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Fred's Inc. (FRED - Analyst Report) reported fiscal 2012 fourth quarter earnings of 18 cents, a decline of 30.7% from the earnings of 26 cents in the same quarter prior-year. Earnings also missed the Zacks Consensus Estimate of 19 cents and the company guidance of 31 cents to 36 cents. The ongoing tough retail environment and higher operating expenses led to the decline in earnings.

Revenue and Margin Performance

Total sales increased 7% year over year to $533.4 million, which missed the Zacks Consensus Estimate of $534.0 million. Fred’s exhibited positive growth on the back of higher merchandise sales and improved consumer traffic, resulting from marketing initiatives. Fred’s comparable store sales grew 4.8% during the quarter.

Gross profits grew 8% to $148.6 million while gross margin expanded 20 basis points to 27.9% from the year-ago quarter. The improved margin was the result of higher pharmacy department gross margin, partially offset by increased charges on general merchandise margin due to sales mix shift.

Selling, general and administrative expense margin increased 150 basis points to 26.3% in the quarter, due to higher depreciation and amortization resulting from higher profits in the pharmacy department.

Operating income plummeted 40.1% to $8.5 million in the quarter while margins shrank 130 basis points to 1.6% due to higher operating expenses.

Fiscal Year Results

For fiscal 2012, earnings went up 6.8% to 93 cents from 87 cents in the prior-year. Earnings beat the Zacks Consensus Estimate of 87 cents and were within the company guidance of 94 cents to 99 cents.

Total sales increased 4% year over year to $1.96 billion, which were in line with the Zacks Consensus Estimate. Comparable store sales for the year rose 1.1%.

Other Financial Update

Fred’s exited the 2012-fourth quarter with cash and cash equivalents of $8.1 million compared to $27.1 million at the end of the same quarter a year ago. Total liabilities stood at $215.9 million, including long-term indebtedness of $12.2 million, as of Feb 2, 2013. This compared with total liabilities of $208.4 million and long-term indebtedness of $6.6 million as of Jan 28, 2012.

Guidance

Management expects tough retail conditions to continue across the markets in fiscal 2013. For the first quarter of fiscal 2013, Fred’s forecasts its total sales to increase 1% to down 1%.

Comparable store sales, including one extra week, are expected to decrease by 1% to 3% in the first quarter due to weak sales in March. The company expects earnings to remain within a range of 26 cents–30 cents per share in the quarter.

For the fiscal 2013, Fred’s expects lower earnings of 77 cents–88 cents per share compared with fiscal 2012. However, excluding the impact of favorable income tax adjustment (12 cents per share) on 2012 results, earnings per share is expected to increase by 12% to 28% in the year. The Zacks Consensus Estimate is pegged at 29 cents per share for the first quarter and 82 cents for fiscal 2013.

Conclusion

Fred’s posted a disappointing fourth quarter with the bottom line missing the Zacks Consensus Estimate. Although revenues increased due to higher comparable store sales, increased expenses constrained margins.

Fred’s currently carries a Zacks Rank #3 (Hold). Other stocks like Joe’s Jeans Inc. (JOEZ - Snapshot Report), Ralph Lauren Corporation (RL - Analyst Report) and PVH Corp. (PVH - Analyst Report) with a Zacks Rank #2 (Buy), are worth considering.

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