Transformation of Fred’s accelerates with acquisition

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MEMPHIS — Fred’s Inc. has taken a huge step forward on its path toward becoming a major drug store chain by agreeing to buy 865 Rite Aid locations from Walgreens Boots Alliance Inc. (WBA) and Rite Aid Corp. for $950 million in cash. The transaction, which also includes certain assets related to store operations, is expected to close several months after the pending acquisition of Rite Aid by WBA, and is subject to approval by the Federal Trade Commission as well as customary closing conditions and approvals. Shareholder approval, however, is not required.

If completed, the acquisition will transform Fred’s from a regional small-box discount and pharmacy retailer into the third-largest drug store chain in the country, with approximately 1,500 stores spanning the eastern and western United States. Fred’s expects to continue to employ all store associates and certain field and regional associates involved with store operations.

The company has secured financing commitments from BofA Merrill Lynch and Regions Bank to fund not only the purchase price but also transaction-related costs, anticipated capital investments and ongoing business operations.

“This will be a transformative event for Fred’s Pharmacy that will accelerate our health care growth strategy through our acquisition of 865 new stores located in highly attractive markets,” says Mike Bloom, chief executive officer of Fred’s. “We believe that this transaction will also create tremendous opportunities for both our new and existing front-of-store and pharmacy team members. We look forward to realizing the considerable benefits this transaction will bring to our customers, patients, payors, supplier partners, team members and shareholders.”

Rumors of the deal had circulated for weeks before its announcement last month. Most recently, the company’s third quarter conference call was prefaced by a statement that executives would not conduct the usual question and answer session due to a “pending ­transaction.”

During the call, Bloom pointedly emphasized the transition of Fred’s to a health care retailer. “First and foremost, I want to emphasize to everyone that we are Fred’s Pharmacy,” he said. “While our past heritage as Fred’s Super Dollar has provided us a base of loyal customers and a deep understanding of their needs, that is the past. Personal health care is among the fastest-growing sectors of consumer spending. As we look ahead to 2017 and beyond, health care is the key to our growth, the key to our profitability and the center of our business model.

“This means an emphasis on our health care customers and patients: The establishment of strategic health care relationships and partnerships with hospitals and payers, and an increased emphasis on both retail pharmacy and specialty pharmacy growth. We have a plan, and we are ready.”

In addition to the scale of the transaction, Fred’s recent financial performance made the company appear an unlikely candidate to step forward and purchase the Rite Aid locations. It reported an adjusted loss for the third quarter of $28.7 million, as sales declined 4.5% to $516.6 million. Its year-to-date net loss topped $44 million, and at the end of the third quarter it counted only $5.7 million in cash on hand.

However, during the conference call, Bloom detailed a series of measures intended to turn around the retailer’s operating performance, which he described as not acceptable. It includes closing 40 underperforming stores during the first half of 2017, based on what he described as a new, data-driven process used to evaluate and forecast store performance.

In addition, Fred’s is revamping its product offerings, eliminating unproductive inventory throughout the chain.

“We have launched several key initiatives around assortment and inventory management that will lower our overall inventory days of supply, optimize our assortment to drive sales and margin, and manage end-to-end product life. We are confident that the new systems and processes we are implementing will optimize our inventory to substantially improve our return on investment.”

Other key initiatives include raising employee engagement through improved compensation and benefits programs and implementing process improvements in such areas as category management and supply chain in partnership with consulting firm A.T. Kearny.

Finally, Fred’s will continue to focus on technology upgrades, which Bloom described as “foundational to supporting our entire growth strategy.”


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