Fred's Q1 Profit Down 46%, Results Miss View; Sees Lower Earnings In Q2

(RTTNews) - Discount retailer Fred's Inc. (FRED) on Thursday reported a 46 percent decline in profit for the first quarter from last year, reflecting flat sales and lower margins. Results for the quarter missed analysts' estimates. Looking ahead, the company forecast lower earnings for the second quarter, citing the continued impact of higher generic drug pricing on pharmacy department gross margin.

Bruce Efird, Chief Executive Officer of Fred's, said, "As we outlined in our April sales release, the first quarter was a challenging period for Fred's due to a number of headwinds. These challenges included intense competitive promotions and poor weather throughout much of the spring, which affected general merchandising."

Efird noted that in addition, the company encountered extraordinary inflationary pressures on generic drugs in the first quarter.

Fred' net income for the first quarter was $6.12 million or $0.17 per share, down from $11.41 million or $0.31 per share in the prior-year period. On average, nine analysts polled by Thomson Reuters expected the company to report earnings of $0.20 per share for the quarter. Analysts' estimates typically exclude one-time items.

Net sales for the quarter edged down 0.6 percent to $498.26 million from $501.50 million in the year-ago quarter. Analysts had a consensus revenue estimate of $499.66 million for the quarter.

Comparable store sales for the quarter declined 1.9 percent, compared to a decrease of 1.3 percent for the year-ago period.

Gross margin for the quarter decreased 150 basis points from the year-ago period to 28.6 percent.

According to Fred's, the deleveraging for the quarter was driven by inflation on pharmacy department purchases, primarily generics, coupled with continued pressure on reimbursement rates. The general merchandise margins were negatively affected by the ongoing sales mix shift to lower-margin consumables and increased promotional activities.

Operating margin also declined 150 basis points from the prior-year period to 2.0 percent.

During the first quarter, Fred's net new locations were unchanged. However, ctivity consisted of two full-service store openings, four new Xpress pharmacy locations and the closure of four full-service stores and two Xpress pharmacy locations, one of which was converted to a full-service store.

Looking ahead to the second quarter, Fred's forecast operating earnings in a range of $0.04 to $0.09 per share, compared with $0.09 per share in the same period last year. The company attributes the lower earnings to the continued impact of higher generic drug pricing on pharmacy department gross margin.

Fred's projects total sales for the second quarter to increase in a range of 1 to 3 percent, and comparable store sales to be flat to up 2 percent. This reflects the new marketing initiatives and continued growth in Pharmacy department sales.

Analysts expect the company to earn $0.08 per share for the quarter on revenues of $487.52 million.

For fiscal 2014, Fred's now forecasts operating earnings in a range of $0.60 to $0.68 per share. Earlier, the company forecast full-year total earnings n a range of $0.74 to $0.80 per share. Street expects the company to earn $0.70 per share for the year on revenues of $1.97 billion.

Efird said, "We are now engaged in a robust reworking of our current pharmacy distribution agreement, with benefits expected to begin in the second half of 2014 and with the full impact anticipated in 2015. We will be making the general merchandising changes over the balance of this year, which include cleaning out unproductive SKUs and exiting categories that do not align with Fred's enlarged convenience model."

Fred's currently estimates the book write-down of cleared inventory in a range of $10 million to $12 million, exclusive of additional store closings.

FRED closed Wednesday's trading at $16.00, down $0.49 or 2.97 percent on a volume of 229,000 shares.