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Fred's, Inc. (NASDAQ:FRED)

Q1 2014 Earnings Conference Call

May 29, 2014 10:00 AM ET

Executives

Pat Watson - Corporate Communications

Jerry Shore - Chief Financial Officer

Michael Hayes - Chairman

Bruce Efird - Chief Executive Officer

Rick Chambers - EVP - Pharmacy Operations

Dave Mueller - SVP - Sales and Marketing

Keith Curtis - SVP and Divisional Merchandize manager

Analysts

Matt Boss - Deutsche Bank

Andrew Wolf - BB&T Capital Markets

Jill Nelson - Johnson Rice & Company

David Magee - SunTrust Robinson Humphrey

John Lawrence - Stephens Inc.

Operator

Good day, and welcome to Fred’s First Quarter Conference Call. Today's call is being recorded. At this time, for opening remarks, I would like to turn the call over to Mr. Pat Watson. Please go ahead sir.

Pat Watson

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 first fiscal quarter ended May 3, 2014.

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, May 29, 2014. Because of the time-sensitive nature of this 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 will turn the call over to Jerry Shore, the company's Chief Financial Officer. Good morning, Jerry.

Jerry Shore

Good morning, Pat and good morning to everyone on the call. Thank you for joining us for our discussion of the first quarter of fiscal 2014 results.

With me this morning and available for questions are Michael Hayes, Chairman; Bruce Efird, Chief Executive Officer; and Rick Chambers, EVP of Pharmacy Operations. Dave Mueller, Senior Vice President of Sales and Marketing and Keith Curtis, Senior Vice President and Divisional Merchandize manager.

Before starting on the first quarter results the company announced on January 9, 2014, that it hire financial advisors to review strategic opportunities to enhance shareholder value. The company does not intend to comment further regarding this process until such time its Board of Directors has determined the outcome of the process or otherwise determine that disclosure is required or appropriate. Therefore I will not be making any comments regarding the process.

As the company reported in its press release earlier this morning for the first quarter of 2014, total sales decreased 0.6% to $498.3 million compared with $501.5 million for the same quarter last year. Comparable store sales for the first quarter decreased 1.9% compared to 1.3% decrease in the year earlier period. During the first quarter sales were heavily impacted by poor weather which we estimate to be approximately 200 basis point on comp store sale. The sales mix comparisons for the first quarter was as follows. Household goods were 21.3% this quarter which compared -- which decreased from 22.7% last year. Apparel and linens 5.5% this quarter decreased from 6.5%. Health and beauty 6.9% decreased from 7.4%. Paper and chemical 7.9% decreased from 8.4%. Food and tobacco 17% decreased from 17.6% and pharmaceutical 39.7% increased from 35.7% last year and franchise 1.7% flat with same quarter last year.

For the quarter comparable store customer traffic decreased 4.3% from last year while the average customer transaction increased 2.4% to $22.07. Sales per average selling square foot in 2014 increased 0.6% to $204 as compared to $203 in the same quarter last year. For the first quarter of 2014 Fred's net income was $6.1 million compared with net income of $11.4 million in the year earlier period. Earnings per diluted share were $0.17 down from $0.31 last year. Earnings per share were negatively impacted $0.01 due to the expiration of available Work Opportunity Tax Credits. It is anticipated that Congress will approve and extension of these credits later in 2014 with retroactive application.

EBIT or earnings before interest and taxes for the first quarter of 2014 totaled $10 million or 2% of sales, a reduction from $17.8 million or 3.5% of sales in the same quarter last year. EBITDA or earnings before interest, taxes, depreciation and amortization during the first quarter totaled $19.9 or 4% of sales compared with $28.1 million or 5.6% of sales in the same quarter last year.

Adjusted EBITDA which adds the non-cash impact of LIFO and stock based compensation during the first quarter totaled $21.5 million or 4.2% of sales compared with $30.4 million or 6.1% of sales in the same quarter last year.

Fred's gross profit for the first quarter decreased to $142.5 million from $151 million in the prior year period. Gross margin for the quarter was 28.6%, a decrease from 30.1% in the same quarter of last year. The reduction in gross margin is attributed to the pressure on pharmacy initial market driven by historically large generic inflation coupled with the continued pressure on the generic reimbursement rate. The reimbursement adjustments from third parties have not been made at the speed of the manufactures rate of price increases. Also general merchandized sales mix towards the lower margin consumable goods and aggressive promotional activity. These were positively -- and we positively impacted vendor rebates which were favorable in the quarter.

