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Fred's (NASDAQ:FRED)

Q2 2013 Earnings Call

August 29, 2013 10:00 am ET

Executives

Pat Watson

Jerry A. Shore - Chief Administative Officer, Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Bruce A. Efird - Chief Executive Officer, President and Director

Alan C. Crockett - Chief Merchandising Officer and Executive Vice President

Rick A. Chambers - Executive Vice President of Pharmacy Operation

Analysts

Andrew P. Wolf - BB&T Capital Markets, Research Division

Dutch Fox - FBR Capital Markets & Co., Research Division

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Michael Richardson - Sidoti & Company, LLC

Patrick McKeever - MKM Partners LLC, Research Division

John R. Lawrence - Stephens Inc., Research Division

Matthew Siler - Deutsche Bank AG, Research Division

Operator

Good day, everyone, and welcome to the Fred's Inc. Second Quarter Conference Call. Today's call is being recorded.

For opening remarks and introductions, I'll turn the call to Pat Watson. Pat, please go ahead.

Pat Watson

Thank you, and good morning, everyone. This is Pat Watson, with Corporate Communications. Thank you for joining Fred's to review the company's financial and operating results for the second fiscal quarter and first 6 months of the year that ended on August 3, 2013.

Before we begin, I would like to remind everyone that management's comments in this conference call that are not based on historical facts are forward-looking statements. These statements are made in reliance on the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to uncertainties and risks. It should be noted that the company's future results may differ materially from those anticipated and discussed in the forward-looking statements. Some of the factors that could cause or contribute to such differences have been described in the news release issued earlier today, in the company's annual report on Form 10-K and in other filings with the Securities and Exchange Commission. We refer you to these sources for more information.

Lastly, I would like to point out that management's remarks during this conference call are based on information and understandings believed accurate as of today's date, August 29, 2013. Because of the time-sensitive nature of these information, it is Fred's policy to limit the archived replay of this conference call webcast to a period of 30 days. This call is the property of Fred's. Any distribution, transmission, broadcast or rebroadcast of this call for commercial purposes, in any form, without the expressed written consent of the company is prohibited.

With those announcements, I'll turn the call over to Jerry Shore, the company's Chief Financial Officer. Good morning, Jerry.

Jerry A. Shore

Good morning, Pat. And thanks to all of you for joining us this morning for our discussion of second quarter results for fiscal 2013. With me and available for questions are Michael Hayes, Chairman; Bruce Efird, Chief Executive Officer; Rick Chambers, EVP of Pharmacy Operations; and Alan Crockett, EVP and Chief Merchandising Officer.

As the company reported in its press release earlier this morning, Fred's total sales for the second quarter fiscal of 2013 increased 2% to $482.2 million from $470.8 million for the same period last year. On a comparable store basis, second quarter sales increased 2.2% compared with a decrease of 1% in the same period last year.

The quarterly sales mix comparison was as follows. Household goods were 22.6%, decreased from 23.4% last year. Apparel and linens were 5.7%, decreased from 6.2%. Health and beauty were 7%, decreased from 7.4%. Paper and chemical were 8.8%, decreased from 9%. Food and tobacco were 7.8%, increased from 16.5%. Pharmaceuticals were 36.4%, increased from 35.7%. And franchise were 1.7%, decreased from 1.8%.

For the quarter, comparable store customer traffic increased 1.6% over last year, while the average customer ticket increased 0.6% to $20.39.

For the first 6 months of 2013, total sales increased 1% to $983.7 million from $971.3 million in the year-earlier period. Comparable store sales for the year-to-date period in 2013 increased 0.5% compared with a decrease of 0.5% in the prior year period.

The year-to-date sales mix comparison was as follows. Household goods were 22.6%, decreased from 23.4% last year. Apparel and linens were 6.1%, decreased from 6.5%. Health and beauty were 7.2%, decreased from 7.4%. Paper and chemical were 8.6%, decreased from 8.8%. Food and tobacco were 8.7% -- or 17.7%, increased from 16.4%. Pharmaceuticals were 36.1%, decreased from 35.7% -- or increased from 35.7%. And franchise, 1.7%, decreased from 1.8%.

On a year-to-date basis, comparable store customer traffic increased 0.3% over last year, while the average customer ticket increased 0.2% to $20.81.

Sales per selling square foot for the trailing 12 months was $209 compared with $204 in the same quarter last year.

Now as I move into net income and earnings per share, I will remind you that the second quarter of 2012 included the benefit of approximately $4 million or $0.11 per diluted share of favorable tax credits related to a state income tax settlement as well as adjustments for other tax-related assumptions and estimates. For comparison purposes, net income and earnings per share numbers in my commentary will be presented including this -- including and excluding this favorable tax credit.

