Fred’s Inc. (FRED) posted EPS of 14 cents in its second quarter of fiscal 2010, which matched the Zacks Consensus Estimate and came in ahead of 13 cents reported in the year-ago quarter. Comparable store sales growth, increased traffic driven by Fred’s sales and profit-driving initiatives resulted in the earnings outperformance.
Including the effect of higher income taxes, EPS in the quarter came in at 13 cents compared to 11 cents in the year-ago quarter, an 18% rise.
Total sales increased 4% year-over-year to $449.5 million, missing the Zacks Consensus Estimate of $452.0 million. The revenue growth also fell short of the company’s guided range of 5% to 7%. Comparable store sales for the quarter increased 2.5% compared with a decrease of 1.3% in the year-ago quarter. Same-store sales were near the lower end of the company’s expectations of 2% to 4% for the quarter.
On a monthly basis, comparable store sales increased 3.5%, 1.7% and 2.7% in May, June and July, respectively. Comparable store sales, in all the three months, were boosted by increased traffic, improved sales mix, solid comparable script growth in the pharmacy department and strong Core 5 department results.
May comparable store sales particularly benefited from a strong finish before the Memorial Day holiday, driven by advertising circulars and success of new sales-driving initiatives put in place. In July, the comparable sales were somewhat negatively affected by 75 basis points due to a shift in the retail calendar that eliminated the first-of-the-month sales benefit for July. Notwithstanding, the pharmacy department continued to post positive script gains.
Cost & Margin Performance
Expenses increased in the quarter with cost of goods sold edging up 3% to $323.5 million and selling, general and administrative expenses increasing 4% to $110.5 million. Based on revenues, cost of products sold improved 20 basis points to 72% and selling, general and administrative expenses upped 20 basis points to 24.6%. The increase in selling, general and administrative costs was ascribed to expenses associated with the company’s store upgrade program and new pharmacy growth.
Gross profit grew 4% to $126 million with gross margin up 20 basis points to 28.0%, benefiting from a favorable product mix and better management of store shrinkage. Operating income edged up 1% to $8.2 million. Operating margin was 1.8% in the quarter compared with 1.9% in the year-ago quarter.
Financial Position
As of July 31, 2010, Fred’s had cash and cash equivalents of $46.9 million, down from $48.2 million as of May 1, 2010. As of May 1, 2010, the debt-to-capitalization ratio improved marginally to 1% from 1.1% as of May 1, 2010.
Store Update
During the quarter, Fred’s upgraded three express pharmacies, opened five express pharmacies and two additional new pharmacies. The company also closed six pharmacies and refreshed 75 stores with its new Core 5 elements. Fred’s ended the quarter with 674 discount general merchandise stores, which included 24 franchised Fred’s stores.
Outlook
According to the company, even though its pharmacy department is delivering above-industry comparable script growth, its performance will be affected over the next one-and-half years. The pharmacy industry will be hurt by changes in third-party reimbursement rates, decreasing sales caused by higher generic drug penetration, and continued expansion of the $4 generic pricing, along with an expanded base of the insured that will phase-in between 2011 and 2014.
In the third quarter of 2010, Fred’s expects total sales to increase 4% to 5%. Comparable store sales are expected to increase 2.0% to 4.0% over 1.0% in the third quarter of last year. The company initiated the third quarter EPS guidance in the range of 16 cents to 19 cents. The company affirmed its EPS outlook for 2010 in the 72 cents to 79 cents range.
Fred’s, based in Memphis, Tennessee, operates discount general merchandise stores mainly in southeastern U.S. It offers nationally recognized brands, and private label and lower-priced, off-brand products. The company’s merchandise mix includes more than 12,000 frequently purchased items, consisting of household goods, apparel, food, tobacco, healthcare and paper products. Some of its retail outlets also feature pharmacies, which offer prescription drugs.
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