SG&A expenses for the first quarter were 24.6% (see press release 26.6%) of sales which is unchanged from the same quarter last year. For the quarter, increased occupancy related cost were offset by reduction in insurance expense and favorable store expenses during the quarter.

Depreciation and amortization expense totaled $9.8 million in the first quarter of 2014 as compared to $10.3 million in the first quarter of 2013. For the first quarter net interest expense totaled $135,000, flat with the same quarter last year. Income tax expense in the first quarter was 38.2% of pre-tax income which compared with 35.3% in the same quarter last year. The higher rate reflects the impact of Work Opportunity Tax Credits not yet approved.

Moving to the balance sheet. We continue to be pleased with its strength and performance. Cash and equivalent was $8.2 million, up from $7.8 million in the year earlier period. Total inventories at the end of first quarter increased 3.5% to $382.9 million compared with $369.9 million in the year earlier period. The increase in inventory is attributed to the inflation experience in pharmacy department primarily in generic inventory and the accelerated growth of our pharmacy department in line with our reconfiguration plan.

Inventory returns at the end of the quarter were 3.7 turn as compared to 3.8 turn last year. Total indebtedness was $4.3 million compared with $5.8 million at the end of the first quarter last year. At the end of the first quarter there were no borrowings under the company's revolving line of credit.

Capital expenditures in the first quarter totaled $5.2 million compared with $6.9 million last year. Capital expenditures were spent as follows. $3.4 million for existing store improvements, $0.8 million for new store and pharmacy and $1 million for technology distribution and corporate expense. Additionally, $8.4 million was spent on acquisition of pharmacies during the first quarter of 2014 compared with $2.4 million in the first quarter of last year.

For the first quarter net cash provided by operating activities was approximately $16.9 million. Free cash flow which we identify as net cash provided by operating activities minus capital expenditures and pharmacy acquisitions totaled $3.2 million.

At the end of the first quarter there were 628 company owned full sized stores, 55 company owned Xpress pharmacy location, 21 franchise stores for a total of 704 discount general merchandized store which include 359 pharmacy.

The 2014 ending store count of --704 compared with 715 at the same period last year. And at quarter end there were 359 pharmacies compared with 349 the same quarter last year. The company's total selling square footage is approximately 9.3 million square feet compared with 9.6 million square feet in the same period last year, a reduction of 3.3% and the reduction is primarily the result of store closures that occurred during 2013.

Moving to guidance. In the second quarter the company expects total sales to increase 1% to 3% as compared to last year. Comparable store sales are expected to be approximately flat to up 2% which compares to 2.2% increase in the second quarter last year. We now anticipate May sales comparable store sales to be in the range of flat to down 2%. Earnings per diluted share on an operating basis are forecasted to be in the range of $0.04 to $0.09 in the second quarter compared with $0.09 in the same quarter last year.

EBITDA or earnings before interest, taxes, depreciation and amortization in the second quarter is projected to total $30 million compared with $15.7 million in the same quarter last year. This excludes potential impairment of assets and expenses that may incur as a result of strategic changes that are being implemented in the second quarter.

Adjusted EBITDA which add back non cash impact of LIFO, stock based compensation and potential write offs during the second quarter is estimated to be $14.5 million compared with $17.2 million in the same quarter last year.

Looking ahead for the full year company expect total sales to increase 3% to 5% primarily driven by new pharmacy growth but also the marketing changes currently being rolled out. Comparable store sales for 2014 are expected to be in the range of 1% to 3% in 2014. We anticipate the pharmacy department comp store sales will continue to be strong throughout the year with general merchandized comp store sales turning positive in the back half of the year as we implement our new programs throughout the store. Based on this outlook the company expects operating earnings per share for 2014 to be in the range of $0.60 to $0.68 per share. We project EBITDA to be in the range of $76 million to $80 million excluding the potential impairment of asset that may occur as a result of strategic changes. Adjusted EBITDA is expected to be in the range of $81 million to $85 million.