Net income for the second quarter of 2013 decreased to $3.3 million from $6.1 million last year. Excluding the favorable tax credit, quarterly net income increased 63% to $3.3 million from $2 million last year. For the second quarter of 2013, Fred's earnings per diluted share decreased to $0.09 per share compared with $0.17 per diluted share in the same quarter last year. Again excluding the tax credit, quarterly earnings per diluted share increased 50% to $0.09 as compared to $0.06 in the same quarter last year.

Net income for the 6 months ended August 3, 2013, decreased to $14.7 million compared with net income of $16 million -- $16.5 million for the same period last year. Excluding the tax credit, net income for the year-to-date period increased 18% to $14.7 million compared with net income of $12.5 million for the same period last year. For the 6 months ended August 3, earnings per diluted share decreased to $0.40 per diluted share from $0.45 per share for the first 6 months of 2012. Again excluding the tax credit, year-to-date earnings per diluted share increased 18% to $0.40 per diluted share from $0.34 for the first 6 months of 2012.

Operating income for the second quarter increased 55% to $5.2 million or 1.1% of sales compared to $3.4 million or 0.7% of sales in the last year. Also during the second quarter, we closed 21 stores, as compared to 14 stores in the same quarter last year. We estimate the negative impact on operating income of the 7 additional store closings and product transition markdowns to be approximately $1.2 million or $0.02 per share during the quarter.

Operating income year-to-date was $23 million or 2.3% of sales compared with $20.5 million or 2.1% of sales last year.

EBITDA or earnings before interest, taxes, depreciation and amortization, during the second quarter increased 23% to $15.7 million or 3.3% of sales compared with $12.8 million or 2.7% last year. EBITDA for the 6 months increased 11% to $43.8 million or 4.5% of sales compared with $39.3 million or 4% last year.

Fred's gross profit for the second quarter of 2013 increased 3% to $136 million from $131.8 million in the prior year period. Gross margin for the quarter was 28.2%, 20 basis points better than last year. During the quarter, increases in pharmacy department margins more than offset increases in general merchandise markdowns and shrinkage.

LIFO expense, which is a noncash item, was unfavorable in the quarter by $800,000 and negatively impacted the gross margin by 16 basis points, and earnings per share by $0.01 per share.

Gross profit for the first half of 2013 increased 3% to $287 million from $279.6 million in 2012. Gross margin for the year-to-date period was 29.2% compared with 28.8% in the prior year. Pharmacy department gross margin improvement is the driving factor in the year-over-year increase.

Selling, general and administrative expenses, including depreciation and amortization, leveraged 20 basis points to 27.1% of sales compared to 27.3% of sales last year. The leveraging in the second quarter was partially offset by sales -- by the sales impact of pharmacy department brand-to-generic shift and investments in new pharmacies. For the first half of 2013, SG&A expenses deleveraged 20 basis points to 26.9% of sales compared with 26.7% in the first 6 months of 2012. The deleveraging in the year-earlier period was primarily attributed to the sales impact of the pharmacy department brand-to-generic shift as well as investments in new pharmacies.

Depreciation and amortization in the second quarter totaled $10.5 million compared with $9.5 million last year. And year-to-date, depreciation and amortization totaled $20.8 million compared with $18.8 million last year.

For the second quarter of 2013, net interest expense was $129,000 versus $136,000 in 2012. We continue to experience only minimal interest expense, and there were no borrowings at quarter end on the company's revolving line of credit. On a year-to-date basis, net interest expense totals $264,000 in 2013 compared with $273,000 last year.

Moving to income taxes. I've already stated the second quarter of 2012 was impacted by the tax settlement with the State of Tennessee, as well as other tax-related assumptions and estimates. Excluding this effect, the income tax rate in the second quarter was 34.5% compared with 36.8% in the year-earlier period. For the first 6 months, the effective tax rate was 35.2% compared with 38.1% in the prior year. The lower effective rate this year reflects the impact of Work Opportunity Tax Credits which has congressional approval this year but were not approved last year until late in the fourth quarter. We now expect full year effective tax rate to be in the range of 35% to 36%.

Moving to the balance sheet. Cash and cash equivalents totaled $7.9 million compared with $23.1 million in the year-earlier period. The decrease in cash is primarily attributable to inventory increases of $8.2 million and accounts receivable increases of $6.7 million.

Total inventories increased by 2.4% to $348.3 million at the end of the quarter compared with $340.1 million in the second quarter of 2012. The increase in inventory is in line with store and pharmacy growth, coupled with the inflationary impact. We continue to believe the quality of our inventory is strong. Inventory turns were 3.8 at the end of the second quarter.

