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Fred's Inc. (FRED - Analyst Report) reported first quarter fiscal 2013 earnings of 31 cents, which climbed 10.7% from both the Zacks Consensus Estimate and the prior year earnings of 28 cents. Earnings were ahead of the company’s guidance of 26 cents to 30 cents. The company’s improved gross margin performance and cost control measures boosted earnings, despite poor weather conditions that affected top-line growth.

Revenue and Margin Performance

Total sales increased only 0.2% year over year to $501.5 million, which missed the Zacks Consensus Estimate of $504.0 million. Sales were within Fred’s guidance of a decline of 1% to an increase of 1%.Categories like household goods, apparels and linens, paper and chemicals, pharmaceuticals and franchise declined in the quarter. Only food and tobacco category witnessed growth in the quarter, while health and beauty remained flat.

Fred’s comparable store sales declined 1.3% during the quarter, due to decline in customer traffic. The decline was wider than the year ago quarter’s decline of 0.4%. The company had expected comparable sales to decline in the range of 1% to 3% due to weak sales in March. Sales at Fred’s were partly hampered due to poor weather conditions and negative impact of the ongoing shift from branded to generic drugs.

Gross profits grew 2.1% to $151.0 million while gross margin expanded 60 basis points to 30.1% from the year-ago quarter. The improvement in gross margin primarily results from higher pharmacy department margins on generic prescriptions.

However, pharmacy department growth and opening of new stores led to higher selling, general and administrative (SG&A) expenses. SG&A expense margin increased 50 basis points to 26.6% in the quarter. During the quarter, Fred's opened one full-service store and three Xpress pharmacy locations. The company also closed one full-service store in the first quarter.

Operating income increased 4.1% to $17.8 million in the quarter while margins increased 10 basis points to 3.5% due to prudent expense management.

Guidance

Second quarter of fiscal 2013

For the second quarter of fiscal 2013, Fred’s forecasts its total sales to increase in the range of 2% to 4%, while it expects comparable store sales to be flat in the second quarter. The company expects earnings to remain within a range of 6 cents–9 cents per share in the quarter.

Fiscal 2013 Outlook Retained

For the fiscal 2013, Fred’s continues to expect earnings in the range of 77 cents–88 cents per share which is lower than the year-ago level. However, excluding the impact of favorable income tax adjustment of 12 cents per share on the 2012 results, earnings per share is expected to increase 12% to 28% in the year.

Management is well on track to improve its pharmacy department growth, expand its specialty drug program, and roll out its expanded auto and hardware program. However, the company continues to expect tough retail conditions to continue across the markets in fiscal 2013. Also, declining comparable store sales over the past several months remain a concern.

The Zacks Consensus Estimate is pegged at 28 cents per share for the second quarter and 83 cents for fiscal 2013.

Fred’s currently carries a Zacks Rank #3 (Hold). Other retail stocks that are worth a look include Green Mountain Coffee Roasters, Inc (GMCR - Analyst Report), Core Mark Holdings Inc (CORE - Snapshot Report) and Natural Grocers by Vitamin Cotta (NGVC - Snapshot Report). While Green Mountain holds a Zacks Rank #1 (Strong Buy), Core Mark and Natural Grocers hold a Zacks Rank #2 (Buy).

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