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

Bruce Efird

Thank you, Jerry. Good morning, everyone. Appreciate you joining us for our 2014 first quarter earnings call. And I will begin this morning with a high level summary of our first quarter followed by our strategic priority before the remainder of the year and beyond. Results for the first quarter did not meet our expectations. Our performance in the first quarter was impacted by intense competitive promotions, unusually harsh spring weather that impacted sales in several key departments such as lawn and garden, softlines and small appliances. In addition to the sales impact of these issues we also encountered extraordinary cost inflation on generic drug in the first quarter. As we forecasted in a year end 2013 press release. Our core customers continues to struggle given the economic headwinds such as reduced SNAP and unemployment benefits, higher taxes and uncertainty about the cost of healthcare. To follow up on Jerry's comments other than the gross margin impact on the pharmacy department, we are pleased with the growth in pharmacy sales of 10.3%, the ongoing comparable script growth and the addition of seven pharmacy units during the quarter. The decrease in pharmacy department gross margin was driven by inflation on pharmacy cost of good primarily generic, coupled with continued pressure on reimbursement rates. There is typically lag between when generic prices are set and reimbursement rates are adjusted. We anticipate those pressures will begin to ease in the back half of the year getting us back to our projection. EIRIS Health Services, our specialty pharmacy division experienced solid script sales and profit growth here in the quarter in line with our internal plan. We will continue to accelerate our penetration into this fast growing segment of pharmacy business. General merchandized gross margin were negatively affected by the continued sales shift -- sales mix shift to consumables and increased promotional activity. In general merchandize, our reconfiguration department notably home improvement continues to perform well.

While weather had a clear impact on our business in the first quarter, we are aggressively and proactively addressing issues within our control by adopting new merchandizing, pricing and marketing strategy designed to regain general merchandized sales momentum which I will outline. Realizing that customers shopping habits are changing faster than ever, we recognize that we need to adapt to these changes and meet the customers' needs on their terms. With this in mind, beginning in January, we took a deep dive into all aspects of our general merchandize business including our internal performance trends, customer and team member surveys, market share report and select industry data. This work was done by our leadership team supported by a system from outside consultants. Working through this extensive research and building a new merchandizing and marketing strategy that can be sustained over a long period of time has taken several months to design, develop and validate. What we learned in this research is exciting and is provided the foundation for the actions plans. The findings reinforce that customers' use Fred's for their need-it-now convenience trips. We see this as an opportunity to further leverage non consumable, higher margin or immediate need convenience department that are currently available in our stores. Our plan is to gain greater top of mind awareness with our existing customers that we have these products and categories available to them. The team developed a solid plan to capitalize on Fred's position as a low priced leader and planned our convenience department advantage over small box competitors.

Starting with the marketing changes, effective with circular post Memorial Day we would change the format, look, content and frequency of this marketing vehicle to drive traffic win and aggressive promotional program. Approximately 80% of circulars would be devoted to consumables with strong price point to drive traffic to the stores. The other approximately 20% of the ad will highlight key items from what we are branding as key convenience centers in our store which include bed, bath, , kitchen, home improvement which include hardware, seasonal and pet. These convenience centers we branded beginning with recognizable, high household penetration items at aggressive price point in each of the distributed circulars. Additionally, we developed an internal store marketing program to highlight these circular items along with additional callout to identify brand and drive awareness of this convenience centers. This will include displays and in store signage. While beginning 6/22, we will place one million circulars in our stores on a weekly basis to drive the awareness of the six key convenience centers. This weekly in store circular will have key items emphasized at aggressive in store prices. We will also involve our team members by asking them to greet and engage the customers by offering them this weekly flier in store and encourage them to shop around store. The intend is to encourage the customers to in shop the entire store and become aware of our diverse offering of needed now products. We believe gaining greater awareness of the convenience departments will drive baskets and trips while improving overall mix and margin. In addition to the marketing and branding changes outlined above, we will begin relaying our stores with a new front end configuration for a faster checkout and a realignment category adjacencies to highlight and brand our in store convenience centers. The front end of our stores will be relayed with power displays and pallet along with the faster checkout configuration; all focused on ease of shopping and design to emphasize the advantages of our 15000 square foot store.

In order to accomplish this store relay process, we will clear unproductive SKUs and exit for reduced product categories that do not align with our go forward convenience center model. Examples of product category changes include a reduction of space in electronics, furniture and apparel, coupled with expansion in home improvement, seasonal, pet and consumables. Another fundamental principle this relay process is to make our stores easier to navigate for our customers. As noted in our press release, the estimated book write-down of cleared inventory will be in the range of $10 million to $12 million exclusive of additional store closing.

