"Reviewing recent comments expressed by competitors in their quarterly reports and outlooks expressed by industry analysts, we anticipate that the competitive climate will be intense and the operating environment challenging in the second half of the year," Efird continued. "Discretionary spending for lower-income consumers – a key customer segment for Fred's – is expected to remain under pressure. The programs we put in place earlier this year, combined with our pharmacy expansion and the aggressive general merchandising initiatives we have planned in the back half of the year, are designed to meet these economic and competitive challenges. We remain confident that our earnings for the year will fall in the middle to the upper end of the range we earlier projected, with earnings in the second half increasing 14% to 28% over the same period last year and earnings for the full year increasing 17% to 25% over 2012, excluding the tax benefit recorded last year."

Fred's gross profit for the second quarter of 2013 increased 3% to $136.0 million from $131.8 million in the prior-year period. Gross margin for the quarter increased 20 basis points to 28.2% compared with 28.0% in the same quarter last year. Gross profit for the first half of 2013 increased 3% to $287.0 million from $279.6 million in the prior-year period. Gross margin for the six-month period improved 40 basis points to 29.2% compared with 28.8% in the prior-year period. The improvements for the quarter and year-to-date period were driven by an increased pharmacy department gross margin, specifically reflecting the impact of the brand-to-generic mix shift, and better shrinkage control.

Selling, general and administrative expenses for the quarter, including depreciation and amortization, leveraged 20 basis points to 27.1% of sales from 27.3% of sales in the prior-year quarter. The leveraging of expenses in the second quarter was driven by store expense management as well as favorable insurance expense reductions. These improvements were partially offset by the sales impact of the pharmacy department brand-to-generic shift and investments in new pharmacies. In the first half of 2013, selling general and administrative expenses deleveraged 20 basis points to 26.9% from 26.7% of sales in the first half of 2012. The deleveraging in the year-to-date period was primarily attributable to the sales impact of the pharmacy department brand-to-generic shift and investments in new pharmacies.

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