NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.

Basis of presentation and accounting policies

Basis of presentation

These notes contain references to the years 2003, 2002, 2001 and 2000, which represent fiscal years ending or ended January 30, 2004, January 31, 2003, February 1, 2002 and February 2, 2001, respectively.  The Company’s fiscal year ends on the Friday closest to January 31.  There will be 52 weeks in the fiscal year ending January 30, 2004, and there were 52 weeks in the fiscal years ended January 31, 2003 and February 1, 2002.  There were 53 weeks in the fiscal year ended February 2, 2001.  The consolidated financial statements include all subsidiaries, except for its not-for-profit subsidiary whose assets and revenues are not material.  Intercompany transactions have been eliminated.

The Company sells general merchandise on a retail basis through 6,113 stores (as of January 31, 2003) located predominantly in small towns in the southern, eastern and midwestern United States.  The Company has distribution centers (“DCs”) in Scottsville, Kentucky; Ardmore, Oklahoma; South Boston, Virginia; Indianola, Mississippi; Fulton, Missouri; Alachua, Florida and Zanesville, Ohio.

The Company purchases its merchandise from a wide variety of suppliers. Approximately 11% of the Company’s purchases in 2002 were made from Procter and Gamble.  No other supplier accounted for more than 4% of the Company’s purchases in 2002.  

All share and per share data reflect the effect of common stock splits.

Restatement

On April 30, 2001, the Company announced that it had become aware of certain accounting issues that would cause it to restate its audited financial statements for fiscal years 1999 and 1998, and to restate the unaudited financial information for fiscal year 2000 that had been previously released by the Company.  The Company subsequently restated such financial statements and financial information by means of its Form 10-K for the fiscal year ended February 2, 2001, which was filed on January 14, 2002.

Cash and cash equivalents

Cash and cash equivalents include highly liquid investments with original maturities of three months or less when purchased.

Merchandise inventories

Inventories are stated at the lower of cost or market with cost determined using the retail last-in, first-out (“LIFO”) method. The excess of current cost over LIFO cost was approximately $5.9 million at January 31, 2003, $14.8 million at February 1, 2002 and $18.3 million at February 2, 2001. Current cost is determined using the retail first-in first-out method.  LIFO reserves decreased $8.9 million, $3.5 million and $0.4 million in 2002, 2001 and 2000, respectively. Costs directly associated with warehousing and distribution are capitalized into inventory.

Pre-opening costs

Pre-opening costs for new stores are expensed as incurred.

Property and equipment

Property and equipment are recorded at cost.  The Company provides for depreciation on a straight-line basis over the following estimated useful lives:

Impairment of long-lived assets

When indicators of impairment are present, the Company evaluates the carrying value of long-lived assets, other than goodwill, in relation to the operating performance and future undiscounted cash flows of the underlying assets.  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.  The Company recorded impairment charges of approximately $1.1 million and $3.6 million in 2001 and 2000, respectively, to reduce the carrying value of the Homerville, Georgia DC (which was closed in fiscal 2000).  These charges were included in Selling, general and administrative (“SG&A”) expense.

Other assets

Other assets consist primarily of debt issuance costs which are amortized over the life of the related obligations, security deposits and goodwill.

Vendor rebates

The Company records vendor rebates, primarily consisting of new store allowances and volume purchase rebates, when realized.  The rebates are recorded 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”).

Operating leases

Contingent rentals . The Company recognizes contingent rental expense when the achievement of specified sales targets are considered probable, in accordance with EITF Issue No. 98-9, “Accounting for Contingent Rent.” The amount expensed but not paid as of January 31, 2003 and February 1, 2002 was approximately $9.0 million and $7.9 million, respectively, and is included in Accrued expenses and other in the accompanying consolidated balance sheets. (See Notes 5 and 9 for further discussion).

Deferred rent . The Company records rental expense on a straight-line basis over the base, non-cancellable lease term.  Any difference between the calculated expense and the amounts actually paid are reflected as a liability in Accrued expenses and other in the accompanying consolidated balance sheets and totaled approximately $3.5 million and $3.0 million at January 31, 2003 and February 1, 2002, respectively.

