LOS ANGELES -- Smart & Final here is getting its business back in focus.
A year after restructuring its operations, the company says it believes it is positioned to take full advantage of what it considers its unique niche in the food industry.
"We hit a bump in the road," Ross E. Roeder, chairman, president and chief executive officer, said in an interview with SN. "But despite taking our eye off the ball for two or three years, our basic store concept is so strong that we've been able to simply tweak the operation here and there to get ourselves right back on track. That speaks to how strong our basic niche is."
That niche -- serving the food and food-service needs of businesses and consumers in the West and Florida in a non-membership format -- is becoming increasingly important, Roeder said.
"That part of the market is enjoying the strongest growth in the food industry right now. Away-from-home eating is growing, while home consumption of food is flat or trending downward, and our business is geared to serving the away-from-home food industry, whether it's restaurants, bowling alleys, catering trucks or refreshment stands at Little League fields."
According to Roeder, who became chairman and chief executive officer in January 1999 and added the title of president two months later, the restructuring didn't involve any massive changes. "What it did was change our focus to make sure we were paying the most attention to our store base," he explained.
"That focus had shifted to food service in the mid-1990s because that was the troubled area. Anytime you bring a different kind of business into your operation, you have to be careful because the core business gets less attention. So we got out of focus, and our stores became secondary."
In the course of restructuring, Smart & Final made changes in the management, procedures and assortments of its food-service operations, encompassing single food-distribution facilities in California and Florida, so it could direct more attention to its core business -- the 218 warehouse stores that account for 77% of its sales base, Roeder said.
In the wake of the restructuring efforts, same-store sales hit a five-year high last year, while earnings moved back into the black after a one-year loss -- and after three years of losses in the food-service division -- Roeder said.
Looking ahead, Roeder said the company's expectations include the following:
Returning to its traditional annual growth rate of at least 15 stores a year beginning in 2001, with an eye toward moving into new markets, possibly in the Southwest or the Mid-Atlantic region.
Reaping the benefits of a turnaround in its food-service business.
Using the Internet later this year to sell equipment and supplies.
For the year ended Jan. 2 -- the first year of Roeder's tenure -- Smart & Final sales rose 7.9% to $1.8 billion and same-store sales increased 5.3%. Sales for the company's warehouse stores increased 15% to $1.4 billion, while food-service sales dropped 10% to $411 billion.
Net income for the year was $4.7 million, compared with a loss of $8.7 million in 1998. In the food-service division alone, the loss last year fell to $7.5 million, compared with losses of $18 million in 1998 and $8.6 million in 1997.
The company's California food-service operation turned profitable last year, Roeder said, and the one in Florida is on track to return a profit this year. The declines in its food-service operation were gradual, he recalled.
"When we got into broadline distribution in 1991 [with an acquisition in northern California], the biggest single oversight we made was not having someone on staff who understood food service," Roeder said. "We didn't anticipate there'd be such a tremendous difference between that business and running the stores, and that created huge problems."
But because food service was initially such a small part of the operation, the problems didn't become apparent until Smart & Final acquired Miami-based Henry Lee Co. in 1994, he said.
"Henry Lee was a family-owned company that had operated very efficiently as a hands-on business. But when we began introducing more sophisticated systems, it created turbulence. And the situation got worse when we began opening stores in Miami and added store distribution to the Henry Lee operation, which was already operating above capacity."
Although Smart & Final was a well-established West Coast name with a history of nearly 125 years at the time, the Florida stores encountered problems because they were located in isolated areas, with no public awareness of what Smart & Final was, Roeder said. "We could have been a clothing store, for all anyone knew."
In addition, the stores opened with the identical assortment to the Western stores, "without any consideration that the Hispanic market is very different there," Roeder said.
As its food-service problems escalated, Smart & Final shifted its focus to that area, to the neglect of its core store base, "which is the heart of our business," Roeder recalled.
Roeder, who had been a Smart & Final director since 1983, was dispatched to Miami in 1998 as a consultant to resolve the situation there. "The first thing we did was to reorganize the division and start over. So we rationalized the warehouse assortment, reduced inventory by a third, upgraded the freezer facility and brought in more competent management, and the changes paid off because Henry Lee will be profitable this year."