Our plan is to begin implementing the new front end adjacencies and fixtures in late June with substantial completion early in the fourth quarter and the balance of the first quarter in 2015. We believe that this is a high return, low risk program for us to execute and we are confident that we can increase our trips and baskets with this program while improving the margins through a shift of the mix in our stores.

Moving to our pharmacy department. We are very optimistic regarding both the short term and long term deals growth in healthcare services. Even though we have experience margin headwinds as of late, I am confident that the plans in place will not only stabilize our recent margin pressures but also begin to show improvement. These plans include but are not limited an increased focus on our third party payer reimbursement specifically on the generic portion of our business. This effort has shown early signs of success that we anticipate will provide strong momentum going forward. Another initiative the team has implemented that will prove to be even more impactful will be additional direct manufacture contracting relationships that will change the way we procure certain generic product and lower our generic growth cost. To further improve the profitability of our pharmacy department, we are engaged and reworking our pharmacy distribution agreement. We expect to incur benefits in the second half of 2014 and full financial benefits in 2015 and beyond.

From a growth perspective, we continue to see a strong pipeline of pharmacy acquisition opportunities. We have eight acquisitions scheduled for the second quarter and an additional 12 acquisitions in the queue for the third quarter. Along with the success of our growth plan, the team has also executed ahead of schedule on our Time My Meds program which is our company wide initiative to improve compliance and adherence while patients which will increase comp script growth.

Shifting to specialty pharmacy. During the first quarter we had a total sales increased of over 43%. The major driver behind this sales increase was EIRIS Health Services that continues to outperform expectations.

To summarize the factors that we shape our performance going forward include transitioning Fred's pharmacy from being primarily a dispenser product to that of a healthcare services provider via our specialty pharmacy and clinical services offering. Execution of our new marketing program to improve transactions, comp sales, market share and gross margin in general merchandize. And execution of our store relay process providing a more convenient and customer friendly shopping experience and continued operational improvement to drive expense leverage.

In closing, our team will relentlessly execute this plan laid out with the goal of delivering stronger bottom line results in the back half of 2014. Thank you again for your interest in Fred's and for joining us today. And I'll now turn the call over to the operator for questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions).

We will take our first question from Paul Trussell with Deutsche Bank.

Matt Boss - Deutsche Bank

Hey, guys, good morning. Actually Matt for Paul. I was just wondering if you could talk a little about kind of what you have learned deciding to go towards the consumable route and the convenience route, what you have learned about the kind of competitive environment. It just seems like between the Dollar Stores and Walmart and Target and some others that it's is getting really competitive and just curious if you could expand upon kind of what you have learned through your process? Thanks.

Bruce Efird

Yes. As we -- as I noted in my prepared comments, we did conduct in-depth research including Nielsen IRI, Buxton, with our consumer package good suppliers as well as internal research with our consumers -- with our team members. And I guess one of the points that really stood out to me that our customer research told us that we have a strong reputation for consumable such as paper, chemical and food. But then they in turn told us that the rest of the story is stuff and the go behind this convenience strategy is really to ensure that we are moving the customer around the store number one and number two that we are focused -- our changes our focused on the female shopper where we are combining these convenience centers. For example that the female shoppers told us that they like the expansion of hardware but we needed to pull together into a total home improvement center, with strong in lighting for example, window treatments and coupled with the hardware but they were not aligned in a single department. So part of the plan is really focused on the store within the store concept underneath the umbrella of those six areas the seasonal, bed, bath, kitchen, pet and home improvement. From a competitive standpoint obviously we are seeing intense competitive pressure out in the -- within the market place and there is a comment made this morning in CNBC from an individual that said he had been in retail over 40 years but it feels like now this based on what's going on. And this plan in the marketing changes as well as store reconfiguration changes are really aligned not only to make our store more convenient but also to respond to what's going on within the market place.

Matt Boss - Deutsche Bank

Great, I appreciate that, it is helpful. And then I guess a follow up. Could you just talk about kind of how GPM is going to flow throughout the year? I mean obviously you saw some pressure in Q1, just try to figure out how is it going to track for the rest of 2014? Thanks.

Jerry Shore

Matt, this is Jerry. We will be --second quarter will be down similar to where we were in the first quarter. Third quarter start improvement and then in the fourth quarter with new pharmacy agreement and new trends in general merchandise we expect to be up somewhat in the fourth quarter.