Insurance claims provisions

The Company retains a significant portion of risk for its workers' compensation, employee health, general liability, property and automobile claim exposures.  Accordingly, provisions are made for the Company's estimates of such risks.  Actuaries are utilized to determine the undiscounted future claim costs for the workers' compensation, general liability, and health claim risks.  To the extent that subsequent claim costs vary from those estimates, future results of operations will be affected. The Greater Cumberland Insurance Company (“GCIC”), a Vermont-based wholly-owned captive insurance subsidiary of the Company, charges the operating subsidiary companies premiums to insure the retained workers' compensation and non-property general liability exposures.  GCIC currently insures no unrelated third-party risk.

Fair value of financial instruments

The carrying amounts reflected in the consolidated balance sheets for cash, cash equivalents, receivables and payables approximate their respective fair values.  At January 31, 2003 and February 1, 2002, the fair value of the Company’s debt, excluding capital lease obligations, was approximately $287.0 million and $268.5 million, respectively, based upon the estimated market value of the debt at those dates.  Such fair value is less than the carrying value of the debt at January 31, 2003 and February 1, 2002, by approximately $7.4 million and $27.1 million, respectively.  Fair values are based primarily on quoted prices for those or similar instruments.  A discussion of the carrying value and fair value of the Company’s derivative financial instruments is included in the section entitled “Derivative financial instruments” below.

Derivative financial instruments

Effective February 3, 2001, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS Nos. 137 and 138 and interpreted by numerous Financial Accounting Standards Board (“FASB”) Issues. These statements require the Company to recognize all derivative instruments on the balance sheet at fair value. These statements also established new accounting rules for hedging instruments, which depend on the nature of the hedge relationship. For 2002 and 2001, the consolidated financial statements include the provisions required by SFAS No. 133, while the 2000 consolidated financial statements were prepared in accordance with the applicable professional literature for derivatives and hedging instruments in effect at that time. The adoption of the provisions of SFAS No. 133 at the beginning of 2001 was immaterial to the Company’s financial position and results of operations.

The Company uses derivative financial instruments primarily to reduce its exposure to adverse fluctuations in interest rates and, to a much lesser extent, other market exposures. When entered into, the Company formally designates and documents the financial instrument as a hedge of a specific underlying exposure, as well as the risk management objectives and strategies for undertaking the hedge transaction. Because of the high degree of effectiveness between the hedging instrument and the underlying exposure being hedged, fluctuations in the value of the derivative instruments are generally offset by changes in the value or cash flows of the underlying exposures being hedged. Derivatives are recorded in the consolidated balance sheets at fair value in either Other assets, net or Accrued expenses and other, depending on whether the amount is an asset or liability.

The fair values of derivatives used to hedge or modify the Company’s risks fluctuate over time. These fair value amounts should not be viewed in isolation, but rather in relation to the fair values or cash flows of the underlying hedged transactions and other exposures and to the overall reduction in the Company’s risk relating to adverse fluctuations in interest rates and other market factors. In addition, the earnings impact resulting from the Company’s derivative instruments is recorded in the same line item within the consolidated statements of income as the underlying exposure being hedged. The Company also formally assesses, both at the inception and at least quarterly thereafter, whether the financial instruments that are used in hedging transactions are effective at offsetting changes in either the fair value or cash flows of the related underlying exposures. Any ineffective portion of a financial instrument’s change in fair value is immediately recognized in the results of operations.

The Company primarily executes derivative transactions with major financial institutions. These counterparties expose the Company to credit risk in the event of non- performance. The amount of such exposure is limited to the unpaid portion of amounts due to the Company pursuant to the terms of the derivative financial instruments, if any. Although there are no collateral requirements if a downgrade in the credit rating of these counterparties occur, management believes that this exposure is mitigated by provisions in the derivative agreements which allow for the legal right of offset of any amounts due to the Company from the counterparties with any amounts payable to the counterparties by the Company. As a result, management considers the risk of counterparty default to be minimal.

At February 1, 2002, the Company was party to an interest rate swap agreement with a notional amount of $100 million. The Company designated this agreement as a hedge of the floating rate commitments relating to a portion of its synthetic lease agreements (see Note 7). Under the terms of the agreement, the Company paid a fixed rate of 5.60% and received a floating rate (LIBOR) on the $100 million notional amount through September 1, 2002. This interest rate swap matured in September 2002, and, as of January 31, 2003, the Company was party to no outstanding derivative financial instruments. During 2002 and 2001 this derivative was 100% effective in hedging the floating rate commitments relating to the underlying exposure being hedged. Accordingly, no hedge ineffectiveness was recognized by the Company relating to this hedging relationship.

