fred-10q_20190504.htm

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ .

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter ) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐ .

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒ .

The registrant had 35,239,125 shares of Class A voting, no par value common stock outstanding as of June 18, 2019.

	May 4, 2019			February 2,
	(unaudited)			2019
ASSETS
Current assets:
Cash and cash equivalents	$	7,184		$	5,353
Inventories		221,460			246,517
Receivables, less allowance for doubtful accounts of $2,369 and $1,360, respectively		23,243			22,970
Other non-trade receivables		29,645			30,412
Current assets held for sale		—			—
Prepaid expenses and other current assets		6,924			10,074
Total current assets		288,455			315,327
Property and equipment, less accumulated depreciation and amortization		64,186			66,346
Noncurrent assets held for sale		4,839			4,839
Intangible assets, net		19,279			21,463
Other noncurrent assets, net		98,016			1,050
Total assets	$	474,774		$	409,025
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	105,897		$	97,107
Current portion of indebtedness		80,631			58,641
Accrued expenses and other		74,129			58,352
Current liabilities held for sale		—			—
Total current liabilities		260,657			214,100
Long-term portion of indebtedness		14,429			14,446
Noncurrent liabilities held for sale		—			—
Other noncurrent liabilities		105,081			15,015
Total liabilities		380,167			243,560

Commitments and contingencies (see Note 8- Leases, Note 9-Legal Contingencies and Note 10-Indebtedness)
Shareholders’ equity:
Preferred stock, nonvoting, no par value, 10,000,000 shares authorized, none outstanding		—			—
Preferred stock, Series C junior participating voting, no par value, 50,000 shares authorized, none outstanding		—			—
Common stock, Class A voting, no par value, 60,000,000 shares authorized, shares issued and outstanding 39,060, 971 at May 4, 2019 and 38,788,689 at February 2, 2019, respectively		127,705			127,182
Common stock, Class B nonvoting, no par value, 11,500,000 shares authorized, none outstanding		—			—
Treasury Stock, at cost; 3,800,000 shares at May 4, 2019 and 3,800,000 shares at February 2, 2019.		(10,823	)		(10,823	)
Retained earnings		(22,830	)		48,547
Accumulated other comprehensive income		555			559
Total shareholders’ equity		94,607			165,465
Total liabilities and shareholders’ equity	$	474,774		$	409,025

	For the Thirteen Weeks Ended
	May 4, 2019			May 5, 2018
Net sales	$	318,951		$	336,399
Cost of goods sold		244,352			247,329
Gross profit		74,599			89,070

Depreciation and amortization		5,055			8,300
Impairment expense		297			—
Selling, general and administrative expenses		96,036			100,941
Total selling, general and administrative expenses		101,388			109,241
Operating loss		(26,789	)		(20,171	)

Interest expense		2,754			1,988
Loss before income taxes		(29,543	)		(22,159	)

Provision for income taxes		—			(196	)
Loss from continuing operations		(29,543	)		(21,963	)
Loss from discontinued operations, net of tax		(4,397	)		(48	)
Net loss	$	(33,940	)	$	(22,011	)

Net loss per share - basic
Continuing operations	$	(0.84	)	$	(0.60	)
Discontinued operations		(0.12	)		(0.00	)
Total loss per common share - basic	$	(0.96	)	$	(0.60	)

Net loss per share - diluted
Continuing operations	$	(0.84	)	$	(0.60	)
Discontinued operations		(0.12	)		(0.00	)
Total loss per common share - diluted	$	(0.96	)	$	(0.60	)

Weighted average common shares outstanding
Basic		35,211			36,485
Effect of dilutive stock options		—			—
Diluted		35,211			36,485

FRED’S, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(in thousands, except share and per share amounts)

