Board decides to terminate dividend to boost cash flow

MEMPHIS, Tenn. — Fred’s Inc. reported a bigger year-over-year loss for its fiscal 2017 third quarter and plans to cancel its dividend and explore the sale of non-core assets.

Fred’s said Wednesday that for the third quarter ended Oct. 28, it reported a net loss of $51.8 million or $1.38 per share, compared with a net loss of $38.4 million, or $1.05 per share, a year earlier.

Charges totaling $45 million, or 96 cents per share after tax, impacted the 2017 quarter’s bottom line, Fred’s noted. They included charges of $20.1 million (53 cents per share) for a valuation allowance against a deferred tax asset from the pretax loss recorded during the quarter; $17.1 million (30 cents per share) for a writedown of unproductive inventory; $5.2 million (9 cents per share) for professional and legal advisory fees from the development and implementation of the company’s turnaround strategy; and $2.6 million (4 cents per share) for asset impairment from the sale of corporate airplane.

Analysts, on average, projected an adjusted net loss of 13 cents per share, with net loss estimates ranging from a low of 17 cents to a high of 1 cent, according to Thomson Reuters.

Fred’s also recorded a larger operating loss in the third quarter, rising to $49.8 million from $44.1 million a year ago. EBITDA (earnings before interest, taxes, depreciation and amortization) came in at a loss of $38.8 million, up from a loss of nearly $32.1 million in the prior-year period, and included charges totaling $24.9 million.

Michael Bloom

“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,” chief executive officer Michael Bloom said in a statement.

“Our third-quarter EPS and EBITDA, excluding nonoperating charges, was negatively impacted by a more aggressive inventory reduction and timing of shipments for higher margin seasonal merchandise, which led to inventory levels nearly $50 million below the prior year, as well as investments in our overall pricing strategy to ensure we remain competitive in the market,” Bloom explained. “While these initiatives 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.”

On the revenue side, sales in the third quarter fell 4.5% to $493.6 million from $516.6 million a year earlier. Fred’s said the decrease stems primarily from the closing of 39 underperforming stores earlier this year.

Same-store sales for the quarter dipped 0.8% year over year, an improvement from a 3.8% decrease in the year-ago quarter. Fred’s said comparable-store sales in the 2017 quarter reflect a negative impact of 36 basis points from the sale of low productive discontinued inventory.

Third-quarter gross profit declined to $94.6 million from $111.2 million, mainly due to the revenue decrease connected with the store closures and increased promotional activity to spur traffic and decrease inventory. Gross margin fell to 19.2% from 21.5%.

“In the third quarter, we furthered our efforts to turn around the company, and we are encouraged by our positive front-store comp sales in both October and November. We are focused on driving traffic, reducing SG&A, generating free cash flow and lowering our debt,” according to Bloom. “We are aggressively executing our turnaround strategy to accomplish these goals, and we are seeing traction in both front store and pharmacy.”

For example, he noted, Fred’s has seen “a complete turnaround” in its tobacco business and has “significantly enhanced” cosmetics and rolled out beer to about 150 stores and wine to roughly 50 stores.

“We have also kicked off a reduced price end-cap test, which is showing promising results, and we intend to roll it out to all stores,” Bloom added. “We are not yet at the point of presenting positive quarterly comp sales and traffic improvement. However, we are improving month-by-month as our initiatives are yielding results. We recognize that there is more work to be done, but we are encouraged by the traction our initiatives are gaining and look forward to capitalizing on that momentum in the coming quarters.”

In a separate announcement, Fred said its board of directors has terminated its quarterly cash dividend to retain free cash flow for debt reduction, share repurchases and other general corporate purposes. The board also amended its stock buyback program to allow for the repurchase of up to 3.8 million shares of Fred’s outstanding Class A voting common stock. The buyback program is valid for up to two years.

And as part of efforts to boost business and shore up financial results, Fred’s said the board is mulling strategic options for certain non-core assets, including real estate and its specialty pharmacy business. The company noted that the decision to consider and these alternatives doesn’t reflect any proposals from a third party.

“We are excited about the progress we have made in executing our strategic turnaround plan, which followed an exhaustive and comprehensive evaluation of our business, and which has prioritized driving traffic, reducing SG&A expenses as a percentage of sales, reducing our leverage levels over time, driving profitability and generating free cash flow per share,” Bloom commented. “We believe that we now are in a position to further enhance our strategic plan by exploring a variety of strategic initiatives and by investing in our common stock which, we believe, given current share prices, represents an attractive use of funds and provides us an additional opportunity to build long-term value for our shareholders.”

Overall, Fred’s has about 600 discount general merchandise stores in the Southeast — more than half of which house pharmacies — and operates three specialty pharmacy-only locations. Included in the retail network are 13 franchised locations.