Fred's, Inc. (FRED) on Q1 2018 Results - Earnings Call Transcript

| About: Fred's, Inc. (FRED)

Fred's, Inc. (NASDAQ:FRED) Q1 2018 Earnings Conference Call June 14, 2018 8:00 AM ET

Executives

Sean McGowan - Investor Relations

Joe Anto - Interim Chief Executive Officer and Chief Financial Officer

Operator

Good morning, everyone and thank you for attending today’s conference call to review Fred’s Financial Results for the First Quarter ended May 5, 2018. Joining us today are Fred’s Interim CEO and Chief Financial Officer, Joe Anto; as well as Fred’s External IR Advisor, Sean McGowan of Liolios. Instructions will be given at the end of the call for follow-up discussions with management.

Now, I would like to turn the call over to Sean McGowan. Sean?

Sean McGowan

Thank you. Good morning everyone, and thank you for joining today’s call to review Fred’s financial and operating results for the first fiscal quarter ended May 5, 2018.

Before we begin, I’d like to remind everyone that management’s comments during 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, and 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, June 14, 2018. Because of the time-sensitive nature of this information, it is the company’s policy to limit the archived replay of this conference call webcast to a period of 30 days. The call is the property of Fred’s and 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 that, I’d like to now turn the call over to Joe Anto, Fred’s Interim CEO and Chief Financial Officer. Joe?

Joe Anto

Thank you, Sean and good morning everyone. I am happy to report that we made progress in Q1 against our two main goals of eliminating our debt balance and generating significant positive EBITDA and free cash flow by Q4 of 2018. However, there is still more work to be done. The reset at Fred’s is moving forward rapidly and I’d like to give an update on the key focus areas we discussed during our last earnings call, strategic transactions, optimizing cost structure and capital allocation, talent acquisition, revenue and margin initiatives and assortment optimization.

On strategic transactions, we have engaged PJ Solomon & Company to analyze the value of our retail pharmacy script portfolio and engage with potential strategic buyers for that piece of our business. That process is well underway and we will provide updates as appropriate. Additionally, we are engaged in sale processes for various properties within our real estate portfolio and expect to have multiple transactions closed over the course of this fiscal year.

On the expense side, we are aggressively reducing expense in every part of the business and this trend will continue throughout the year. We are on track to hit our $30 million to $40 million target for operating expense reductions for fiscal year 2018. Additionally, expenses should continue to decrease into fiscal 2019 as we invest in a new ERP system, which will help to automate processes that are currently very manual within our business. From a talent perspective, we continue to recruit new people into all parts of the organization and are aggressively recruiting and hiring for key positions in merchandising, IT, data analytics, and finance. Our corporate office headcount currently stands at approximately 274 people, down from 440 people this same time last year and we are continuing to optimize headcount in every part of the organization.

From a revenue and gross margin perspective, we are making great progress across a number of key initiatives. In private brands, we have identified approximately 200 items we are adding to our assortment by the end of the fiscal year and are working with an agency to redesign packaging and branding for our private brands in all categories over the coming months. We have also created a dedicated closeouts group within merchandising focused solely on sourcing great deals across all categories. We will be introducing our first wave of these deals to a group of test stores over the course of July and we will have the ability to rapidly expand to the rest of the chain once we analyze initial results. Additionally, we have identified over 250 near-term opportunities to direct import items within our assortment and are working with overseas suppliers to secure the best pricing on these items and place orders. This will have a meaningful impact on our gross margins and we are working to identify many more opportunities for direct importing over the coming months.

In terms of assortment optimization, we are continuing to rationalize our SKU count and are also working on various initiatives to optimize product pricing and procurement across all categories. We are using data analytics to guide our decision-making in these areas and we see tremendous opportunities to increase both revenue and gross margin as a result of more systematic pricing and procurement strategies. Regarding new categories, our beer and wine initiative is continuing to progress and we are in the process now of optimizing the assortment in beer and wine as well as determining the critical success factors for our beer and wine store, which will inform our choices for the next group of stores to introduce these products into over the rest of the year. Currently, we have approximately 251 stores selling beer and 81 stores selling wine. I am encouraged by the progress our team is making in resetting the business and ultimately providing better value and a better experience for our customers.

I will now turn to the numbers and will address the first quarter results and trends on a year-over-year basis. And as a reminder, all of these current and prior year results reflect the fact that our Specialty Pharmacy business has been classified as a discontinued operation. For the first quarter of 2018, net sales decreased 6% to $437.1 million from $464.2 million for the first quarter of 2017. Comparable store sales for the quarter decreased 3.9% compared to a 4.2% decrease in comparable store sales in the first quarter of last year.

Gross profit in the first quarter decreased 13% to $111.6 million from $128.6 million in the prior year period. Gross margin decreased 220 basis points to 25.5% from 27.7% in the same quarter last year. As discussed on our fourth quarter call, our gross margins continue to be negatively impacted in the Front Store by the mix of sales and in the pharmacy by pressure on reimbursement rates and increasing DIR fees. Lower gross margin in the Front Store is being driven primarily by the increased percentage of consumables we are selling relative to higher margin general merchandise. We are confident that the initiatives we discussed earlier in the call will help offset the margin decline we are seeing in the Front Store.

SG&A expense is continuing to decline as first quarter selling, general, and administrative expenses, including depreciation and amortization, improved year-over-year by 560 basis points to 29.7% of sales from 35.3% last year. The improvement in expenses was largely attributable to a reduction in professional, legal, and banking fees related to the attempt to acquire Rite-Aid stores and expenses related to the closing of 43 stores in the first quarter of 2017. Selling, general and administrative expenses, including depreciation and amortization adjusted for non-recurring items, such as those previously mentioned, improved by $7.5 million for the first quarter of 2018 compared to the same period last year.

Net loss from continuing operations for the first quarter totaled approximately $19.9 million or $0.54 per share compared to a net loss from continuing operations of $37.8 million or $1.02 per share for the first quarter of 2017. For the first quarter of 2018, adjusted EBITDA, which further excludes items management does not consider to be indicative of our core operating performance, was negative $3.3 million compared to positive $6.2 million in the first quarter of 2017. Free cash flow, which management views as net cash provided by operating activities, less capital expenditures was negative $11.4 million for the first quarter of 2018 compared to negative $23.9 million in the same period of last year.

Turning to our balance sheet, we ended the quarter with $6.1 million in cash compared to $6.6 million at the end of fiscal 2017. Inventory at the end of the first quarter was $293 million, up from $279 million at the end of fiscal year 2017. Total debt stood at $175.5 million compared to $167.1 million at the end of fiscal year 2017. As of June 12, our ABL balance stood at $135 million compared to $162 million at the end of the fiscal quarter primarily as a result of the sale of our Specialty Pharmacy business. We expect this balance to come down over the coming weeks as we collect the outstanding receivables associated with the Specialty Pharmacy business. In terms of capital deployment, in the first quarter, our CapEx was $2.5 million compared to $2.1 million a year ago. While capital expenditures were slightly higher in the first quarter compared to the same period last year, we are monitoring CapEx very closely and expect capital expenditures to be down for fiscal year 2018 versus 2017.

Before I end the call, I would like to reiterate a couple of things. The team here at Fred’s is energized and excited by the prospects for this company and our ability to achieve our two main goals of eliminating our debt balance and generating significant EBITDA and free cash flow by Q4 2018. We are confident in our plan and look forward to updating folks as we have new developments to share. Thank you for participating today and we look forward to addressing you when we report our second quarter results in September.

Question-and-Answer Session

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

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