During 2002, the Company recorded a $1.9 million decrease to Other comprehensive loss, net of both income taxes and reclassifications to earnings, primarily related to recognized net losses on its interest rate swap agreement, which generally offset cash flow gains relating to the underlying synthetic lease agreements being hedged during the year. The Company did not discontinue any hedging relationships during 2002.

The following table summarizes activity in Other comprehensive loss related to derivatives held by the Company during the period from February 2, 2002, through January 31, 2003 (in thousands):

The balance remaining in Other comprehensive loss at January 31, 2003 relates solely to deferred losses realized in June 2000 on the settlement of an interest rate derivative that was designated and effective as a cash flow hedge of the Company’s forecasted issuance of its $200 million of fixed rate notes in June 2000 (see Note 7). This amount will be reclassified into earnings as an adjustment to the effective interest expense on the fixed rate notes through their maturity date in June 2010. The Company estimates that it will reclassify into earnings during the next twelve months approximately $0.2 million of the net amount recorded in Other comprehensive loss as of January 31, 2003.

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.

The pro forma effects on net income for 2002, 2001 and 2000 are not representative of the pro forma effect on net income in future years because they do not take into consideration pro forma compensation expense related to grants made prior to 1995.

The Company has historically permitted employees to use shares acquired through the exercise of stock options to satisfy tax-withholding requirements in excess of minimum employer statutory withholding rates.  The Company recognizes compensation expense for such stock option exercises and grants in accordance with the provisions of EITF 87-6, “Adjustments Relating to Stock Compensation Plans,” and FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation – An Interpretation of APB 25,” as applicable.  On December 17, 2001, the Company modified its personnel policies to eliminate the employee excess tax-withholding option.  

During 2001, the Company modified its stock incentive plans to extend the exercise period for outstanding stock option grants from one to three years for estates of deceased employees, to the extent that the stock options were fully vested at the date of death.  However, this modification did not extend the ten-year maximum contractual exercise term following the date of grant.  In accordance with the provisions of APB No. 25, as interpreted, this modification has resulted in the recording of compensation expense, using the intrinsic-value based method of accounting, only for those vested stock options held by estates of employees which would benefit from the extended exercise period.  On the modification date, the Company could not estimate whether and to what extent estates of deceased employees would benefit from this modification and, accordingly, no compensation expense was recorded during 2001.  However, in subsequent periods, the Company has recognized and will continue to recognize compensation expense for those estates of deceased employees that benefit from the extended exercise period, and, it is possible that such compensation expense could materially affect future consolidated financial statements. The Company recognized compensation expense relating to its stock option plans of approximately $0.1 million and $1.9 million in 2001 and 2000, respectively. There was no such expense in 2002.

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 $0.1 million, $0.4 million, and $-0- in 2002,  2001, and 2000, respectively. (See Note 12 for further disclosure relating to stock incentive plans).

Revenue and gain recognition

The Company recognizes sales at the time the sale is made to the customer. The Company records gain contingencies when realized.

Advertising costs

Advertising costs are expensed as incurred and were $7.1 million, $6.6 million, and $7.0 million in 2002, 2001, and 2000, respectively.

Interest during construction

To assure that interest costs properly reflect only that portion relating to current operations, interest on borrowed funds during the construction of property and equipment is capitalized.  Interest costs capitalized were approximately $0.1 million, $1.3 million and $6.7 million in 2002, 2001 and 2000, respectively.

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.

Management estimates

The preparation of financial statements and related disclosures in conformity 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.  Actual results could differ from those estimates.

 Accounting pronouncements

In June 2001, 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 began to apply the new accounting rules effective February 2, 2002.  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 2, 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.

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 1, 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. 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 January 31, 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 EITF reached a consensus on EITF 02-16, which 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 and are consistent with the Company’s existing accounting policy. Accordingly, the adoption of EITF 02-16 did not and will not have a material impact on the Company’s financial position or results or 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.

Reclassifications

Certain reclassifications of the 2001 and 2000 amounts have been made to conform to the 2002 presentation.

2.