Capital expenditures for the second quarter totaled $7.2 million compared with $6 million last year. The breakdown of second quarter capital expenditures include $900,000 for new stores and pharmacies; $3 million for existing and remodeled stores; and $3.3 million for technology, corporate and other miscellaneous upgrades. On a year-to-date basis, capital expenditures totaled $14 million compared with $12.1 million in the first half of 2012. The breakdown of the year-to-date capital expenditures includes $1.3 million for new stores and pharmacies; $8.7 million for existing and remodeled stores; and $4 million for technology, corporate and other miscellaneous upgrades.

Additionally, there was $5.4 million related to acquisitions of pharmacies, as compared to $2.6 million in the second quarter of last year. Year-to-date expenditures for acquisitions of pharmacies were $7.8 million compared to $7.9 million last year.

At the end of the second quarter, accounts payable was $103.6 million or 30% of total inventory, as compared to $103.1 million, also 30% at the same point last year. Total debt at the end of the quarter was only $5.4 million compared to $7.1 million last year. And there -- as I said earlier, there was no debt at quarter end on the company's revolving line of credit.

Free cash flow, which we identify as net cash provided by operating activities, net of all capital expenditures, pharmacy acquisitions and related activity, totaled $11.5 million in the first half of the year.

At the end of the second quarter, there were 627 owned full-size stores, 49 company-owned Xpress stores, 21 franchise stores, for a total of 697 stores and 350 pharmacies. During the second quarter, Fred's opened 3 new locations, consisting of 2 new stores and 1 new Xpress pharmacy location, and closed 21 store locations. During the first half of 2013, Fred's opened 7 new locations, consisting of 3 new stores and 4 Xpress pharmacies, and closed 22 locations.

The company's total selling square footage was approximately 9.3 million feet compared to 9.5 million square feet in the same period the last year. The reduction in square footage is primarily the result of the store closures that took place in the second quarter.

We now expect to open a range of 14 to 18 new stores and 25 to 30 new pharmacies in 2013. Closings in 2013 are anticipated to be approximately 25 stores and 5 pharmacies. Selling square footage will be approximately flat for the year, as compared to year-end 2012.

Our guidance for the third quarter and remainder of the year is as follows. We now anticipate August total sales to be in the range of flat to up 2%, with comparable store sales approximately flat, which is at the low end of our earlier projections of flat to up 2%. Sales in August have been lower than we have seen in June and July due to slowness in back-to-school sales this year as well as a calendar shift with there being no first of the month in the August fiscal calendar. In the third quarter, the company expects total sales to be up 1% to 3% over last year, reflecting more store and pharmacy openings. Comparable store sales for the quarter are expected to be in the range of flat to up 2%.

Earnings per share are forecasted to be in the range of $0.19 to $0.23 for the third quarter, an increase of 6% to 28% over the $0.18 earnings per share during the same period last year. Based on our year-to-date results and this outlook, the company continues to expect total earnings per diluted share for 2013 to be in the range of $0.81 to $0.86, which represents an increase of 17% to 25%, excluding the favorable impact in 2012.

This concludes our financial summary, and I will now turn the call over to Bruce Efird.

Bruce A. Efird

Thank you, Jerry. Good morning, everyone. To follow up on Jerry's comments, I will share with you a summary of what we saw in the second quarter performance as well as how we're thinking about the back half of 2013.

Starting with the overall performance delivered by our team during the quarter. There were several improvements in the quarter that we are pleased with, including comparable store sales increase of 2.2% during the quarter, with both general merchandise and pharmacy departments delivering positive results. We were also pleased with the breakdown of customer traffic and ticket, as traffic increased 1.6% and ticket increased 0.6%. Gross margins improved 20 basis points in the quarter even with a 16 basis points negative impact from LIFO expense on pharmacy inventory.

Total company operating expenses leveraged 20 basis points, as virtually all divisions managed and leveraged their costs. We're pleased with the continued improvement in cash flow and EBITDA. As Jerry noted, EBITDA improved 23% in the quarter and year-to-date free cash flow is $11.5 million. These results reflect the team effort that is progressing on our reconfiguration plan.

As a reminder, the reconfiguration plan is a 3-year plan centered around 2 fundamental principles: number one, an aggressive expansion of our pharmacy presence and healthcare services; and number two, expanding space in more productive discretionary product lines within our general merchandise departments. Our 3-year reconfiguration plan is designed to position Fred's to leverage areas in which we see future growth, specifically in pharmacy and healthcare services. During the quarter, both of these principles, although in early-stage rollout, produced strong results.

Starting with pharmacy. I'm pleased to report that our pharmacy department continues to grow in line with our projections. During the quarter, we increased the penetration of stores with pharmacy departments from 50% to 52%. Our 3-year goal is to increase that penetration to 65% to 70%. Pharmacy department comparable store sales were positive 1% for the quarter, the first quarterly increase in over a year. As a reminder, pharmacy top line sales have been adversely affected by the large brand-to-generic drug conversions. Our team continued to drive traffic in this department, with a script comp increase of 1.3% and overall script increase of approximately 5% during the quarter.