Operator

And we will take our next question from Andrew Wolf with BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets

Okay, good. Just in terms of the magnitude of the mix and how you're --what's -- now that you have sort done a postmortem is -- was the original guidance and expectations, could you kind of give us a sense of -- it was most of that from the generic gap and the generic reimbursement versus the inflation versus your plan, I mean you saw that coming but it sounds like it was pretty big hit in the last or was more of it still from competitive situations and the weather. Help us figure out what kind of things that come out a little better, weather wise, what would that amount to then? Was this mainly the competitive environment alluded as alluded in the last question or the generic situations is being lot worse than you expected?

Jerry Shore

Andy, this is Jerry. I'll talk about in terms of the numbers first. The weather impact on the first quarter, we estimated to be about $2.5 million or about $0.04 per share. And the pharmacy impact from the generic inflation, we estimated to be about $5.8 million and that is about $0.10 per share. So if you look at those two factors there you basically have the reconciliation between last year's earnings and this year's earnings. That being said, there definitively were competitive pressures on the gross margin in the first quarter prices.

Andrew Wolf - BB&T Capital Markets

All right, that's helpful. Just looking at generic the way drugs are prices and ethical drugs are priced. What gives you confidence that a smaller pharmacy chain like Fred's versus some of the large guys who not only have direct sourcing relationships with the generic manufacture but have global sourcing and really getting some big savings out of that. Why do you think Fred's can successfully negotiate with third party and/ or by going direct and get better direct pricing or better middleman pricing with PBM or the payers like the government?

Rick Chambers

Yes, Andy, this is Rick. On that, way we look at that somewhat counter stability what you would think in terms of scale versus our size and by that I mean we are able to go to some of these smaller mid-tier manufactures that are making these products particularly the ones that we are saying the hyper inflation owned. We are going direct to those manufactures and where they can supply our need but they may not be able to supply the need of national retailer. They are able -- we fit very nicely into their sweet spot in terms of volume which allows us to get into a price point that is competitive as some of the larger manufactures that are able to supply these national retailers. So when we look at the -- there is roughly 25 to 30 drug molecules that are causing the majority of this mix that Jerry referenced and those are the ones that -- in Bruce's comments, he pointed out that we are going after and attacking and have had some very positive feedback and expect that product flow to start very soon.

Andrew Wolf - BB&T Capital Markets

Okay, that's helpful. Do all of these -- can you get all 25 to 30 those drugs placed by this mid sized manufacturers who can get you to close to the market pricing or is there --I thought another aspect of it was PBM is not raising the reimbursement rate or government payers, direct government payers or whoever is in the middle or paying pharmacy chain that there was some lag for Fred's as well.

Rick Chambers

Correct. There is definitely lag in that reimbursement adjustment as the market sees these price increases. Depending on who you are listening to in the market from different retailer perspective, some people are talking about it more and some people are talking about it less. And they are referencing it maybe in a different way than we are. But it is out there the conversations we've had both with industry groups as well as the wholesaler community is, it is an ongoing daily event for this generic cost increases. And with the consolidation that we are seeing in the industry but back to your question can we back sale those all 25 to 30, the vast majority of those affected products are having success addressing those. There may be gap here or there but again the majority of what we are going after we are successfully accomplishing our goal with that. And then to follow back around your question regarding reimbursement, there is that lag that we talked about before and it is more than 80:20, 90:20 rule by that I mean it is 80% to 90% the cost inflation and 10% to 20% the reimbursement lag because that reimbursement lag is always been within the industry. I don't want to overplay that. It is an issue. We do have a new resources in house that we have dedicated resources to managing that on a daily basis and literally down to the claim to the NDC that we are addressing each day when we see this underpayment and we are seeing some response on that in a favorable way.

Andrew Wolf - BB&T Capital Markets

Okay. And, Bruce, I want to direct question to you on the shift in strategy towards -- more towards convenience. Listening to the way you talked about how is the customer see you -- the brand representing certain categories and then the bunch of other stuff. You want to make it obviously broaden out the appeal of the brand and by categories. Your traffic is down but to me it sounds like it is a plan that really is just emphasize on, I want to make --see if I understand it this way. Is emphasizing once the customer is in the store, see if -- try to get them to buy one or two more items in some other categories that you want them really make a much stronger statement as a convenient store or power retailer or is there also a component of strategy that's going to try to drive traffic whether that's through probably circulars are being redone or increased advertising or can you help me just think about if the comps gets going on this new strategy, where it is going come from in the front end regarding one more item or take it versus or bringing traffic in.