															Accumulated
															Other
	Common Stock					Treasury Stock						Retained			Comprehensive
	Shares			Amount		Shares			Amount			Earnings			Income			Total
Balance, February 2, 2019		38,788,689			127,182		(3,800,000	)		(10,823	)		48,547			559			165,465
Restricted stock grants, net of cancellations		273,283			—		—			—			—			—			—
Issuance of shares, other		—			—		—			—			—			—			—
Retired shares under employee stock ownership plan		(981	)		—		—			—			—			—			—
Repurchased and cancelled shares		—			—		—			—			—			—			—
Stock-based compensation		—			523		—			—			—			—			523
Adjustment for postretirement benefits (net of tax)		—			—		—			—			—			(4	)		(4	)
Cumulative effect of adopted accounting standard		—			—		—			—			(37,437	)		—			(37,437	)
Net loss		—			—		—			—			(33,940	)		—			(33,940	)
Balance, May 4, 2019		39,060,991			127,705		(3,800,000	)		(10,823	)		(22,830	)		555			94,607

														Accumulated
														Other
	Common Stock				Treasury Stock						Retained			Comprehensive
	Shares		Amount		Shares			Amount			Earnings			Income		Total
Balance, February 3, 2018		38,366,517		123,950		(1,242,000	)		(4,975	)		61,514			559		181,048
Restricted stock grants and cancellations		32,517		—		—			—			—			—		—
Retired shares under employee stock purchase plan		—		—		—			—			—			—		—
Repurchased and cancelled shares		—		—		—			—			—			—		—
Stock-based compensation		—		1,248		—			—			—			—		1,248
Adjustment for postretirement benefits (net of tax)		—		—		—			—			—			—		—
Purchase of Treasury Stock		—		—		—			—			—			—		—
Net loss		—		—		—			—			(22,011	)		—		(22,011	)
Balance, May 5, 2018		38,399,034		125,198		(1,242,000	)		(4,975	)		39,503			559		160,285

	Thirteen Weeks Ended
	May 4, 2019			May 5, 2018
Cash flows from operating activities:
Net loss	$	(29,543	)	$	(21,963	)
Adjustments to reconcile net loss to net cash flows from operating activities:
Depreciation and amortization		5,104			8,314
Net gain on asset disposition		310			13
Asset impairments		284			—
Stock-based compensation		522			1,246
(Recovery) for uncollectible receivables		1,010			(330	)
LIFO reserve increase		(1,509	)		(530	)
Deferred income tax benefit		(15	)		—
Amortization of debt issuance costs		225			123
Changes in operating assets and liabilities, net of effects of business acquired:
(Increase) decrease in operating assets:
Trade and non-trade receivables		(519	)		5,734
Inventories		26,566			(13,316	)
Other assets		(93,814	)		(475	)
Increase (decrease) in operating liabilities:
Accounts payable and accrued expenses		24,567			8,869
Income taxes receivable		10			1,197
Other noncurrent liabilities		52,636			(1,638	)
Net cash used in operating activities of continuing operations		(14,166	)		(12,756	)

Cash flows from investing activities of continuing operations:
Capital expenditures		(1,444	)		(2,468	)
Proceeds from asset dispositions		90			—
Net cash provided by (used in) investing activities of continuing operations		(1,354	)		(2,468	)

Cash flows from financing activities of continuing operations:
Payments of indebtedness and capital lease obligations		(17	)		(16	)
Proceeds from revolving line of credit		215,211			228,043
Payments on revolving line of credit		(193,186	)		(219,460	)
Debt issuance costs		(260	)		(256	)
Proceeds (payments) from exercise of stock options and employee stock purchase plan		—			(31	)
Transfer (to) from discontinued operations		(4,397	)		6,767
Net cash (used in ) provided by financing activities of continuing operations		17,351			15,047

Decrease in cash and cash equivalents		1,831			(177	)

Cash flow from discontinued operations
Cash flows from operating activities of discontinued operations, net		(4,397	)		6,449
Cash flows from financing activities of discontinued operations, net		4,397			(6,767	)
Net increase (decrease) in cash and cash equivalents		1,831			(495	)
		—
Cash and cash equivalents, beginning of year		5,353			6,573
Net increase (decrease) in cash and cash equivalents		1,831			(495	)
Cash and cash equivalents, end of year	$	7,184		$	6,078

Supplemental disclosures of cash flow information:
Interest paid		1,114			6,297
Income taxes refunded		—			(1,721	)