Cash and short-term borrowings

The Company’s cash management system provides for daily investment of available balances and the funding of outstanding checks when presented for payment.  Outstanding but unpresented checks totaling approximately $91.3 million and $74.6 million at January 31, 2003 and February 1, 2002, respectively, have been included in Accounts payable in the accompanying consolidated balance sheets.  Upon presentation for payment, they will be funded through available cash balances or the Company’s existing credit facilities.

The Company closed on a new revolving credit facility in June 2002, which included a $150 million, 364-day revolving credit facility. There were no amounts outstanding under this facility during 2002. Borrowings under this facility, if any, are subject to restrictive covenants. As a result of the new facility, the Company terminated a $175 million revolving credit facility that was scheduled to expire in September 2002.  There were no borrowings outstanding under the $175 million facility at February 1, 2002 (see Note 7).

The weighted average interest rate for all short-term borrowings was 4.0% in 2001.

At January 31, 2003 and February 1, 2002, the Company had commercial letter of credit facilities totaling $150.0 million and $210.0 million, respectively, of which $85.3 million and $72.9 million, respectively, were outstanding for the funding of imported merchandise purchases.

3.

Inventory markdown

In the fourth quarter of 2000, the Company determined that it had certain excess inventory that would require a markdown to assist with its disposition. Accordingly, the Company recorded a markdown that had the impact of reducing inventory at cost at February 2, 2001 and increasing cost of goods sold in the fourth quarter of 2000 by approximately $21.5 million. The Company recorded an additional markdown relating to this inventory in the second half of 2002 which increased cost of goods sold and decreased inventory by approximately $3 million.  Approximately $25 million (at cost) of this inventory remains on hand at January 31, 2003.  The Company anticipates that any further markdowns required to assist with the disposition of the remaining inventory identified as excess in the fourth quarter of 2000 will be immaterial to its future financial position and results of operations.

4.

Property and equipment

Property and equipment is recorded at cost and summarized as follows:

Depreciation expense related to property and equipment was approximately $135.3 million, $122.3 million and $110.9 million in 2002, 2001 and 2000, respectively. Amortization of capital lease assets is included in depreciation expense.

5.

Accrued expenses and other

Accrued expenses and other consist of the following:

6.

Income taxes

The provision for taxes on income consists of the following:

A reconciliation between actual income taxes and amounts computed by applying the federal statutory rate to income before income taxes is summarized as follows:

Sources of deferred tax assets and deferred tax liabilities are as follows:

State net operating loss carryforwards as of January 31, 2003, totaled approximately $245.9 million and will expire between 2003 and 2023.  The valuation allowance has been provided for certain state loss carryforwards and state tax credits.  The change in the valuation allowance was $0.5 million, $0.2 million, and $0.7 million in 2002, 2001, and 2000, respectively.  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 assets after giving consideration to the valuation allowance.

7.

Long-term obligations

Long-term obligations consist of the following:

The Company closed on a $450 million revolving credit facility (the “Credit Facilities”) in June 2002, pursuant to which SunTrust Bank is serving as Administrative Agent, Credit Suisse First Boston is the Syndication Agent and KeyBank N.A. and U.S. Bank N.A. are Co-Documentation Agents.  The Company used the Credit Facilities (i) to replace a $175 million revolving credit agreement (the “Old Credit Facility”), under which no amounts were outstanding at February 1, 2002, and to refinance $383 million outstanding under two synthetic lease facilities (the “Synthetic Lease Facilities”), which were scheduled to expire and mature, respectively, in September 2002, and (ii) for working capital and other general corporate purposes.  The Credit Facilities are comprised of a $300 million three-year revolving credit facility, and a $150 million 364-day revolving credit facility.  The Company pays interest on funds borrowed under the Credit Facilities at rates that are subject to change based upon the rating of the Company’s senior debt by independent agencies.  The Company has two interest rate options, base rate (which is usually equal to prime rate) and LIBOR.  At the Company’s current ratings, the facility fees are 37.5 basis points and 32.5 basis points on the two facilities, respectively.  The all-in drawn margin under the LIBOR option is LIBOR plus 237.5 basis points on both facilities.  The all-in drawn margin under the base rate option is the base rate plus 125 basis points and the base rate plus 120 basis points on the two facilities, respectively.  The Credit Facilities are collateralized by the same real estate assets that served as collateral for the Synthetic Lease Facilities: approximately 400 of the Company’s retail stores, its headquarters and two of its DCs.  As of January 31, 2003, the Company had no outstanding borrowings and $15 million of standby letters of credit under the Credit Facilities.  The standby letters of credit reduce the borrowing capacity of the Credit Facilities. The Credit Facilities contain financial covenants which include the ratio of debt to cash flow, fixed charge coverage, asset coverage, minimum allowable consolidated net worth (approximately $1.08 billion as of January 31, 2003) and maximum allowable capital expenditures.  As of January 31, 2003, the Company was in compliance with all of these covenants.

