FRED
#Good morning, everyone.
Thank you for joining today's call to review Fred's Financial and Operating Results for the Third Quarter Ended October 28, 2017.
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 those 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 to be accurate as of today's date, December 6, 2017.
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.
With me this morning and also sharing prepared remarks is Mike <UNK>, Chief Executive Officer.
In addition, Tim <UNK>, Chief Operating Officer of Pharmacy; and John Foley, Executive Vice President of Stores, will be available during the Q&<UNK>
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 express written consent of the company is prohibited.
With those remarks, I'll turn the call over to Mike <UNK>.
Thank you, Jason, and good morning, everyone.
I'd like to start this morning by discussing the execution of our turnaround and assure you that our team remains committed to delivering long-term, sustainable growth and value creation.
We are focused on driving traffic, reducing SG&A, generating free cash flow and lowering debt.
Before I speak to that, I want to address our EPS results for the quarter.
Our third quarter EPS deterioration, excluding nonoperating charges, was caused primarily by the following: timing issue related to shipments of higher-margin seasonal merchandise; reductions in overall inventory.
Historically, our inventory levels have been too high, but this is now being managed more efficiently.
While this has impacted our gross margins, our cash flow plan remains on track as we streamline our business for the benefit of the company's long-term success.
In fact, cash flow from operations before onetime nonoperating items actually improved versus the same period last year.
And investments made in price to remain on strategy to ensure we stay competitive in the market.
We recognize that our EPS results are below expectations.
However, the management team, working closely with the Board of Directors, is taking the actions necessary to ensure Fred's achieves profitability and growth over the long term.
We continue to make progress to turn the company around, and we remain committed to achieving our goals.
Our intense efforts are squarely focused on the following key priorities: driving traffic into our stores, reducing SG&A, generating free cash flow and lowering our debt.
We are aggressively executing our turnaround strategy, and we are seeing traction in both Front Store and pharmacy.
We are not yet at the point of presenting positive quarterly comp sales and traffic improvement.
However, I can tell you that we are improving month-by-month as our initiatives are yielding results.
Our performance in September was an improvement over August, and our performance in October was even better and represents a strong indication that our plan is working.
Still, we are aware that there's a lot of work to be done, and our entire team continues to work with a sense of urgency.
To that end, we have already taken some actions this quarter that support our key priorities, including: a reduction in our workforce, which will translate to approximately $8 million to $10 million in annualized savings; the implementation of 0-based budgeting, which is becoming the foundation of our SG&A reduction initiatives.
With SG&A that is more in line with our peers, we will generate free cash flow, enabling repayment of debt and reinvestment in the business to drive sustainable growth and profitability.
As we accelerate our turnaround strategy, we are working to eliminate unnecessary expenses as quickly as possible and aggressively manage capital expenditures.
We have renegotiated leases in 30 locations during 2017.
In addition, nonoperating losses have been a topic of particular focus.
This quarter, we took steps to address previously unresolved excess inventory issues.
We recorded a $17.1 million write-down of excess inventory, and will execute clearance sales to drive traffic as well as sell this inventory.
In response to the larger-than-anticipated losses in the third quarter, we have implemented new processes to mitigate the risk of building excess inventory in the future.
Seasonal and fashion ladder plans will be used to ensure timely markdowns and that product is cleared out.
In addition, planograms will have individual item level tracking to better manage the entire product life cycle.
In order to lower costs, we are critically evaluating each and every expenditure to ensure that we are only spending in ways that align with our priorities.
As we pursue this reduced cost structure, we will enable an environment where our savings can be passed on to the consumer, in turn driving increased traffic and sales and ultimately, shareholder value.
As part of our turnaround, we are laser-focused on driving increased traffic.
This quarter, we kicked off a reduced price endcap test, which is showing promising results, so much so that we have decided to roll it out to all stores.
Our new circular strategy that was executed this quarter is proving popular among customers and will be a key component to driving traffic and sales.