Fred’s, Inc. and its subsidiaries (“Fred’s”, “We”, “Our”, “Us” or the “Company”) operated, as of May 4, 2019, 556 discount general merchandise stores in fifteen states in the Southeastern United States. Our mission is to improve the lives of customers by selling products that deliver value and convenience to the communities we serve. There are 169 full service pharmacy departments located within our discount general merchandise stores, including one within franchised locations.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and are presented in accordance with the requirements of Form 10-Q and Article 10 of Regulation S-X and therefore do not include all information and notes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with GAAP. The accompanying financial statements reflect all adjustments (consisting of only normal recurring accruals) which are, in the opinion of management, necessary for a fair presentation of financial position in conformity with GAAP. The accompanying financial statements should be read in conjunction with the Notes to the Consolidated Financial Statements for the fiscal year ended February 2, 2019 included in our Annual Report on Form 10-K, which we filed with the Securities and Exchange Commission (the “SEC”) on May 3, 2019.

We meet the SEC’s definition of a “Smaller Reporting Company,” and therefore qualify for the SEC’s reduced disclosure requirements for smaller reporting companies.

During the second quarter of fiscal year 2018, the Company completed the sale of its specialty pharmacy business for a cash purchase price of $40.0 million (plus an additional $5.5 million for inventory). During the fourth quarter of fiscal 2018, Fred’s completed its sale of certain prescription files and the related data and records, retail pharmaceutical inventory and certain other assets from 179 of the Company’s retail pharmacy stores for a cash purchase price of approximately $176.7 million. The results of operations for both businesses have been presented as discontinued operations in accordance with Accounting Standards Codification (“ASC” Topic 205-20) ASC 205-20- Results of Operations – Discontinued operations for all periods presented. See Note 2: Assets Held for Sale and Discontinued Operations for additional information.

In addition, during the fourth quarter of 2018, Fred’s Board of Directors (the “Board”) approved a plan to actively market its headquarters building located in Memphis, TN. The building has been reflected as Assets Held for Sale on the consolidated balance sheets in accordance with ASC 360 – Assets held for sale. See Note 2: Assets Held for Sale and Discontinued Operations for additional information.

Excluding the “Assets Held for Sale and Discontinued Operations” subsection, amounts and percentages for all periods discussed below reflect the results of operations and financial condition from Fred’s continuing operations.

The results of operations for the thirteen-week period ended May 4, 2019 are not necessarily indicative of the results to be expected for the full fiscal year.

All references in this Quarterly Report on Form 10-Q to 2017 and 2018 refer to the Company’s fiscal years ended February 3, 2018 and ending February 2, 2019, respectively.

As discussed in our Annual Report on Form 10-K for fiscal year 2018 filed with SEC on May 3, 2019, the Company has experienced significant net losses and negative cash flows from operating activities in recent years and cannot offer assurance that such losses and negative cash flows will not continue for the foreseeable future. For the fiscal years ended February 2, 2019 and February 3, 2018, the Company incurred net losses of $136.2 million and $144.5 million, respectively, and our net cash flows used in operating activities were $91.7 million and $44.7 million, respectively. For the thirteen-week periods ended May 4, 2019 and May 5, 2018, the Company incurred net losses of $33.9 million and $22.0 million, respectively, and our net cash flows used in operating activities were $14.2 million and $12.8 million, respectively. Furthermore, the Company has limited availability under its Revolving Credit Agreement (as defined below), which along with cash from operations has traditionally been the Company’s primary source of working capital. As of May 4, 2019, the Company had outstanding borrowings of $81.3 million under our Revolving Credit Agreement and excess availability of $33.0 million. Under our Revolving Credit Agreement, we have a financial covenant to maintain at all times excess availability of at least 10% of the commitments, and if excess availability falls below such threshold ($21.0 million at May 4, 2019), it would constitute an event of default under the Revolving Credit Agreement. The Company’s failure to comply with the financial covenants and other obligations under the Revolving Credit Agreement would result in an event of default, which if not cured or waived, may permit acceleration of our indebtedness and other remedies. If our indebtedness is accelerated, whether due to the Revolver EODs described in Note 10 or otherwise, the Company cannot be certain that we will have sufficient funds available to pay the accelerated indebtedness or that we will have the ability to refinance the accelerated indebtedness on terms favorable to us or at all, which could have a material

adverse effect on the Company’s business, results of operations and financial condition and could impact our ability to continue as a going concern. Furthermore, our Revolving Credit Agreement has a maturity date of April 9, 2020, and we can provide no assurance that we will be able to renew or refinance such facility on terms acceptable to us or at all. The foregoing conditions raise substantial doubt about the Company’s ability to continue as a going concern.