On June 21, 2000, the Company sold $200 million principal amount of 8 5/8% Notes due June 2010 (the “Old Notes”) in a private offering under Rule 144A of the Securities Act of 1933.  Subsequent to the offering, the Company and its guarantor subsidiaries filed a registration statement on Form S-4 enabling the Company to exchange its 8 5/8% Exchange Notes due June 2010 (the “New Notes” and, together with the Old Notes, the “Notes”) for all outstanding Old Notes.

The Notes require semi-annual interest payments in June and December of each year through June 15, 2010, at which time the entire balance becomes due and payable.  In addition, the Notes may be redeemed by the holders thereof at 100% of the principal amount, plus accrued and unpaid interest, on June 15, 2005.  The Notes contain certain restrictive covenants.  At January 31, 2003, the Company was in compliance with all such covenants.

In June 2000, DCs in Indianola, Mississippi and Fulton, Missouri were purchased by the Company and subsequently sold in sale-leaseback transactions resulting in twenty-two year, triple net leases with renewal options for an additional thirty years.  These properties were refinanced to bolster liquidity and diversify sources of funds.

The Company received waivers during 2001 and 2002 with respect to the leases of its DCs in Indianola, Mississippi and Fulton, Missouri. These waivers cured any alleged default of covenants under the leases as a result of the Company’s representations regarding its previous audited financial statements and the restatement of such financial statements. The Company reached agreement with all relevant parties to effect such waivers and in 2002 incorporated certain amendments in the lease documents, as a material inducement to obtain such waivers. The amendments to the leases involve the Company’s agreeing to comply with all obligations under its revolving credit agreements, as in effect from time to time, including, without limitation, all affirmative and financial covenants and to not violate any negative covenants set forth in such agreements.

Throughout 2001, the Company obtained waivers from its lenders to extend the requirement to deliver its audited 2000 financial statements, and unaudited 2001 quarterly financial statements, as a result of delays related to its restated financial statements (see Note 1).  The Company executed waivers with its various lenders during 2001, certain of which prohibited the Company from repurchasing its shares, limited its capital expenditures, increased its cost of borrowing and accelerated the maturity of one of the Synthetic Lease Facilities. The Company paid a total of approximately $1.6 million in fees during 2001 for all of the waivers and amendments, which are included in SG&A expenses.

8.

Earnings per share

The amounts reflected below are in thousands except per share data.

Basic earnings per share was computed by dividing net income by the weighted average number of shares of common stock outstanding during the year.  Diluted earnings per share was determined based on the dilutive effect of stock options using the treasury stock method.

Options to purchase shares of common stock that were outstanding at the end of the respective fiscal year but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares were 18.3 million, 14.4 million and 10.2 million in 2002, 2001 and 2000, respectively.

9.

Commitments and contingencies

Leases

As of January 31, 2003, the Company was committed under capital and operating lease agreements and financing obligations for most of its retail stores, four of its DCs, and certain of its furniture, fixtures and equipment.  Most of the stores are operated under traditional operating leases that include renewal options for periods ranging from two to five years. Approximately half of the stores have provisions for contingent rentals based upon a percentage of defined sales volume.  Certain leases contain restrictive covenants.  As of January 31, 2003, the Company was in compliance with such covenants.

In January 1999 and April 1997, the Company sold its DCs located in Ardmore, Oklahoma and South Boston, Virginia, respectively, for 100% cash consideration.  Concurrent with the sale transactions, the Company leased the properties back for periods of 23 and 25 years, respectively.  The transactions have been recorded as financing obligations rather than sales as a result of, among other things, the lessor’s ability to put the properties back to the Company under certain circumstances.  The property and equipment, along with the related lease obligations, associated with these transactions are recorded in the accompanying consolidated balance sheets.