We are observing positive traffic and comp sales trends in our stores as we concentrate on executing beer and wine, reduced price endcaps and new assortments in household chemicals, pet, cosmetics and tobacco, to name just a few, all of which have contributed to a 400 basis point improvement in Front Store traffic within the quarter.
This improvement has continued through November as traffic has remained relatively flat.
We expect these trends to continue.
In addition, and based on recent store visits, our stores and field operators are ready for the holiday season, which is off to a good start.
We have also witnessed a complete turnaround in our tobacco business, and our weekly trends are now flat on a 2-year stack basis.
We are pleased to report that the issues that were previously burdening this area of our business have been resolved, and we expect tobacco to be a strong piece of our business going forward.
Market share is a key metric that we use to gauge our performance, and it has improved over the last 52 weeks as a result of these initiatives.
For market share purposes, our Front Store business is divided into 4 categories: general merchandise, health and beauty, nonfood grocery and dry grocery.
I'm pleased to report that general merchandise market share, which was flat 52 weeks ago, has gained 14 basis points in the last 13 weeks and 28 basis points in the last 4 weeks.
Nonfood grocery lost share during the last 52 weeks but most recently, gained 24 basis points in the last 4 weeks.
And dry grocery and health and beauty picked up 4 basis points and 8 basis points of share the latest 4 weeks, respectively.
Clearly, we are seeing positive trends in market share across areas of our business.
Before I turn it over to Jason, I also want to highlight that today, we announced the cancellation of our dividend, an update to our share repurchase program and a review of alternatives for the noncore assets of real estate and the Specialty Pharmacy business.
The Board of Directors determined to cancel the quarterly cash dividend in order to retain free cash flow for debt reduction, share repurchases and other general corporate purposes.
I want to reiterate that we remain committed to our strategy and the team is focused on what matters most as we manage through this turnaround.
We are executing the necessary initiatives to achieve our key priorities of driving traffic into our stores, reducing SG&A, generating free cash flow and lowering our debt.
And with that, I'll turn the call back over to Jason to discuss our financials in greater detail.
Thank you, Mike.
Net sales for the third quarter decreased 4.5% to $493.6 million from $516.6 million in the third quarter of 2016.
The decline in sales was related primarily to the closure of 39 underperforming stores earlier this year.
Comparable store sales for the quarter declined 0.8% versus a 3.8% decline in the third quarter of 2016.
Comparable store sales for the third quarter of 2017 were negatively impacted by the continued increase in Generic Dispensing Rate as well as a 36 basis point impact from the sale of low productive, discontinued inventory versus the prior year period.
Fred's net loss for the third quarter totaled approximately $51.8 million or $1.38 per share, which included the following notable charges totaling $45 million or $0.96 per share: $20.1 million or $0.53 per share for a valuation allowance against the company's deferred tax assets resulting from the pretax loss recorded in the third quarter; $17.1 million or $0.30 per share after tax for a write-down of unproductive inventory; $5.2 million or $0.09 per share after tax for professional and legal advisory fees incurred in connection with the development and implementation of the company's turnaround strategy; and $2.6 million or $0.04 per share, after tax, for asset impairment for the sale of the corporate airplane.
We experienced greater-than-expected losses in the third quarter of 2017, in part due to nonoperating items, including nonrecurring charges related to inventory and fixed asset impairments.
Fred's third quarter loss compares to a net loss of $38.4 million or $1.05 per share for the third quarter of 2016.
Gross profit for the quarter of ---+ third quarter 2017 decreased 14.9% to $94.6 million from $111.2 million in the prior year period.
Gross margin for the quarter decreased 230 basis points to 19.2% from 21.5% in the same quarter last year, reflecting the contribution of incremental sales of lower-margin specialty drugs and tobacco products and a shift in timing of shipments to our stores of higher-margin seasonal merchandise.
Fred's recorded a LIFO reserve increase of $1.5 million in the third quarter of 2017 compared with an increase of $2.1 million in the same quarter last year.