The gross margin in the pharmacy department has continued to improve despite the significant third-party payor reimbursement pressures. We estimate public and private third-party reimbursement reductions to be approximately $4.4 million or $0.12 per share during the first half of 2013. The pharmacy department margin improvement comes from an increase in generic penetration rate and purchasing productivity.

Shifting to general merchandise components of reconfiguration. Our expanded Hometown Auto & Hardware departments performed well in the second quarter, with comparable store sales increase of 18.6% and 65.3%, respectively. The comparable store sales in our reconfigured stores outpaced the remainder of the chained by 216 basis points. Overall, we saw general merchandise comparable store sales increase 3.2% in the quarter, the largest quarterly increase of 3 years.

Overall, comp sales in consumables were exceptionally strong throughout the second quarter. Tobacco sales, which were a strong customer traffic driver, experienced double-digit comp sales increases. Our discount tobacco shop rollout has been a key initiative of our merchandising team after experiencing declines last year.

Other areas that performed well in the quarter include paper, pet, beverage and lawn and garden. Lawn and garden rebounded in the second quarter but is still behind last year on a year-to-date basis. I believe the model we are building is right for our customers and markets as we continue to see a challenging economy that puts constant pressure on our customers.

Shifting to SG&A. Expenses leveraged 20 basis points in the second quarter, as the team managed expenses well throughout the company. This was accomplished despite an increase of 20 basis points in depreciation and amortization which comes from our continued investments in growth, especially in pharmacy acquisitions.

Moving into the second half of 2013, we remain confident in achieving our financial objectives that we set forth at the beginning of the year. We have left our projections constant despite the anticipation of a competitive climate that is intense and an economic environment that is very challenging. We continue to see challenges on our customer's discretionary spending and are not expecting this to change in the third and fourth quarters. However, we're -- we still are positive about the initiatives we continue to roll out and the initiatives that we could -- that we will accomplish in the back half of this year.

In the back half of the year, we will continue to accelerate our pharmacy acquisitions and growth. We expect to complete approximately 20 to 25 acquisitions in cold starts, which will put us in a range of 370 to 375 pharmacies by the end of the year. We expect to be at 54% penetration rate of our stores that include a pharmacy department.

For the balance of 2013 and as we move into 2014, we are continuing to evolve our pharmacy strategy to become a provider of broader healthcare services as opposed to a dispenser of products only. This focus will include our immunization programs and medication therapy management, as well as our prescription-compliant strategy to improve adherence among our multi-script patients. We were pleased with the initial progress surrounding the execution of our specialty pharmacy initiatives, including our Diplomat Specialty Pharmacy relationship, and our internal specialty buildout which is on track to open in the third quarter. Again, our 3-year reconfiguration plan will enable us to leverage future growth opportunities as the Affordable Care Act comes into play and as specialty prescription growth continues to accelerate.

Moving to general merchandise. Our auto and hardware Phase 2 expansion began in August at a very rapid pace, and we expect the reconfiguration -- to reconfigure 150 additional stores by the first week in October. Upon the completion of Phase 2, we will have reconfigured 328 stores or 47% of the chain. Phase 2 of the reconfiguration also includes expansion of health and beauty aids and seasonal-spaced expansions in 75 stores with pharmacies.

In the back half of 2013, we will continue to analyze our new concept stores, including Getwell Drug & Dollar and our new Yazoo Trading Company stores. In the second quarter of 2013, we opened one additional Getwell Drug & Dollar, bringing the total to 5 stores, and we opened 5 new destination concept stores called Yazoo Trading Company. We also expect strong performance of our $1 layaway program in the second half of the year. We launched our layaway program in -- on August 27, nearly a month earlier than last year. Our program is very simple and easy to understand. It provides a great value proposition for our economically challenged customers.

In addition to our reconfiguration strategy, our general merchandise team has a number of other initiatives planned in the second half, including the launch of 25 new or expanded categories of products in expanded fall home event and expanded fall lawn and garden event and the incremental distribution of 3 mid-month circulars.

In closing, the financial accomplishments in the quarter were strong and the challenges -- and the changes taking place to drive the reconfiguration plan put our company in a great position for the future. As we look forward to the third and fourth quarter, we are confident in our ability to continue the sales momentum which will deliver strong returns to our shareholders, with second half earnings improvement in the range of 14% to 28% and full year improvement in the range of 17% to 25%, excluding the tax benefit in the prior year.

Again, thank you for joining us today, and I will now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go first to Andrew Wolf with BB&T Capital Markets.

