Fred’s, Inc.

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Fred’s, Inc.

4300 New Getwell Road
Memphis, Tennessee 38118
U.S.A.
(901) 365-8880
Fax: (901) 365-8865

Public Company
Incorporated: 1947 as Baddour, Inc.
Employees: 4,800
Sales: $492.2 million (1997)
Stock Exchanges: NASDAQ
SICs: 5331 Variety Stores

Fred’s, Inc. is a discount retailer with stores in ten states in the southeastern United States. Serving small and medium sized towns, Fred’s stores offer housewares, Pharmaceuticals, clothing and linens, health and beauty aids, paper and cleaning supplies, food, and tobacco products, including more than 300 items with the proprietary Fred’s label. According to demographic studies, the company’s typical customer is a woman over age 25 who lives in a rural location and has a household income of $25,000. As of February 1998, Fred’s operated 261 discount general merchandise stores, over a dozen stand-alone Fred’s Xpress pharmacies, and a mail order pharmacy facility. More than 110 of the stores have full-service pharmacies and some 90 locations have lawn and garden centers. The company also markets goods and services to 31 franchised Fred’s stores.

1947–88: Founding as Baddour, Inc.

The history of Fred’s, Inc. may be traced to the mid-1940s founding of Baddour, Inc. Paul Baddour and his two brothers, sons of Lebanese immigrants, started the family-owned retail business in 1947, with one “Good Luck” store in Coldwater, Mississippi. Paul incorporated the company as Baddour, Inc., but as he expanded the chain throughout the Southeast, he began naming the individual stores after one of his brothers, Fred.

Fred’s stores were located in such small towns as Stamps, Arkansas, and luka, Mississippi, and offered mostly closeout items that could be sold at discounted prices. The company grew in its niche market, opening franchised units as well as its own new stores for nearly 20 years, until a major upheaval occurred on the discount store scene with the arrival of Sam Walton and his Wal-Mart stores.

Beginning in 1962, Walton moved into rural areas, first in Arkansas and Missouri, and then across the South, opening stores that were much larger than those already serving a town and stocking a much wider variety of discount priced merchandise.

Paul M. Baddour took over the presidency of Baddour Inc. from his father in the early 1970s, determined to compete head-on with Wal-Mart. He built bigger stores, increasing the size of the average Fred’s from 5,000 square-feet to 30,000 square-feet, and ordered a broader inventory of merchandise, including products with the “Fred’s” label. In 1980, he created a subsidiary, Retail Consulting Services, Inc., to provide advice and services to other retailers. One of its first projects, developed originally for the rapidly growing Fred’s, was an integrated inventory management system called SWORD (Store, Warehouse, Ordering, Replenishment and Distribution). Among the customers for at least certain aspects of the program were G.C. Murphy Co. and Grand Central in Salt Lake City.

By the mid-1980s, Fred’s company had over 200 locations, but the expansion had left Baddour $56 million in debt, and its banks wanted their money. At this time, the Memphis Retail Investors Limited Partnership (MRILP) entered the scene, lending Baddour Inc. $15.3 million at an interest rate of 8.95 percent in 1986. This allowed the company to pay back its more expensive debt. In return, MRILP got the right to convert its note into 51 percent of the company’s equity.

One of the major players in MRILP was Michael Hayes, who had just left Wall Street’s Oppenheimer & Co., where he had been head of corporate finance. According to William Stern’s article in Forbes, Hayes thought that with an infusion of money, Paul M. Baddour would be able to get the company back on track, and then MRILP would convert the note into shares, take the company public, and sell its equity at a big profit. Hayes, along with his partner, David Gardner, were elected to the board of directors in January 1987.

But things did not work out as Hayes hoped. Instead, the company lost $27 million over the next three years. MRILP went to court in Tennessee and, in the autumn of 1989, received 51 percent of the company under a court settlement. Paul M. Baddour resigned immediately, and Hayes and Gardner took over as managing directors in October, with Hayes also serving as chief executive.

1989–91: New Management and a New Name

Hayes and Gardner quickly moved to improve profitability, adopting five goals: 1) recapture traditional Fred’s customers; 2) focus management, store managers, buyers, and pharmacists on profitability; 3) reduce employee turnover; 4) reduce corporate operating expenses; and 5) increase pharmacy and related products sales.

To accomplish these, Hayes revised the merchandise mix, eliminating expensive items such as microwaves and color TVs and concentrating on inexpensive household goods. He standardized store size and layout around a 13,000 square-foot model and closed several unprofitable locations. He also put into place a bonus incentive plan for all salaried employees and started a management training program. Finally, Hayes also changed the company’s advertising strategy, eliminating direct mail circulars, adding coupon books, and using television and radio advertising, with an actor playing the role of “Fred” in the television ads.

Hayes’ strategy was to make the smaller size of his stores a strength by appealing to customers who wanted to buy between five and ten specific items at a competitive price, in a friendly, familiar environment. He targeted customers who were not interested in roaming a huge superstore to find things they might need, and the company made the differentiation between “buying” at Fred’s and “shopping” at larger, less conveniently located stores.

The changes quickly improved Fred’s financial picture. In 1990, comparable store sales rose by six percent, and for the first time in four years, the company earned a profit. In 1991, net income tripled to $3.8 million on sales of $291 million. Moreover, the bonus incentive and training programs helped reduce the turnover among store management personnel, from 75 percent in 1988 to less than 25 percent in 1991. For store managers alone, turnover dropped from 55 percent to less than 20 percent in the same period.

Fred’s stores were typically located in a shopping center or “strip mall” (anchored by a high-traffic grocery store) in small-to-medium sized towns. According to the 1993 Forbes article, Fred’s could be profitable in a town with only 1,500 citizens, compared to Wal-Mart, which targeted towns with a population of 10,000 or more. Customers were generally low, middle, and fixed income families.