Selling, general and administrative expenses for the quarter, including depreciation and amortization, decreased to $144.4 million or 29.3% of sales from $155.3 million or 30% of sales in the prior year quarter.
The decrease in expenses was primarily driven by our increased focus on expense controls, the closure of 39 underperforming stores in early 2017 and the change in asset impairments recorded in the third quarter of 2017 versus the third quarter of 2016.
For the third quarter of 2017, operating loss, which is equivalent to earnings before interest and taxes, or EBIT, a non-GAAP financial measure, increased to a loss of $49.8 million compared with an operating loss of $44.1 million in the same quarter last year.
For the third quarter of 2017, EBITDA, a non-GAAP financial measure that further excludes depreciation and amortization from EBIT, was a loss of $38.8 million.
Third quarter EBITDA included the following notable charges totaling $24.9 million: $17.1 million or $0.30 per share after tax for a write-down of unproductive inventory; $5.2 million or $0.09 per share after tax for professional and legal advisory fees incurred in connection with the development and implementation of the company's turnaround strategy; and $2.6 million or $0.04 per share after tax for asset impairment for the sale of the corporate airplane.
In the third quarter, we saw a 13.5% reduction in our inventory level on a year-over-year basis from 36 ---+ $366.6 million to $317.2 million.
This development is part of our ongoing efforts to drive free cash flow and is another indicator that we are on the right path.
In addition, as part of our turnaround strategy, we expect our debt level will decrease to below $160 million by year-end.
In closing, I want to reiterate our commitment to the company's business model and turnaround strategy.
We are focused on accelerating the execution of our plan, reducing SG&A and improving cash flow.
Now I'll turn the call back over to Mike.
Thanks, Jason.
While we fully understand that there's a lot to accomplish, the investments and process improvements we've made are gaining traction.
Our Retail Pharmacy business continues to improve.
Our focus on technology and process improvement has yielded results.
The retail business has generated essentially flat comp scripts adjusted for 90 days year-to-date and continues to benefit from a shift to more profitable generic prescriptions, delivering a 68 basis point improvement in the Generic Dispensing Rate during the third quarter to 88.4%.
As we work to continue the improvements in our Retail Pharmacy business, we are focused on the execution of key initiatives, including, increasing the number of flu shots, which resulted in a flu shot comp increase of 9.7%; expanding our 340B program in an effort to help our customers gain access to more affordable drugs while improving our profitability deepening our relationships with payers in our markets, network changes as of January 1 are expected to provide access to 1.7 million lives, resulting in the potential for more traffic and filling more prescriptions; continuing to enhance our marketing efforts in order to improve the ROI on our marketing spend; and continuing our aggressive inventory management by reducing inventory levels by over $16 million from the third quarter of last year and ensuring that we are focused on the profitability of every script filled while continuing to deliver excellent care to our patients.
As I mentioned earlier, the board is considering various strategic transactions and alternatives for the Specialty Pharmacy business.
While this is under way, we remain laser-focused on continuing to grow the Specialty Pharmacy business.
This quarter, we built on the momentum from previous quarters by investing in salespeople, technology and therapy diversification.
In fact, last week, we had the largest sales week in the history of Specialty Pharmacy, which is a reflection of our strategy and the great people we have that are delivering these results.
Some specific initiatives that are contributing to the performance include: expanding our territories within our existing therapies; driving substantial double-digit sales comp on a year-to-date basis; leveraging our relationships with our payer partners to expand network access, as a result, our Specialty Pharmacy business will have the potential to access 5 million new patients in our markets; continuing to develop our relationships with pharmaceutical manufacturers to accelerate our growth into new therapies and revenue streams; diversifying our therapy mix and physician referral base, which positions the company for new drug introductions in the future; and continuing the development of new technology investments, which will improve decision-making, dataflow and patient care.
Moving to the Front Store.