Andrew P. Wolf - BB&T Capital Markets, Research Division

With what's going on with the sort of hitting a soft patch in the economy and with the consumer and, like you said, with competitors talking about the second quarter slowing, have you seen any specific competitive responses to the hardware and the auto, the rollouts, where they've been done either by general merchandisers or by specialty stores that specialize in those departments?

Bruce A. Efird

Andy, this is Bruce. To date, we have seen no competitive response relative to our Hometown Auto & Hardware expansions and rollouts. And as far as our new destination concept store, Yazoo Trading Company, which is one of the primary areas within that store is automotive and hardware, it's too early to say there's any competitive response going on there. So but I guess the short answer is, no, we haven't seen any response to our expansion in our stores. But don't tell anybody.

Andrew P. Wolf - BB&T Capital Markets, Research Division

Okay, no. Secondly, as you narrowed the guidance up because of things -- execution and so forth and the results so far, but you also brought down the high end, is that -- what's in there in terms of, like, as we're thinking of risks in the back half, is it more just your outlook on sales versus the consumer? Or are you also -- should we sort of -- are you also thinking -- again, I'm trying to get back to the competitive environment that you might see, heightened competition for the consumer and sort of what you're experiencing now overall. It sounds like you're sort of saying things aren't getting more competitive, it's more the consumer. I don't want to put words in your mouth, but I'm just trying to see if you can elaborate on that.

Jerry A. Shore

Andy, this is Jerry. I will just say that, yes, we did narrow the range. As we, first of all, have the actual results of the first 2 quarters and more of a better outlook for the last 2 quarters of the year, we were able to do that. If you will recall, when we issued a wide range in the very first quarter or when we started the year, we said that, that wide range was due to some circumstances such as insurance and some other factors that we didn't have as good an outlook of. So we -- as we've come through the year, we've been able to narrow that range, but that range is still skewed towards the higher portion of the annual forecast, as compared to where we were back then.

Bruce A. Efird

And Andy, just a comment on the economy. There are so many dynamics creating volatility in the back half that we anticipate with the ongoing pressure of the payroll tax increase on our -- specifically, our economically challenged customers, will continue to pressure those customers. And then the competitive activity, we typically say it every year that you don't realize how much more actually impactful it's going to be in the back half relative to competitive activity. We do anticipate heightened competitivity, particularly with our major competitor that did not have a strong sales comp in the second quarter. And -- but we put the programs that I outlined, the rolling out layaway earlier, the general merchandise programs, the additional distributed ads that will -- 3 additional distributed ads in the third quarter that we saw a strong impact in Q1 and Q2 when we had those additional distributed ad. So I really can't discern how much of the impact -- or the anticipation of the economy versus competitive impact, but we see challenges on both fronts moving into the back half.

Operator

We'll go next to Dutch Fox with FBR Capital Markets.

Dutch Fox - FBR Capital Markets & Co., Research Division

So I'm kind of following up on the last question a little bit. When you're talking about August being off to a little bit of a slow start, when you're breaking out the -- first off, when you're breaking out the impact of the calendar shift and the slowdown in BTS, if you could help us understand how much each of those 2 factors contribute to the taking-in of guidance, sort of comp ends [ph] just a little bit. And secondly, when you say BTS, first -- or back-to-school, first off, is back-to-school a huge category in and of itself for you? And are you seeing weakness just in your back-to-school categories, implying that back-to-school itself is off to a bad start? Or is it just kind of a little bit coming out of each category, you're just not quite getting the traffic in the store the way you expected it month-to-date?

Alan C. Crockett

Dutch, this is Alan. I'll start on that, with the back-to-school piece. Back-to-school is a broad range of categories. As we define it, it's not just school supplies, it encompasses a lot of different areas. We are seeing softness, really, across most areas concerned with back-to-school. However, we have had a couple of wins in back-to-school. We added this year, for the first time, back-to-school uniforms. Those have done really well. But overall, back-to-school itself is down. The industry is predicting back-to-school to be down across all of retail by about 7%. So it is really all of the categories that encompass back-to-school and not just what we traditionally think of as back-to-school supplies.

Dutch Fox - FBR Capital Markets & Co., Research Division

Are you guys doing better than that down 7%? I mean, would it appear that you're taking BTS market share, maybe?

Alan C. Crockett

We're right on -- we're flat with where the industry is, according to the syndicated data.

Jerry A. Shore

And Dutch, I will address your question about the impact of each one of those. When I -- when we issued the press releases in July, we projected the August comp to be flat to up 2%, whereas in June and July, we were in the 3% range. The difference between those 2 were -- or to the midrange, say, 1% from 3%, that was the impact of the calendar. So the difference, then, on the back-to-school portion of it would be the fact that we said we'd be in the range of 0 to 2% versus now saying we're at the bottom end of that. So it's about that 100 basis points on the overall comp that would be the impact of the back-to-school.