As further described in Note 10 below, on May 15, 2019, the Company and certain of its subsidiaries entered into the Forbearance Agreement, Eighth Amendment to Credit Agreement and Fourth Amendment to Amended and Restated Addendum to Credit Agreement (the “Forbearance Agreement and Eighth Amendment”) in response to certain events of default identified by our lenders. As a result of the Forbearance Agreement and Eighth Amendment, the lenders under the Revolving Credit Agreement have agreed, subject to the satisfaction of certain conditions, to not take any action to accelerate our indebtedness or exercise other remedies with respect to the Revolver EODs until July 22, 2019, but there can be no assurance that such lenders will not do so on or after such date or if the conditions in the Forbearance Agreement and Eighth Amendment are not met in the future. We are in discussions with potential financing sources relating to the condition in the Forbearance Agreement and Eighth Amendment to obtain a signed commitment letter for a refinancing of all loans under the Revolving Credit Agreement. There can be no assurance that we will obtain such a commitment letter or complete a refinancing by the deadlines in the Forbearance Agreement and Eighth Amendment or at all.

The Company has evaluated its plans to alleviate this doubt, including engaging PJ Solomon in April 2019 to assist the Company in evaluating its strategic alternatives. In addition, while we analyze these strategic alternatives, the Company is also assessing potential alternative financing arrangements and undertaking a number of operational measures that we believe will enhance our cash position and improve our profitability, including, among other things:

The Company can provide no assurance, however, regarding the outcome of its evaluation of strategic alternatives, that alternative financing will be on terms acceptable to us or at all, or that the operational measures being undertaken by the Company will be successful in improving the Company’s financial performance, in which case the Company may be unable to continue as a going concern.

The accompanying consolidated financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and settlement of liabilities in the normal course of business, and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from uncertainty related to its ability to continue as a going concern.

In February 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU provides companies with the option to reclassify tax effects resulting from the Tax Cuts and Jobs Act (“TCJA”) within Accumulated Other Comprehensive Income into Retained Earnings. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The Company adopted the ASU during the thirteen weeks ended May 4, 2019, however, the adoption did not have a material impact to our financial position, results of operations or the cash flows.

In February 2016, the FASB established ASU No. 2016-02 Leases (Topic 842), which requires lessees to recognize a right-of-use (ROU) asset and a lease liability on their balance sheet for all leases, including operating leases, with a term of greater than 12 months. In July 2018, the FASB issued ASU 2018-11 which added a transition option permitting entities to apply the provisions of the new standard at its adoption date instead of the earliest comparative period presented in the condensed consolidated financial statements. Under this transition option, comparative reporting would not be required, and the provisions of the standard would be applied prospectively to leases in effect at the date of adoption. We adopted the new standard on February 3, 2019 and elected to use the optional transition method provided by ASU 2018-11. An adjustment to beginning retained earnings of $37.4 million was required related to the impairment of ROU at adoption. See Note 8-Leases for further discussion of the adoption Topic 842.

The Company also elected the package of practical expedients permitted under the transition guidance within the new standard. The following practical expedients were applied when implementing the new standard:

The adoption of the new standard had a material impact on our condensed consolidated balance sheet for the addition of lease assets and liabilities, primarily related to real estate operating leases. The adoption of the new standard did not have a material impact on our results of operations or cash flows.

The vast majority of Fred’s contracts with customers are made at the point of sale (POS) in the retail stores, and the performance obligation is the transfer of merchandise which is satisfied at POS when customer pays for merchandise and title transfers to them.

We evaluated principal versus agent considerations with regards to the 340B Direct program under ASC 606. Because Fred’s is primarily responsible for fulfilling the promise to provide the 340B Direct prescription drugs and assumes control of and risk for inventory prior to transfer of goods to the customer, including pricing apart from when determined by federal mandate, Fred’s recognizes revenue on a gross basis as principal for the 340B Direct program.

When customers purchase gift cards, the sale is not recognized until the card is redeemed. The gift cards are not always fully redeemed and as such, the Company recognizes breakage. Based on the results from our historical breakage model, the Company defines the likelihood of redemption as remote after three years of no activity.