We are encouraged by the trends we're seeing.
While our comp sales were negative, we did see sequential improvements month-to-month.
In fact, Front Store comp sales were positive in October and up 3.6% in November.
The changes we've made are showing results, and we continue to roll out additional enhancements, some of which include resolving the issues that were previously hindering tobacco sales.
We improved the supply chain, replenishment technology, pricing strategy, assortment and circulars leading to very positive trends in tobacco this quarter; turning around cosmetics, which is an excellent example of the transformative initiatives we are putting in place and the type of results we expect from our efforts, without expanding the physical space of our cosmetics department, we were able to double the average sales per week by listening to our customers and utilizing data to transform this department to meet their needs; successfully rolling out the high-traffic category of beer to approximately 150 stores and wine to approximately 50 stores, and we're on track to complete the rollout to the remaining stores, where permitted, by the first quarter of 2018.
The preliminary results of our reduced price endcap program indicate that this will be a significant driver of sales and traffic, so much so that we intend to roll out the program to all stores this year.
And plans to go live with lottery in a 20-store test market this month.
Lastly, in our reading glass and sunglass business, we implemented a scan-based trading agreement, enabling us to sell our inventory back to the supplier and only pay for items as we sell them.
Changes like this allow us to improve our free cash flow.
In closing, we are aware that there's a lot of work to be done, and we are working diligently to position the company for sustainable future growth and profitability.
The initiatives we have implemented are working, and we are beginning to see the payoff of our turnaround efforts and expect accelerated improvement as we continue to aggressively pursue our key priorities of driving traffic into our stores, reducing SG&A, generating free cash flow and lowering debt.
As we streamline our operations, we become increasingly nimble and better able to drive the company toward growth, profitability and enhanced shareholder value.
And with that, I'd like to open the call up for questions.
Operator.
Yes.
Gabby, we're not providing forward guidance at this time, and that would include in terms of our margins.
But I think that one thing we can say, and I believe Mike alluded to, is that the write-down of inventory that we took in the third quarter is not anticipated to be a recurring event, that we are addressing the pockets of inventory that we have that we believe are unproductive and that we expect to have more normalized results going forward.
Sure, <UNK>, let me give you a little color there.
We don't disclose separately Pharmacy from Front Store, so I'm not going to get into details on the margin of each.
I can tell you, though, that we're describing ---+ I mean, we did describe in our comments, some of the pressures we felt on the Front Store.
So that's where our focus was, I would say.
And within that area, I would tell you that it was ---+ again, while I'm not going to break it down in detail, I can tell you that, of the types of things impacting our margins negatively in the first ---+ excuse me, in the third quarter, there was a split between what I would call inventory and timing-related issues, and then some actions that we took to make sure we remain competitive in terms of pricing.
On the inventory side, as we bring down inventory, there are ---+ we do our own distribution.
We have 2 distribution centers.
And as we bring down inventory levels, the cost in those distribution centers, that in the past may have been attached to inventory going into our stores, is pushed through the P&L as a period cost as we also then look to reduce those overall distribution costs.
That was affecting us in the third quarter, in addition to the delay in terms of some of the shipping of our higher-margin seasonal products into the stores.
Again, that was all part of our plan because we don't need to be investing in that inventory as early as we were.
We need to invest at the right time.
And then the remainder being, again, as we mentioned, some actions that we took to make sure that we are competitive from a price perspective in all the key areas of our Front Store business.
That's actually a great question, <UNK>.
And I would tell you that as we think about our debt level and as we've suggested the target to get ourselves under $160 million by year-end, we are considering that from operations.
So this is Tim <UNK>.
We started to think about the specialty business related to the future, and we're evaluating whether we should be investing heavily into the space to grow the business or we should be seeking alternatives to capitalize on the value of the business.
We're in the middle of that evaluation right now, and I think that we're excited about the path we're going down with this.
I think that if we do nothing, you run the risk of being irrelevant in the space.
