
request to Jerry A. Shore, Executive Vice President
and Chief Financial Officer.

Annual Meeting of Shareholders
The 2003 annual meeting of shareholders will be held
at 7:00 p.m. Eastern Daylight Time on
Wednesday, June 18, 2003, at the Holiday Inn Express,
2192 South Highway 41, Dublin, Georgia.
Shareholders of record as of May 2, 2003, 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 May 2, 2003,
the Company had an estimated 16,000 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. All
amounts have been adjusted for a five-for-four
stock split distributed in June 2001 and a three-for-
two stock split distributed in February 2002.

High

Low

Dividends
Per Share

$ 13.89
$ 17.20
$ 22.70
$ 28.73

$ 10.87
$ 12.91
$ 15.99
$ 20.77

$ 40.10
$ 39.05
$ 35.00
$ 30.22

$ 27.39
$ 26.25
$ 26.10
$ 23.23

$ 0.03
$ 0.03
$ 0.03
$ 0.03

2001
First
Second
Third
Fourth

2002
First
Second
Third
Fourth

SIC 5331

4300 New Getwell Road
Memphis, Tennessee 38118