Future minimum payments as of January 31, 2003, for capital leases, operating leases and financing obligations, are as follows:

Capital leases were discounted at an effective interest rate of approximately 8.4% at January 31, 2003.  The gross amount of property and equipment recorded under capital leases or financing obligations at January 31, 2003 and February 1, 2002, was $184.3 million and $556.9 million, respectively.

Rent expense under all operating leases was as follows:

Legal proceedings

Restatement-Related Proceedings. On April 30, 2001, the Company announced that it had become aware of certain accounting issues that would cause it to restate its audited financial statements for fiscal years 1999 and 1998, and to restate the unaudited financial information for fiscal year 2000 that had been previously released by the Company. The Company subsequently restated such financial statements and financial information by means of its Form 10-K for the fiscal year ended February 2, 2001, which was filed on January 14, 2002.

The Securities and Exchange Commission is conducting an investigation into the circumstances that gave rise to the Company’s April 30, 2001 announcement.  The Company is cooperating with this investigation by providing documents, testimony and other information to the Securities and Exchange Commission.  At this time, the Company is unable to predict the outcome of this investigation and the ultimate effects on the Company, if any.

As previously discussed in the Company’s periodic reports filed with the Securities and Exchange Commission, the Company and the individual current and former Company director and officer defendants settled the lead shareholder derivative action relating to the restatement that had been filed in Tennessee State Court.  The settlement agreement provided for a payment to the Company from a portion of the proceeds of the Company’s director and officer liability insurance policies as well as certain corporate governance and internal control enhancements.  The terms of such agreement required that all of the derivative cases, including the federal derivative cases  previously described in the Company’s periodic reports filed with the Securities and Exchange Commission, be dismissed with prejudice by the courts in which they were pending in order for the settlement to be effective.  Following confirmatory discovery, the settlement agreement received final approval by the Tennessee State Court on June 4, 2002.  All other derivative cases pending in the Tennessee State Court were subsequently dismissed. The federal derivative actions were dismissed on September 3, 2002.

The settlement of the shareholder derivative lawsuits resulted in a net payment to the Company, after attorneys’ fees payable to the plaintiffs’ counsel, of approximately $25.2 million in August 2002, which was recorded as income during the third quarter of 2002.

Also as previously discussed in the Company’s periodic reports filed with the Securities and Exchange Commission, the Company settled the consolidated restatement-related class action lawsuit filed in the United States District Court for the Middle District of Tennessee on behalf of a class of persons who purchased or otherwise made an investment decision regarding the Company’s securities and related derivative securities between March 5, 1997 and January 14, 2002.  The $162 million settlement was approved by the court on May 24, 2002 and was paid in the first half of 2002.  This amount had been previously expensed by the Company in the fourth quarter of 2000.  The Company received from its insurers $4.5 million in respect of such settlement in July 2002, which was recorded as income during the second quarter of 2002.  In connection with the settlement, plaintiffs representing fewer than 1% of the shares traded during the class period chose to opt out of the class settlement and may elect to pursue recovery against the Company individually.  In the fourth quarter of 2002, the Company reached an agreement to settle, and paid, a claim by one such plaintiff and recognized an expense of $0.2 million in respect of such agreement.  To the Company’s knowledge, no other litigation has yet been filed or threatened by parties who opted out of the class action settlement.  The Company cannot predict whether any additional litigation will be filed or estimate the potential liabilities associated with such litigation, but it does not believe that the resolution of any such litigation will have a material adverse effect on the Company’s financial position or results of operations.

Other Litigation .  On March 14, 2002, a complaint was filed in the United States District Court for the Northern District of Alabama to commence a purported collective action against the Company on behalf of current and former salaried store managers.  The complaint alleges that these individuals were entitled to overtime pay and should not have been classified as exempt employees under the Fair Labor Standards Act (“FLSA”).  Plaintiffs seek to recover overtime pay, liquidated damages, declaratory relief and attorneys’ fees.  This action is still in the initial discovery phase and the court has not found that the case should proceed as a collective action.  The Company believes that its store managers are and have been properly classified as exempt employees under the FLSA and that the action is not appropriate for collective action treatment.  The Company intends to vigorously defend the action.  However, no assurances can be given that the Company will be successful in defending this action on the merits or otherwise , and, if not, the resolution could have a material adverse effect on the Company’s financial position or results of operations.