Operator

We'll go next to David Magee with SunTrust.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

The -- so just so I'm clear, when comps go from, say, a 2 level down to flatter, is that a traffic differential, or is it the ticket size?

Jerry A. Shore

David, we are seeing that in both, but we are seeing it more in the ticket than we are in the traffic, with our traffic has continued to be relatively strong with the emphasis towards basic and consumable products.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

I see. And then as you look at the second half, I believe the comparisons get more difficult from the sort of the generic profitability standpoint, as last year you had some good conversions, and the timing might be different this year. Are you -- do you see that in your business, in that the hill's a little steeper in terms of generics and the contribution there?

Rick A. Chambers

David, this is Rick. Yes, in regards to the back-half comparisons to last year, we do have our gross margins planned down versus last year because of the brand-to-generic cycling of the what we saw last year. And again, with the 2 primary drugs coming out in late fourth quarter, Cymbalta [ph] and AcipHex [ph], those are both going to be out late in the year, so we're not going to have a lot of benefit from that in the back half. So we do have our planned tempered somewhat versus LY as we look into the back half.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

But then it should improve at some point next year, right? If -- would you think it's toward midyear, or could it be sooner than that?

Rick A. Chambers

Yes, it would be early mid- to late-midyear 2014 as we -- again, as we start to see those exclusivity windows open back -- or close, I guess, is a better way to say that, in terms of the new generics that come off in late '13. That's correct.

Bruce A. Efird

And Rick, we'll also see pressure as well as we grow the specialty business and take advantage of that top line growth and are very, very bullish on the opportunity with specialty. Given the buildout that's in place, our ongoing relationship with Diplomat in expanding specialty will put pressure. And as I noted in my comments, we will see the ongoing pressure from third party, both private third-party and public third-party payors.

Rick A. Chambers

And obviously, that will be an early 2014 concern for us as we move into the health insurance exchanges, as those start to take shape early next year.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Right, right. Have you quantified what percent of business now comes from specialty?

Rick A. Chambers

In percent of sales, it's very, very small. I would not want to break that out right now but, again, because we are still somewhat early in that process. So more to come on that.

Operator

We'll take our next question from Jill Caruthers with Johnson Rice.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

A question on the store portfolio. It looks as though you're opening fewer full-line stores. And could you talk about that? And kind of how does your portfolio stand today after the 20-plus closings this quarter in terms of underperforming stores or ones that could be on the docket for closing?

Jerry A. Shore

Jill, this is Jerry. I will comment on the number. Yes, we have slowed the number of openings in 2013 where we originally had planned closer 20. Most of that is coming from available sites and some of the market's toughening up in terms of costs and then with the returns that we require in order to pass and hurdle to open new stores. So that's really been the biggest cause of the new stores. As far as the store closings that we completed, we were pleased. We have a very small number of stores that don't cash flow, so those are the ones that we emphasize when we close stores. And with the closings that we have done through the second quarter, it puts us in a very good position of having stores that at least cash flow.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Okay. And then question on the expense structure. I think, previously, you had expected some slight deleverage for the year, but I was wondering if your outlook has changed now given it looks so [ph] improved performance in the second quarter, that was on a nice comp, or what have you.

Jerry A. Shore

Yes, I expect the store -- additional store and pharmacy openings in the back half to have an impact on SG&A, but for the back half, I believe that SG&A will be relatively flat as a percentage of sales. So not leveraging but also not deleveraging in the back half.

Bruce A. Efird

But leveraging from an operating standpoint...

Jerry A. Shore

Yes, correct. Excluding depreciation and amortization, there would be leverage.

Jill R. Caruthers - Johnson Rice & Company, L.L.C., Research Division

Okay. And then last question, a broader one on some of the expansion of auto and hardware. Do you think you're gaining a new customer? Or do you think you're getting that existing customer to reach out and buy more in that category? Just talk about some of the things you're doing under the reconfiguration plan about [ph] the customer reach or gain?

Alan C. Crockett

Sure, Jill. This is Alan. We do believe we're attracting a new customer with the Hometown Auto & Hardware. We are seeing strong performance in those areas, obviously, but we are also seeing improved performance in the Home area, in conjunction where we have put in the Hometown Auto & Hardware. We believe that it's a different trip in that the customer is project oriented and looking for things for immediate needs to do a fix-up project, and that goes naturally with the Home area. When they're thinking about projects, they to adhere to Home. So we have seen an improvement in Home. And we've also seen an improvement in pet, which is if we look at our new concept stores, they are centered around hardware, auto and pet, so there's a strong attachment there as well. But we do believe that we're attracting a new customer, but also we believe that we're certainly getting our current customer to responding as well. It is a much expanded assortment and really has a lot of basic fix-up type items that you really can complete a lot of that home projects with. So it's twofold in that we are attracting a new customer but also attracting our current customers to those departments.