Bruce Efird

Andy, I guess the foundation for this whole plan is based on the principle of leveraging your strength and mitigating your weaknesses. And there is a component of defining, better defining these need it now or convenience centers because one of the things that came out in the research is the fact that we anticipate the need base trip will become more common to the consumer because as we see the internet and online shopping increase, we believe that there is a space and opportunity for us within that need based trip. For example with the expansion of hardware typically an individual will not go online to get a toilet repair kit. But it is designed -- part of the plan is designed not only with the relay of the store to make the store more shopable, the customers told us our stores were too cluttered and we are -- part of it is addressing that. As far as the trips and traffic, that's based on the marketing plan where we're -- the frequency of ads, we will still have a distributed first of month ad, a distributed mid month ad. In addition to that we will have weekly in store ads that really emphasize these convenience centers and then the distributor ads very strong or powerful consumables to drive trips in the store. Then the interaction, I guess one of the key components; the secret sauce is the interaction with team members in the store with the million copies distributed weekly to instead of just a reading interaction with the customer to make it more of sales interaction with the customer. So it is a combination of the relay and then aligned with the changes in the advertising strategy to drive traffic.

Andrew Wolf - BB&T Capital Markets

Okay. Which would come first? Getting traffic I would think unless you start promoting things really cheap, would take a little time for consumers to understand generally whether it's -- here it is merchandizing change or pricing change, usually there is a lag but if the merchandize is presented and promoted better in the store I assume that the tickets -- should we -- if the third and fourth quarter when the store start to get reset, should we be looking more for ticket or traffic to improve? That's my last question.

Bruce Efird

Yes. Andy, I guess the sequence of the rollout will start as I commented on start in May as far as the ad changes and then we will be in full course in by mid July. And we are very pleased with what we are seeing with some of the near term results of the ad changes. And but then there will be obviously take longer with the relay and changes that we are making in the stores. Dave?

Dave Mueller

This is Dave Mueller, Andy. I agree, I think the immediate will be the traffic based on the change in the circulars and the push on these consumables which we started this week and then I think it will transition over once we get the in store signage, the displays and all the activity around these convenience department situated will see more of the ticket and the result of those as we flow into later part of this year. So I -- that will be the way I would position it, yes.

Andrew Wolf - BB&T Capital Markets

Okay. So it is the opposite what I was saying. Now are the ads hot? Is that why you expect the traffic to be up, you are going to run some hot promotion or is it more the way you redesigned the ads, the way you discussed?

Keith Curtis

Andy, this is Keith. We are very committed to the pricing strategy that will include competitive everyday pricing and much more aggressive promotions on fewer items in our advertising. One good thing is thing we have chosen, the ads that have been chosen and will be strategically chosen with a lot of careful analysis, of information provided by the consultants and focus groups that we have been doing. And there are going to be key traffic drivers designed to get the customers excited about getting to Fred's and then moving around the store when we get them in there, these will be items that will resonate with the customers' value perception and key traffic drivers. The marketing strategy is to get them in and get them around the store, focus around their grouping of categories and what we are calling centers. And a good example of that is the convenient home improvement center which includes hardware, basic plumbing, electrical lighting, blinds and seasonal some of those areas, these areas that we are -- that are strengths for us already but in our 15000 square foot box will allow us to market them more strongly as an advantage to our smaller box competitors.

Operator

We will take our next question from Jill Nelson with Johnson Rice

Jill Nelson - Johnson Rice & Company

Good morning. Quick question on the pharmacy beginning in June you start to lap the rebound you reach back to the positive pharmacy comps given as you lap the big generic launches could you talk about your ability to maintain positive pharmacy comps going up against tougher compares?

Rick Chambers

Yes. This is Rick. And regards to that comparison on the sales comp line, we do have some aggressive sales comps in the back that we are still comfortable with those and by that what we are seeing on this inflation both on the generics side of our business because we are seeing some generic script price inflation. I don't want that to get lost in the message of this cost inflation. It is also is driving the top line inflation helping us on that sales comp along with the acceleration and expansion of our specialty business both through EIRIS as well as our retail specialty offering. We feel those three aligning with our comparable year-over-year will put us in a good spot in the back half on those sales comps. We are making sales calls for specialty, I am sorry.