The Company is involved in other legal actions and claims arising in the ordinary course of business.  The Company currently believes that such litigation and claims, both individually and in the aggregate, will be resolved without material effect on the Company’s financial position or results of operations.  However, litigation involves an element of uncertainty.  Future developments could cause these actions or claims to have a material adverse effect on the Company’s financial position or results of operations.

Other matters

In July of 2002 the Company filed amended federal income tax returns for 1998 and 1999.  In October of 2002 the Company filed its federal income tax returns for 2000 and 2001.  The Internal Revenue Service is currently conducting a normal examination of the Company’s 1998 and 1999 federal income tax returns.  The results of the examination, and any other issues discussed with the IRS in the course of the examination, may result in changes to the Company’s future tax liability.

10.

Employee benefits

Effective January 1, 1998, the Company established a 401(k) savings and retirement plan.  All employees who had completed 12 months of service, worked 1,000 hours per year, and were at least 21 years of age were eligible to participate in the plan.  Employee contributions, up to 6% of annual compensation, were matched by the Company at the rate of $0.50 on the dollar.  The Company also contributed a discretionary amount annually to the plan equal to 2% of each employee’s annual compensation.

Effective January 1, 2003, the Company’s 401(k) savings and retirement plan was amended to allow all employees to participate in the plan and contribute up to 25% of pay from their date of hire.  After employees complete 12 months of service, including 1,000 hours of service, the Company will match employee contributions at a rate of $1.00 for each $1.00 contributed, up to 5% of annual compensation. Expense for this plan was approximately $5.9 million in 2002, $7.4 million in 2001, and $7.2 million in 2000.

Effective January 1, 1998, the Company also established a supplemental retirement plan and a compensation deferral plan for a select group of management and highly compensated employees.  The supplemental retirement plan is a noncontributory defined contribution plan with annual Company contributions ranging from 2% to 12% of base pay plus bonus depending upon age plus years of service and salary level.  Under the compensation deferral plan, participants may defer up to 65% of base pay and 100% of bonus pay.  Effective January 1, 2000, both the supplemental retirement plan and compensation deferral plan were amended and restated so that such plans were combined into one master plan document. Effective January 1, 2003, the plan document was amended to clarify certain provisions and to mirror the 401(k) plan employer contribution provisions that became effective on January 1, 2003, as described above. An employee may be designated for participation in one or both of the plans, according to the eligibility requirements of the plans.  Compensation expense for these plans was approximately $0.2 million in 2002, $0.1 million in 2001, and $0.1 million in 2000.

In September 2000, the supplemental retirement plan and compensation deferral plan assets were invested in Company stock and mutual funds as designated by the plan participants and placed in a rabbi trust.  The mutual funds are stated at fair market value, which is based on quoted market prices, and are included in Other current assets.  In accordance with EITF 97-14 “Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested,” the Company’s stock is recorded at historical cost and classified as Common stock held in trust.  Pursuant to the terms of the plan, a participant’s account balance will be paid in cash by (a) lump sum, (b) monthly installments over a 5, 10 or 15 year period or (c) a combination of lump sum and installments.  The deferred compensation liability is recorded at the fair value of the investments held in the trust and is included in Accrued expenses and other in the accompanying consolidated balance sheets.

11.

Capital stock

The Company has a Shareholder Rights Plan (the “Plan”) under which Series B Junior Participating Preferred Stock Purchase Rights (the “Rights”) were issued for each outstanding share of common stock.  The Rights were attached to all common stock outstanding as of March 10, 2000, and will be attached to all additional shares of common stock issued prior to the Plan’s expiration on February 28, 2010, or such earlier termination, if applicable.  The Rights entitle the holders to purchase from the Company one one-hundredth of a share (a “Unit”) of Series B Junior Participating Preferred Stock (the “Preferred Stock”), no par value, at a purchase price of $100 per Unit, subject to adjustment.  Initially, the Rights will attach to all certificates representing shares of outstanding common stock, and no separate Rights Certificates will be distributed.  The Rights will become exercisable upon the occurrence of a triggering event as defined in the Plan.

On March 13, 2003, the Company was granted the authority by its Board of Directors to repurchase up to 12 million shares of its outstanding common stock. This authorization expires March 13, 2005.

12.

Stock incentive plans

The Company has established a stock incentive plan under which restricted stock awards and stock options to purchase common stock may be granted to executive officers, directors and key employees.