Store layaways are agreements with our customers to provide or deliver goods for a specified price at a future date. Layaway programs run annually for a duration of less than one year and are most popular during the Christmas seasons. Under the Company’s layaway plan, the customer is obligated to pay only the amount equivalent to the value of the good plus sales tax. The Company does not assess a layaway fee or interest but requires an upfront deposit. The customer does not take delivery of the merchandise until the full value is collected.

Our performance obligation is the transfer of merchandise which is satisfied at the point of customer pick-up, not at transaction initiation. Any payments received prior to customer pick-up are considered advance payments and deferred and recognized when the performance obligation is satisfied. Layaway sales are deferred when the customer transaction is initiated and are recognized as revenue when the layaway merchandise is transferred.

In the following table, consolidated sales are disaggregated by major merchandising category.

During the fourth quarter of 2017, Fred’s Board of Directors approved a plan to actively market its specialty pharmacy business (“Entrust”). On May 4, 2018, Fred’s entered into the Specialty Asset Purchase Agreement with Advanced Care Scripts, Inc., a Florida corporation (“Specialty Buyer”) and an affiliate of CVS Health Corporation, pursuant to which, the Buyer agreed to purchase Entrust, consisting of three pharmacy locations, pharmaceutical inventory, and related intellectual property. The Specialty Buyer paid Fred’s $40.0 million for the purchased assets (plus up to an additional $5.5 million for inventory). On June 1, 2018, the sale of the Entrust assets was completed. The results of operations for the Entrust business have been presented as discontinued operations in accordance with ASC 205-20 for all periods presented.

On September 7, 2018 the Company, entered into an Asset Purchase Agreement with Walgreen Co., an Illinois corporation. On October 23, 2018, the Company entered into an amendment to the Asset Purchase Agreement (the “Amendment”). Under the Asset Purchase Agreement, as amended by the Amendment (the “Amended WBA Asset Purchase Agreement”), the Company agreed to sell certain prescription files and related data and records, retail pharmaceutical inventory, and certain other assets from 179 of the Company’s 346 retail pharmacy stores (such assets from such 179 retail pharmacy stores collectively referred to as “Retail Pharmacy”) for a cash purchase price of approximately $157 million plus an amount equal to the value of the inventory included in the Retail Pharmacy assets up to an approximately $35 million cap, in each case subject to certain adjustments.

As of the end of the fourth quarter of fiscal 2018, the Company had closed the transactions contemplated by the Amended WBA Asset Purchase Agreement, and the Company received cash proceeds of approximately $156.1 million, plus approximately $20.6 million for the inventory sold in the transaction, in each case after adjustment as described in the Amended WBA Asset Purchase Agreement. The Company recorded a gain of $145.7 million related to the Retail Pharmacy sale. The Company used the proceeds received in the transaction to pay down the Company’s existing indebtedness and for general corporate purposes.

During the fourth quarter of 2018, the Board approved a plan to actively market its headquarters building located in Memphis, TN. As a result, the Company has reclassified the headquarters building to assets held for sale in accordance with ASC 360 – Assets held for sale. The building has been reclassified to held for sale on the consolidated balance sheet and the depreciation associated with the asset has concluded. The Company has assessed the fair value of the building base on the selling price of other assets within the surrounding area. The market price is reasonable in relation to the current selling price of similar assets on the market.

The following table provides a reconciliation of the carrying amounts of major classes of assets and liabilities which are included in assets and liabilities held-for-sale in the accompanying consolidated balance sheet for each of the periods presented:

The following tables summarize the results of discontinued operations for the thirteen weeks ended May 4, 2019 and May 5, 2018, respectively:

Merchandise inventories are valued at the lower of cost or market using the retail first-in, first-out (FIFO) inventory method for goods in our stores and the cost FIFO inventory method for goods in our distribution centers. The retail inventory method is a reverse mark-up, averaging method which has been widely used in the retail industry for many years. This method calculates a cost-to-retail ratio that is applied to the retail value of inventory to determine the cost value of inventory and the resulting cost of goods sold and gross margin. The assumptions that the retail inventory method provides for valuation at lower of cost or market and the inherent uncertainties therein are discussed in the following paragraphs. In order to assure valuation at the lower of cost or market, the retail value of our inventory is adjusted on a consistent basis to reflect current market conditions. These adjustments include increases to the retail value of inventory for initial markups to set the selling price of goods or additional markups to adjust pricing for inflation and decreases to the retail value of inventory for markdowns associated with promotional, seasonal or other declines in the market value. Because these adjustments are made on a consistent basis and are based on current prevailing market conditions, they approximate the carrying value of the inventory at net realizable value (market value). Therefore, after applying the cost to retail ratio, the cost value of our inventory is stated at the lower of cost or market as is prescribed by GAAP.

Because the approximation of net realizable value (market value) under the retail inventory method is based on estimates such as markups, markdowns and inventory losses (shrink), there exists an inherent uncertainty in the final determination of inventory cost and gross margin. In order to mitigate that uncertainty, the Company has a formal review process, conducted by product class which considers such variables as current market trends, seasonality, weather patterns and age of merchandise to ensure that markdowns are taken currently, or a markdown reserve is established to cover future anticipated markdowns on a particular product class. This review also considers current pricing trends and inflation to ensure that markups are taken if necessary. The estimation of inventory losses (shrink) is a significant element in approximating the carrying value of inventory at net realizable value, and as such the following paragraph describes our estimation method as well as the steps we take to mitigate the risk of this estimate in the determination of the cost value of inventory.

The Company calculates inventory losses (shrink) based on actual inventory losses occurring as a result of physical inventory counts during each fiscal period and estimated inventory losses occurring between yearly physical inventory counts. The estimate for shrink occurring in the interim period between physical counts is calculated on a store-specific basis and is based on history, as well as performance on the most recent physical count. It is calculated by multiplying each store’s shrink rate, which is based on the previously mentioned factors, by the interim period’s sales for each store. Additionally, the overall estimate for shrink is adjusted at the corporate level to a three-year historical average to ensure that the overall shrink estimate is the most accurate approximation of shrink based on the Company’s overall history of shrink. The three-year historical estimate is calculated by dividing the “book to physical” inventory adjustments for the trailing 36 months by the related sales for the same period. In order to reduce the uncertainty inherent in the shrink calculation, the Company first performs the calculation at the lowest practical level (by store) using the most current performance indicators. This ensures a more reliable number, as opposed to using a higher level aggregation or percentage method. The third portion of the calculation ensures that the extreme negative or positive performance of any particular store or group of stores does not skew the overall estimation of shrink. This portion of the calculation removes additional uncertainty by eliminating short-term peaks and valleys that could otherwise cause the underlying carrying cost of inventory to fluctuate unnecessarily. The methodology that we have applied in estimating shrink has resulted in variability that is not material to our financial statements.

Management believes that the Company’s retail inventory method provides an inventory valuation which reasonably approximates cost and results in carrying inventory at the lower of cost or market. For pharmacy inventories, which were approximately $12.0 million and $13.2 million at May 4, 2019 and February 2, 2019, respectively, cost was determined using the retail last-in, first-out (LIFO) inventory method in which inventory cost is maintained using the retail inventory method, then adjusted by application of the Producer Price Index published by the U.S. Department of Labor for cumulative annual periods. The current cost of inventories exceeded LIFO cost by approximately $27.3 million at May 4, 2019 and $28.8 million at February 2, 2019.

The Company has historically included an estimate of inbound freight and certain general and administrative costs in merchandise inventory as prescribed by GAAP. These costs include activities surrounding the procurement and storage of merchandise inventory such as merchandise planning and buying, warehousing, accounting, information technology and human resources, as well as inbound freight. The total amount of procurement and storage costs and inbound freight, inclusive of the accelerated recognition of freight capitalization expense, included in merchandise inventory at May 4, 2019 is $14.9 million, with the corresponding amount of $21.3 million at February 2, 2019.

The Company accounts for its stock-based compensation plans in accordance with FASB ASC 718 “Compensation – Stock Compensation. ” Under FASB ASC 718, stock-based compensation expense is based on awards ultimately expected to vest, and therefore has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant based on the Company’s historical forfeiture experience and will be revised in subsequent periods if actual forfeitures differ from those estimates.