Jill Nelson - Johnson Rice & Company

And then I guess just kind of a bigger picture question. Could you talk about may be misuse regarding location versus competition? And you have talked about the mix and store being cluttered and what not but may be do you think it is a real estate issue as well? And then just a follow up, the increase and focus on consumables, how do you feel that you can compete on price versus the big box players and the deep discount players as well? Thank you.

Jerry Shore

I will take this now. I will comment on the real estate. It is -- the locations of some of the competitors particularly Dollar General has been a factor and will continue to be a factor. It is really one of the reasons why we are relying on more data from Buxton as well as tactician and we do have the information. It is not like there is a shortage of site but it is a fact. One thing that we plan to monitor and take advantage is the Family Dollar closings that have been announced and will be taking place. And we are also doing work in that regard in terms of marketing as well as store operations and how we set the stores. And then on the pharmacies, we really haven't still been able to see the opportunities come forward in pharmacy.

Bruce Efird

And one point I would add to Jerry's comment relative to our recent store growth is that we are seeing improved top line sale performance overall in our general merchandize and the store we've opened over the past couple of years. Whether opening at 15% to 20% higher sales trend than previous based on the research model that we have in place. Jerry -- second question around the competition pricing.

Keith Curtis

Jill, this is Keith. It is a very competitive landscape out there for us and we realize fully our role in providing our customers with value and pricing. So we are extremely focused on that. And as I said our pricing strategy will include aggressive promotion on fewer items to drive traffic into our stores.

Bruce Efird

Part of it, Jill, is that we have laid out this strategy that has the benefit in this intense competitive market coupled with the changes that have been made within merchandizing and marketing around the ad where we are putting fewer items and reallocating or redirecting the markdowns to those key traffic driving items. And then again going back to the in store changes and in store layout as well as the interaction with our team members in store is this designed to get that customer around the store to pick up the additional items.

Jill Nelson - Johnson Rice & Company

Okay. A quick question. One quick follow-up on your comment about the new stores performing in the 15% to 20% higher sales I guess the main drivers of that are you going into higher rent locations are more attractive kind of a locations to get that list what's the drivers there? Thank you.

Bruce Efird

Yes, I think there is a couple of factors I would say we are going into a location however we are going into locations that have much more intelligence in the decisions that we are making with our tacticians model that we use coupled with now our Buxton intelligence and market information with the fact that we do have much more intensity around the market visits, there is -- and typically we are looking at a pharmacy in a store, we have the regional vice president, the health care manager, district manager as well as the real estate team and then the senior leadership team involved in that decision. So I believe it is a combination of the data that we have available today that we used historically combined with the process revamp that we put in place.

Jerry Shore

Jill, one more point to add is that all of our store openings are being done with pharmacies and that helped us drive traffic in those new stores.

Operator

(Operator Instructions).

We will take our next question from David Magee with SunTrust Robinson Humphrey.

David Magee - SunTrust Robinson Humphrey

Hi, good morning, everybody. Just a couple of questions. One is, on the categories that you are downsizing a bit, I think I heard you say electronics and apparel and of course apparel has been sort of a trend for a while. Who do you think you are losing shares to in those categories? Do you think it's Dollar General or is it somebody else out there?

Dave Mueller

David, this is Dave Mueller. I will comment first. I think it is -- so we've commented on the internet, certainly the choices the customers has today finding whether it is top line apparel or products like electronics and many different end use, I think that some of the challenges we face and with technology changing today, whether it is smartphones and gaming and all these other things, the traditional electronic that we used to sell sort of slowed and disappeared. So I think there are a number of factors causing some of that. Keith, if you want to comment?

David Magee - SunTrust Robinson Humphrey

Does a change how aggressive you might be about your own web business in the future?

Bruce Efird

We don't have e-commerce so-- we don't David. It's really longer-term and not prepared on that today. But we certainly keep an eye on the impact of internet shopping and other uses of smartphones et cetera.

Jerry Shore

David, short answer is that we have discussed that often on for a number of years however we choose to focus our capital and our investments on more productive areas such as growth in pharmacy.