Bruce A. Efird

And Jill, it will position us well, as housing recovers over the coming years.

Operator

We'll take our next question from Mike Richardson with Sidoti.

Michael Richardson - Sidoti & Company, LLC

I just actually want to follow up on the last question. The better comps that you're seeing in stores that are being reconfigured, is that being driven by a higher average ticket? Or is it more of an increase in traffic?

Alan C. Crockett

It's really both. We are seeing, with that Home trip [ph], you do get a higher average ticket because obviously the product in those areas do carry a higher retail. So we are seeing a higher ticket and we are seeing higher traffic in those stores as well.

Bruce A. Efird

The increase in the stores that have the hometown, automotive, hardware mirror what we're seeing, and the balance of change is slightly higher on the ticket.

Michael Richardson - Sidoti & Company, LLC

And just one more, and I may have missed it. Did you guys -- did you provide what you -- a year-end store count, total store count?

Jerry A. Shore

I did not, Mike. And the total store count at the end of the year is projected to be around 710. We're at 697 now, and we're going to open about 14 more, somewhere in that range.

Michael Richardson - Sidoti & Company, LLC

Okay, a majority of those, you would expect to be in the third quarter? Or is that sort of...

Jerry A. Shore

No, I would expect most of those to be in the fourth quarter.

Operator

We'll go next to Patrick McKeever with MKM Partner.

Patrick McKeever - MKM Partners LLC, Research Division

Just you mentioned expanding health and beauty aids, I think, or an expansion of health and beauty aids soon, and I'm just wondering if you could give us a little more detail on what you're doing there.

Alan C. Crockett

Yes, that's what -- this is Alan. We have expanded health and beauty aids in our 75 pilot stores as part of this -- or we will be, in part, in this round of reconfiguration. There really are a number of areas that we're expanding, including foot care and eye care, vitamins, braces and wraps, adult nutritional, body wash and cosmetics more on the beauty aids side. So there is quite an extensive expansion there in our -- to what we carry currently and moving that health and beauty aids assortment more towards a full-on drug store, which is obviously the intention of the expansion, and coupling that with the pharmacy.

Patrick McKeever - MKM Partners LLC, Research Division

So with -- and so you're focused more on developing a bit more of a drugstore mix, as opposed to, perhaps, a more of a competitive response to what we've seen with the big-dollar store chains?

Alan C. Crockett

Yes, it is much more a -- I guess the fundamental thesis behind reconfiguration is tailoring the product mix in our stores with pharmacy departments to be more reflective of that pharmacy and healthcare services offering. And then more of the focus in the stores without the pharmacy department is driving the automotive and hardware, which is aligned with both increasing the sales in our higher-margin discretionary departments as well as improving the overall productivity of the stores.

Patrick McKeever - MKM Partners LLC, Research Division

Okay, got it. And then a question on private label. Just wondering where you are right now with private label as a percent of your total sales, and just private label development, and if you're seeing growth in private label and what the plan is there.

Alan C. Crockett

Own brand is down again. Own brand continues to be obviously very important for us. We have added a lot of new products this year. Just a couple of examples, a lot in the food area. We've added cereal which has been very big for us; a lot of HBA in the nonedible consumable areas. We have experienced some softness in our own brands this year. Really twofold, one, because of our addition of national brands, our customer -- we know our customer responds to national brands, and we've added a number of those this year, so it has pushed penetration down a bit. And also, the conversion of -- from -- away from incandescent light bulbs to a more energy-efficient bulb has really caused a tremendous impact in that category, which is a very big category for us in own brand. But it is still a very important area of concentration for us. We are continuously, every quarter, adding new items to that, and we will continue to focus on that throughout the balance of the year and next year as well.

Bruce A. Efird

And now we're seeing return of brands that have been off the shelf, particularly in healthy aids...

Alan C. Crockett

Just -- I didn't add that. Yes, we -- and we've seen Excedrin come back. We've seen Tylenol, to some extent, come back, we're about to see [indiscernible] come back. So there have been a number of very recognized, named brands that have been off the shelf for either a number of months or a number of years that are coming back. And those are -- the customers, obviously, when they see those brands, they respond to them even though they've been gone for quite some time. So that's also putting pressure on the own brand as well because customers did move -- when those products were not available, they did move to the own brand product.

Patrick McKeever - MKM Partners LLC, Research Division

Okay. And then just a last one, I guess. The -- on Yazoo Trading Company, what is the thought process behind pushing into a new concept? I know you only have a few stores, but is it to leverage some core competencies? Or do you see just an underserved opportunity, I guess? If you could just talk through it.