In 2001, the Company awarded a total of 32,000 shares of restricted stock to certain executive officers at a weighted average fair value of $17.20 per share.  The difference between the market price of the underlying stock and the purchase price, which was set as zero for all restricted stock awards in 2001, on the date of grant was recorded as a reduction of shareholders’ equity as unearned compensation expense and has been amortized to expense on a straight-line basis over the restriction period, which was set at one year for all restricted stock awards in 2001.  Under the terms of the Company’s 1998 Stock Incentive Plan, recipients are entitled to receive cash dividends and to vote their respective shares, but are prohibited from selling or transferring shares prior to vesting.  In addition, the maximum number of shares eligible for issuance under the terms of the Company’s restricted stock award plans has been capped at 100,000.  At January 31, 2003, 68,000 shares were available for grant under the Company’s restricted stock award plan.

All stock options granted in 2002, 2001 and 2000 under the 1998 Stock Incentive Plan were non-qualified stock options issued at a price equal to the fair market value of the Company’s common stock on the date of grant.  Non-qualified options granted under these plans have expiration dates no later than 10 years following the date of grant.

Under the plan, stock option grants are made to key management employees including executive officers, as well as other employees, as prescribed by the Compensation Committee of the Board of Directors.  The number of options granted is directly linked to the employee’s job classification.  Beginning in 2002, vesting provisions for options granted under the plan changed from a combination of Company performance-based vesting and time-based vesting to time-based vesting only.  All options granted in 2002 under the plan vest ratably over a four-year period.

The plans also provide for annual stock option grants to non-employee directors according to a non-discretionary formula.  The number of shares granted is dependent upon current director compensation levels and the fair market value of the stock on the grant date.

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 $6.15, $6.77 and $10.76, respectively. The fair value of each stock option grant was estimated on the date of grant using the Black- Scholes option pricing model with the following assumptions:

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

A summary of the balances and activity for all of the Company’s stock option awards for the last three fiscal years is presented below:

The following table summarizes information about stock options outstanding at January 31, 2003:

At January 31, 2003, there were approximately 6.2 million shares available for granting of stock options under the Company’s stock option plans.

13.

Related party transactions

In July and August of 2002, Cal Turner, the Company’s Chairman and then Chief Executive Officer, made voluntary payments to the Company totaling approximately $6.8 million in cash.  Of such amount, approximately $6.0 million represented the value on April 10, 2002 of stock Mr. Turner acquired on April 7, 1999 and April 20, 2000 upon the exercise of stock options (net of the strike price of such options), which stock Mr. Turner continues to own, and approximately $0.8 million represented the value of performance-based bonuses received by Mr. Turner in April 1999 and April 2000.  Mr. Turner voluntarily paid such amounts to the Company because the options vested and the performance bonuses were paid based on performance measures that were attained under the Company’s originally reported financial results for the period covered by the Company’s restatement.  Those measures would not have been attained under the subsequently restated results.  The Company recorded the approximately $6.0 million receipt as a contribution of capital, which was recorded as an increase in Additional paid-in capital in the accompanying consolidated balance sheet as of January 31, 2003.  The Company recorded the approximately $0.8 million receipt as a reduction of SG&A expenses during the third quarter of 2002.

14.

Segment reporting

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 January 31, 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.”

15.

Quarterly financial data (unaudited)

The following is selected unaudited quarterly financial data for the fiscal years ended January 31, 2003 and February 1, 2002.  Amounts are in thousands except per share data.  

The third quarter 2002 net income and related per share amounts above include pretax insurance proceeds of $25.2 million related to the settlement of the Company’s shareholder derivative litigation (see Note 9). The fourth quarter 2002 and 2001 gross profit and net income and related per share amounts include pretax LIFO adjustments of $8.9 million and $3.5 million, respectively (see Note 1).

16.

Guarantor subsidiaries

All of the Company’s subsidiaries, except for its not-for-profit subsidiary whose assets and revenues are not material (the “Guarantors”), have fully and unconditionally guaranteed on a joint and several basis the Company’s obligations under the Notes described in Note 7.  Each of the Guarantors is a direct or indirect wholly owned subsidiary of the Company. In order to participate as a subsidiary guarantor on certain of the Company’s financing arrangements, a subsidiary of the Company has entered into a letter agreement with certain state regulatory agencies to maintain stockholders’ equity of at least $250 million.

The following consolidating schedules present condensed financial information on a combined basis.  Dollar amounts are in thousands.