FASB ASC 718 also requires the benefits of income tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required prior to FASB ASC 718. For a discussion of the Company’s stock-based compensation plans, refer to “Note 9 – Equity Incentive Plans” of the Company’s Annual Report on Form 10-K for the year ended February 2, 2019. Stock based compensation expense was $0.5 million and $1.2 million for the thirteen weeks ended May 4, 2019 and May 5, 2018, respectively.

The 2004 Employee Stock Purchase Plan (the “2004 Plan”), which was approved by Fred’s shareholders, permits eligible employees to purchase shares of our common stock through payroll deductions at the lower of 85% of the fair market value of the stock at the time of grant, or 85% of the fair market value at the time of exercise. In 2017, Management and the Board decided to suspend purchases through the ESPP effective December 31, 2017. As such, there has been no additional shares issued under the ESPP plan in fiscal 2019. There were 1,410,928 shares approved to be issued under the 2004 Plan as of May 4, 2019 and 595,681 shares were available.

The following table summarizes stock option activity during the thirteen weeks ended May 4, 2019:

	Options			Weighted- Average Exercise Price		Weighted- Averaged Contractual Life (years)		Aggregate Intrinsic Value (000s)
Outstanding at February 2, 2019		596,125		$	13.97		3.91	$	—
Granted		—			—
Forfeited / Cancelled		(85,682	)		13.36
Exercised		—			—
Outstanding at May 4, 2019		510,443		$	14.10		4.40	$	—
Exercisable at May 4, 2019		423,778		$	14.54		4.40	$	—



TENNESSEE	62-0634010
(State or Other Jurisdiction of	(I.R.S. Employer Identification Number)
Incorporation or Organization)

4300 New Getwell Road
Memphis, Tennessee 38118
(Address and Zip Code of Principal Executive Offices)

(901) 365-8880
(Registrant’s telephone number, including area code)

Large accelerated filer ☐	Accelerated filer ☒
Non-accelerated filer ☐	Smaller reporting company ☒
	Emerging Growth Company ☐

	Page No.
Part I - Financial Information

Item 1 - Financial Statements:

Condensed Consolidated Balance Sheets as of May 4, 2019 (unaudited) and February 2, 2019	3

Condensed Consolidated Statements of Operations for the Thirteen weeks Ended May 4, 2019 (unaudited) and May 5, 2018 (unaudited)	4

Condensed Consolidated Statements of Comprehensive Loss (unaudited)	5

Condensed Consolidated Statements of Changes in Shareholders' Equity for the Thirteen weeks Ended May 4, 2019 (unaudited) and May 5, 2018 (unaudited)	6

Condensed Consolidated Statements of Cash Flows for the Thirteen weeks Ended May 4, 2019 (unaudited) and May 5, 2018 (unaudited)	7

Notes to Condensed Consolidated Financial Statements (unaudited)	8

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	21

Item 3 – Quantitative and Qualitative Disclosures about Market Risk	27

Item 4 – Controls and Procedures	28

Part II - Other Information	29

Item 1 – Legal Proceedings	29
Item 1A – Risk Factors	29
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3 – Defaults Upon Senior Securities	30
Item 4 – Mine Safety Disclosures	30
Item 5 – Other Information	30
Item 6 – Exhibits	31

Signatures	32

	For the Thirteen Weeks Ended
	May 4, 2019		May 5, 2018
Pharmacy	$	104,651	$	103,969
Consumables		114,332		136,520
Household Goods and Softlines		95,990		92,902
Franchise		3,978		3,007
Total Sales Mix	$	318,951	$	336,399

	For the thirteen weeks ended
(in thousands)	May 4, 2019		May 5, 2018
Revenues	$	—	$	69,846
Cost of Goods Sold		—		67,470
Gross Margin		—		2,377
Depreciation and amortization		—		608
Selling, general and administrative expenses		—		3,924
Loss from discontinued operations before income taxes		—		(2,155	)
Loss from discontinued operations, net of tax	$	—	$	(2,155	)

	Headquarters Building
	May 4,		February 2,
(in thousands)	2019		2019
Property and equipment, less accumulated depreciation and amortization		4,839		4,839
Total noncurrent assets held-for-sale	$	4,839	$	4,839