David Magee - SunTrust Robinson Humphrey

And then secondly, how disruptive will the resets be over the next couple of quarters? And I have notice you've got a little bit tougher comparison on year-over-year basis in terms of comps and your guidance is pretty decent over next couple of quarters, low single, so I am just curious, are you fully accounting for whatever might be disruptive about the change?

Jerry Shore

David, this is Jerry. I will speak from what we have seen historically. What we are including is the impact of what we have seen historically and it is a slight disruption but we have not factored in a significant impact on the sale. We think there is more opportunity with the work that we are doing in the stores with utilizing our team members to drive more of the customer awareness and customer service.

David Magee - SunTrust Robinson Humphrey

Do you think that, that will increase SG&A a bit? If you got -- your team members doing extra work like that too?

Jerry Shore

We have an increased in store labor and store marketing in our new plan and yes we do but in terms of leveraging we do believe strongly that the increase in sales will drive leverage and expenses as well. A lot of our expense structure today is fixed. So we can -- as long as we add the store labor to handle that we can accomplish our mission and still leverage expenses.

Operator

We will take our next question from John Lawrence with Stephens Inc.

John Lawrence - Stephens Inc.

Good morning, guys. Would you comment just quickly, Jerry, several years ago when you did this distribution agreement on the pharmacy side, just compare that timeframe to now and what's different -- obviously you got a little bit more scale and how that we should perceive that?

Rick Chambers

This is Rick. I will take that first and then Jerry can follow up if it need be. When we look at this, where we are today versus three years ago in terms of the negotiations of this contract, may be the key point obviously we have more volume both on the brand and generic to bring to a perspective wholesaler, so that's a very straight forward positive force. But also as you have seen within the market where a lot of the national players are moving more into these strategic partnerships, joint ventures if you will. The industry is changing as we see it today around us. And we believe that we are in a position, a good position to be able to capitalize on that. Again with also with the industry consolidation that have seen in the last two or three years since that last renewal. We are one of the key players within that space, if you look at peer pharmacy place in terms of not food, drug or mass, we are number four out there nationally in terms of annual sale. So again we see those as positives and way that we can leverage that back to wholesaler arrangement and then with our high generic penetration and that continuous to outpace the industry that makes it even much more appealing even more so than it was three years ago. And I'll close with when you see some of the national retailers particularly the one that we compete with fairly often here moving away from where generic warehousing per se, we believe again that we made a very good decision three years ago and it helped prepared us to be in the position that we are today to move into a very positive agreement with whoever we choose.

Jerry Shore

And John, the only thing I will add to that is that in addition to the volume that we have increased today pharmacy growth is really the number on strategic priority. So we are looking not only at the growth we have to date and where we are but also the growth in the future.

Rick Chambers

And John just to follow back on that, that's a very good point the Jerry brought up because if you look at pharmacy retailers within our size or smaller, we hear constantly from the wholesalers that we are talking to that there is a not a lot of retailers like us out there that are growing and that's one very big positive that we have out there so --

Jerry Shore

John, we probably didn't address your point of financially what is that mean and we are early in that stage and can't really address the financial side of that.

John Lawrence - Stephens Inc.

Got it.

Rick Chambers

To believe it, we will be positive, yes.

John Lawrence - Stephens Inc.

Thank you for that. Secondly, just real quick, Jerry, can you put a number on the categories that you are exiting how much sales volume over the last 12 months or any way you want to slice that sales volume of categories being exited?

Jerry Shore

John, I will just say that the way we are looking at that is more on the gross profit per foot, that's how we are evaluating those and those areas that we are downsizing are more in the low-teen dollars per foot on gross profit dollars where some of our others are considerably higher and we have the ability to raise that in those areas. Bruce?

Bruce Efird

Just to add to that John, we are really focusing the capital on these convenience centers to increase the density and assortment. While at the same time we are looking at the less productive SKUs or categories that are under review based on not only the gross margin dollar per square foot but GMROI items. Again there is -- it run through a financial filter into the decision as well as strategic decision and whether that particular item supports our strategy around becoming the convenience center or the aligned with that particular strategy.

Operator

It appears there are no further questions at this time. Mr. Bruce Efird, I would like to turn the conference back to you for any additional or closing remarks.

Bruce Efird

Thanks. Thank you very much for your questions, your input today and hope you have a great day.

Operator

That concludes today's presentation. Thank you for your participation.

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