Discount merchandiser Fred's (Nasdaq: FRED) became one of the Nasdaq's top gainers yesterday, with its stock flying nearly 9% by market close. Why? I'm not entirely sure.
Fred's did manage to beat consensus analyst estimates, if by a roundabout route. In the third quarter of last year, Fred's earned $0.19. Expectations for this quarter had been muted by the effects of the third quarter's slew of southern hurricanes, such that, although the company itself previously forecast profits in the range of $0.19 to $0.22 per share, Wall Street expected only $0.18.
What Fred's actually reported went as follows: Net profits were $0.16 (an apparent earnings miss). But the company renewed a contract with its drug wholesaler, AmerisourceBergen (NYSE: ABC), ahead of schedule this quarter, in order to lock in some advantageous prices earlier than anticipated. As a result, Fred's had to defer $2.2 million worth of pre-tax profits -- shifting $0.03 worth of post-tax profits off of this quarter's books and into the future. Absent that accounting shift, the company would have hit the lower end of its profits target and beaten the consensus $0.18 number.
Aside from the prospect of those $0.03 in profits reappearing in the future, however, the quarter honestly doesn't look to have been so great for Fred's. Sales increased 8%, but that increase represents an apparent slowdown from year-to-date sales growth, which has been 10%. On the other hand, absent the effects of the contract shifting profits around, Fred's gross profits would have risen 9%, and gross margins would have increased by 50 basis points against the year-ago quarter.
All in all, to this Fool, the quarter really looked like a mixed bag. And the one thing that would have justified a 9% rise in stock price was entirely absent from the firm's earnings report: news of free cash flow growth. All the firm had to say on that subject was that the shift "had no effect on cash flow for the quarter."
Now presumably, that's meant to signify that free cash flow was not depressed in tandem with the firm's GAAP numbers. But considering the firm's free cash flow history, a clearer statement to that effect would have been helpful. Over the past eight quarters (previous to Q3, for which no cash flow statement has yet been provided), Fred's has burnt through $18.3 million worth of free cash flow, all the while reporting $60.1 million in profits under GAAP. Fred's has began reversing that trend this year, but if it succeeded in keeping free cash flow up in Q3, a Fool has to wonder why it didn't just come out and tell us that.
Fool contributor Rich Smith owns no shares in either of the companies mentioned in this article.
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