Bruce A. Efird

Yes, Patrick, you hit on 2 of the key principles. But one of the concepts -- I guess one of the principles relative to our Yazoo Trading Company and our destination store is to improve the overall productivity of the existing stores without pharmacies. This concept is based on in-depth market and competitive research. And we do see a niche, a market niche, that we can fill in providing that unique experience of a hardware store coupled with a front-end auto parts store, with strong pet and then seasonal lawn and garden, under one roof. So we see that not only the market niche but also the capability to leveraging -- to leverage our existing distribution as well as leveraging 2 major distributors that we partnered with, one in auto distribution, auto-parts distribution, as well as the hardware distribution. So it's leveraging both the internal capacity, a market niche that we've identified for future growth, and then aligned with our overall company strategy of improving the productivity of existing stores.

Patrick McKeever - MKM Partners LLC, Research Division

And any comments on just early performance there?

Bruce A. Efird

Yes. We've had -- 4 of them have been open one week. One was opened in June. And overall, we've been pleased with the customer feedback. And quite frankly, we've increased the confidence after seeing the concept. When it's on paper, you have a certain amount of confidence, but then when a store opens and you get to see it and walk the store and get the customer feedback, it's actually increased our confidence in the overall concept since opening.

Operator

We'll go next to John Lawrence with Stephens.

John R. Lawrence - Stephens Inc., Research Division

Bruce, would you comment a little bit? I mean, obviously, the competitive environment second half, what some of your big box competitors have talked about. How are you looking at the message to the customer during that time frame? Any strategic plans on advertising media different than we've seen in the last couple of years? And just sort of walk through the thought process, please?

Bruce A. Efird

Yes, John. I'll let Alan, who's been working with his team on these programs. He can give better commentary than I can.

Alan C. Crockett

Thanks. John, this is Alan. As we said earlier, we certainly expect competition to be as more -- or more than usual in Q4 because of the recent trends in our competition. We -- as we said earlier, we have started our layaway program. We kicked that off Tuesday. It's very simple concept, and it's the same one that we did last year, the same that we did in the first quarter. So it's very simple. It's $1 down, very easy to understand. We're kicking that off a month earlier than we did last year. We expect a benefit from that certainly in the third quarter. And in the fourth quarter, we have not changed our ad cadence from last year, but we do have a different strategy for the fourth quarter than we did last year as to how we approach especially the Black Friday week and then December, the whole month of December. I'm not going to elaborate too much on that because I don't want to spill the beans on that at this point, but strategically, we do have a different plan than we did last year. And but we do expect competition to be very, very tough, as usual. And let me add one more thing to that: We have -- as we said earlier, we have -- we will be distributing 3 additional mid-months in the third quarter as well. So that is a plus to last year, and also it helps us deliver our layaway message really more consistently and throughout the 3 months where layaway is really a big deal. So it really is good in terms of the additional distribution but also to deliver that consistent layaway message to the customer.

John R. Lawrence - Stephens Inc., Research Division

And then not belaboring it too far, I understand, for competitive reasons, but would that -- would part of that strategy be more about some of the new things you have available, certain items with auto and home versus just solely on price?

Alan C. Crockett

It is, John. We certainly have -- we know our customer response to newness. We have a lot of new items that are -- will be rolled out. As Bruce said in his comments, we have 25 new product categories -- or products in Q3. We have a lot of new products for Thanksgiving day and for Black Friday. So certainly, newness will be a factor in our offering to the customer, and we know they respond to that.

Bruce A. Efird

But John, just to add to that. You're hitting at the key point of the reconfiguration. We're basing the product offering within the store to be much more of a need-based trip driver in automotive and hardware and less reliance on enticing the customers with huge promotions. It's a needs-based trip more so than a promotional "come in and have soft drinks that you're selling below cost" to get them in the store.

Operator

And we'll take our next question from Paul Trussell with Deutsche Bank.

Matthew Siler - Deutsche Bank AG, Research Division

It's actually Matt, for Paul. I was hoping you could help me just flesh out kind of your expectations for gross profit margins in the back half of the year. Is it something we can expect to see a similar expansion as we saw in the first half? Or given your pharmacy comments, is that -- is it likely to slow down in the second half?

Jerry A. Shore

Matt, our expectations in the back half of the year are we do expect them to continue upwards. We do not expect pharmacy margins to continue at the acceleration that we saw in the first half of the year. But then general merchandise, even with the continued sales mix towards consumable products, is expected to improve later in the year.

Operator

And with no other questions at this time, I'll turn the conference back to Mr. Jerry Shore for closing remarks.

Bruce A. Efird

This is Bruce. And thank you again for joining us today. And hope you all have a great Labor Day weekend. Thank you.

Operator

Ladies and gentlemen, thank you for your participation. This does conclude today's conference. Have a great rest of your day.

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