Fred’s stores offered some 12,000 items, primarily merchandise that people purchased frequently. Stores with pharmacies stocked an additional 600 items. By 1991, the 45 in-store pharmacies accounted for 12.1 percent of store sales, up from 7.2 percent in 1988.

Fred’s discount prices were typically lower than those at drug or smaller variety/dollar stores. In 1991, household goods made up just over a quarter of store sales, followed by health and beauty aids (17.5 percent), apparel and linens (17 percent), paper and cleaning supplies (15.2 percent), pharmaceuticals (12.1 percent), and food and tobacco products (11.4 percent). The company’s private label products included pet foods, disposable diapers, paper products, beverages, household cleaning supplies, and health and beauty aids. In 1991, these products constituted about four percent of total sales.

In May 1991, Hayes was named company president, and the shareholders voted to change the company name from Baddour Inc. to Fred’s Inc. The change, according to the company prospectus, reflected the company’s focus on its store operations and away from the family name of the founders and former management.

1992–95: Emphasizing Pharmacies

In 1992, Hayes took the company public, selling 39 percent of the shares for $52 million and using proceeds to pay off most of the bank debt. At the time, Fred’s operated in eight states and had 144 company-owned stores and 43 franchise stores.

During the year, Hayes opened 12 new stores, reaching 156 company-owned locations, while the number of franchised stores dropped to 39. As a result, in both 1991 and 1992, wholesale sales to franchisees and others declined as a percentage of total sales. Hayes also added pharmacies in 15 stores, bringing the total to 60. At end of the fiscal year, the company, which was now operating in nine states, paid its first quarterly cash dividend, $.04 per share.

In 1993, Hayes began exploring the possibilities of significantly increasing the company’s size. In March, the company announced plans to buy Bill’s Dollar Stores. Bill’s, a privately held discount retailer based in Jackson, Mississippi, had 530 stores in 13 southern states. If the two chains had joined, they would have had total sales of over $540, but the merger did not happen. Three years later, on March 1, 1996, the company announced it had reached an agreement in principal to a merger with Rose’s Stores, Inc. But the acquisition of Rose’s, which had 105 retail stores in ten southeastern states, was also canceled later that year.

While Fred’s management had concluded that merging with these other discount store chains would not be as beneficial as originally anticipated, the company did acquire a drug store chain. In 1995, Fred’s paid Southern Wholesale Co. $3 million in cash for 18 Super D stores in Alabama, Georgia, North Carolina, and Tennessee. The company also acquired one independent pharmacy that year. Five of the purchases were established as stand-alone Fred’s Xpress pharmacies. That concept, with locations ranging in size from 1,000 to 6,000 square feet and selling pharmaceuticals and other health and beauty items, allowed Fred’s to enter a new market less expensively than if it were to open a new store. The company’s plan was to expand these locations into a full-size Fred’s when business warranted. At the end of 1995, in addition to the five Fred’s Xpress units, the company had 87 stores with full service pharmacies.

Prescriptions and other pharmacy products were an increasingly important part of Fred’s merchandise mix. In 1995, phar-maceuticals accounted for nearly 18 percent of sales, the second largest sales category, behind household goods. This performance occurred amid the growth in alternative sources for prescriptions resulting from the managed care movement. Third-party firms, such as health maintenance organizations, hospitals, and mail-order houses, paid 70 percent of all prescription drug bills in 1995, up from four percent in 1960.

As more employers shifted their employees’ health coverage to managed care or health maintenance organizations, pharmacies and drug store chains were under great pressure. That pressure led to consolidation in the drugstore business and helped Fred’s strategy of expanding its pharmacy activities by acquiring established independent pharmacies. The company either employed the pharmacists whose operation the company bought or purchased customer lists from retiring independent pharmacists.

The Mid-1990s and Beyond

Fred’s continued to increase the number of pharmacies in its stores, reaching 101 by the end of 1996, more than double the number of pharmacies there had been five years before. The importance of this segment of products to the company was reflected in its portion of sales, which reached nearly 20 percent in 1996. The company also implemented a new pharmacy management system that provided centralized control of its chain of pharmacies.

Still, the company was not ignoring its other merchandise categories. It expanded its selection of garden supplies and established lawn and garden centers. By 1996, 89 of the stores had such centers, and 26 were full-line centers complete with green houses, a wide selection of garden equipment and tools, and live plants. During the year, Fred’s also introduced moderately priced videos and pre-paid telephone calling cards as well as new items with the Fred’s label.

During this period, the company restructured its management ranks and revised its pricing strategy, introducing everyday low prices in 1994. The process involved reducing prices for many key items and eliminating four sale events in 1995 and two in 1996. Initially, this resulted in a significant drop in net income in 1995. But by 1996, customers began to shop at Fred’s more regularly, not just during sales events. Although the average customer in 1996 spent 10 cents less each time she shopped at Fred’s ($11.15), there were one million more customer transactions (34 million) than there were in 1995.

1997 proved to be a very good year for the company, with record sales and growth. Sales for the year increased 17.7 percent to $492.2 million, up from $418.3 in 1996. Sales in stores that had been operating for a least 12 months rose 8.3 percent from the prior year. In November, Fred’s bought 17 drug stores from CVS Corporation, expanding the company’s presence in Georgia, Mississippi, and Tennessee and continuing its growing presence in the pharmacy business. That presence was further enhanced when Hayes announced in February 1998 that Fred’s had opened a mail order pharmacy facility and had signed its first national contract with participants in all 50 states. Fred’s moved into its sixth decade of operations secure in its own niche. And through its pharmacy segment, with its increased buying power and systems capabilities, the company was moving to become the preeminent pharmacy in its markets.