Fred's Inc.'s (NasdaqGS:FRED - News) third quarter 2011 adjusted earnings shot up 20% year over year to 24 cents a share. The reported earnings also surpassed the Zacks Consensus Estimate by 2 cents.

Profits were driven by the success of Core 5 program taken up by the company. The Core 5 Program is a long-term strategy designed by the company to highlight key categories within its stores. The Core 5 categories - Home, Celebration, Pet, Pharmacy and Paper and Chemical - are strong trip driving departments in which FRED'S has a clear and marketable advantage versus small box competitors.

The merchandising and marketing plans will expectedly continueto deliver great values and exciting shopping experiences for Fred's customers in the upcoming holiday season.

Quarter in Detail

Total sales increased 2% year over year to $444.4 million, but missed the Zacks Consensus Estimate of $446.0 million. In addition, Fred's comparable store sales growth rate remained flat with the prior year at 1.5%.

As part of the fiscal 2011 operating plan, Fred's opened seven new stores and six express pharmacy stores during the third quarter. However, one store and three express pharmacy locations were shut down in the quarter.

A total of 79 stores were remodeled and refreshed with its new Core 5 elements in the quarter. Thus, the upgraded stores totaled to 411 during 2010 and 2011.

Cost and Margin Performance

Cost of goods sold inched up 1.1% to $308.4 million. The results were impacted by higher depreciation and amortization, store occupancy costs, and insurance expense. Selling, general and administrative expenses declined as a percentage of sales from 27.6% to 27.1% in the third-quarter 2011.

Gross profit increased 5% to $136.0 million from $129.7 million in the prior-year period. The higher profit was the result of controlling general merchandise markdowns and higher pharmacy department gross margin.

Operating income climbed up 16% from the prior-year period, totaling $13.6 million. Operating margin expanded by 30 basis points from third quarter 2010.

Other Financial Update

At the end of October 29, 2011, Fred's cash and cash equivalents went down to $19.97 million, compared with$37.5 million as of October 30, 2010.

Outlook

Management expects tough retail conditions to continue across the markets in 2011, due to ongoing concerns about rising petroleum prices and their macro-economic effects. On the other hand, Fred anticipates improvements from its Core 5 Program, and expects its strategic initiatives and cost reduction programs to maintain profitability compared with last year.

For the fourth quarter 2011, Fred forecasts its total sales to increase 2% to 4%, while it expects its comparable store sales to increase 1% to 3% versus an increase of 2.3% in the third quarter last year.

The company expects earnings per share to increase to a range of 23 cents to 27 cents for the upcoming fourth quarter compared with earnings per share of 22 cents in the same period last year. Based on this outlook, the Company expects total earnings per diluted share for 2011 to be in the range of 84 cents to 88 cents, representing an increase of 12% to 17% over last year.

Fred's, based in Memphis, Tennessee, operates discount general merchandise stores mainly in southeastern U.S. It offers nationally recognized brands, and private label and lower-priced, off-brand products.

The company's merchandise mix includes more than 12,000 frequently purchased items, consisting of household goods, apparel, food, tobacco, healthcare and paper products. Some of its retail outlets also feature pharmacies, which offer prescription drugs.

Fred's faces stiff competition from Dollar General Corporation (NYSE:DG - News) and Walgreen Co. (NYSE:WAG - News). It currently holds a Zacks 2 Rank. On a long-term basis, we maintain a Neutral rating on the stock, with a short-term 'Buy' rating.

WALGREEN CO (WAG): Read the Full Research Report

FRED'S INC (FRED): Read the Full Research Report

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