In the northern California food-service division, the company also introduced a new senior-management team, which sought to improve the warehouse assortment and shift the focus to more credit-worthy customers -- which hurt sales but helped profits, Roeder said. He said earnings there turned positive last year.
At store level in Florida, the company lowered its pricing structure and began a promotional campaign, Roeder said. The result was a 30% increase in same-store sales last year, on top of a 20% increase in the second half of 1998.
"Those increases validated our view that the Smart & Final warehouse-store concept is expandable nationwide," Roeder said.
As a result, Smart & Final expects to began expanding beyond its current West Coast and Florida operating areas in the next couple of years, Roeder said. "We will be examining new markets, and by 2002 we expect to begin our expansion. But we have no notion right now where that will be."
He said Smart & Final already serves most of the major population centers west of the Rockies except for Salt Lake City and Albuquerque, "but we will probably be servicing those areas and all communities west of the Rockies in the next few years. That won't be the focus of our expansion, but we will fill in smaller markets as distribution allows."
As for new markets, "We've looked at sites in Texas, Kansas City, the Mid-Atlantic and the Midwest," Roeder said, "but it's hard to predict right now where we'll go."
According to Martin A. Lynch, executive vice president and chief financial officer, "The Mid-Atlantic looks promising, with potential markets for us in Philadelphia, Baltimore and Washington."
Roeder said the company's expansion options have broadened because of its supply arrangement for the Cash & Carry stores it acquired in 1998 from United Grocers (now part of Unified Western Grocers, Los Angeles). "That's been a terrific arrangement for us, and because Unified is affiliated with four or five other Western cooperatives, those companies are potential sources of supply for our stores in other states," he explained.
"When we got into broadlines, we had few distribution options," Roeder recalled. "But the advantage we have now is, we know our broadlines facilities can supply our stores and we know Unified can supply our stores, and that gives us additional options as we look at new markets to distribute from our own broadline facilities or from our distribution center or to buy from a third party."
Smart & Final had been expanding at the rate of 15 new stores a year until 1998, when it cut back to acquire the Cash & Carry stores, Lynch explained; it opened only three stores last year, while devoting most of its capital to integrating the Cash & Carry operation, he added.
He said Smart & Final spent a record $100 million on its capital budget in 1998 ($60 million of which went to pay for the Cash & Carry acquisition); it spent $29 million last year and expects to spend $35 million this year and $40 million in 2001, he noted.
According to Roeder, Smart & Final plans to open eight to 10 new stores this year, including five in California, two in Florida, one in Mexico and two Cash & Carry locations in the Pacific Northwest. He said the company expects to return to its norm of 15 or more new stores a year beginning next year.
As the company has shifted its focus back to its existing store base, it has expanded the number of in-store offerings, Roeder said, including the addition of more than 200 perishables items -- such as produce, meat, frozen foods and dairy; an increased selection of wines, and expansion of institutional-sized packages in most categories.
It has also moved equipment and supplies to the front of its stores and expanded the selection by 20% to 30%, Roeder said, "because that's a category that sets us apart from the competition. We carry commercial-quality and professional equipment that's not available anywhere else except at restaurant-supply houses," including refrigerators, stoves, pots and pans, popcorn machines and bar blenders.
The company has also been localizing an ethnic assortment at each store to enable it to market better to the communities in which it operates, Roeder said.
In meat, Smart & Final has been testing the sale of half-primal cuts at 38 stores. "That's working out well, but we don't plan to expand it," Roeder said.
To make room for the expanded selections, Smart & Final dropped 1,500 to 2,000 items "so we could focus on categories where we can be dominant while offering unique items and value prices," Roeder said.
The stores cut back on health and beauty aids "because we can't be a dominant player when every chain drug store has the same merchandise," Roeder said. The company also eliminated scratch bakeries "because they were very expensive to run," Lynch added. "We tested them for a little less than a year, and it was a good test but it didn't work."
To strengthen its image, Smart & Final introduced a new advertising slogan -- "Where the Pros Shop" -- that Lynch said helped boost customer transactions 13% to 37.3 million in 1999, compared with 33 million in 1998; average store transactions also rose 13% to $35.65 per customer from $31.52 in 1998, Lynch added.
Roughly half of Smart & Final's sales base is consumer-oriented and half is business-related, while the Cash & Carry stores are business-only and require a resale number to shop there, Roeder said.
Because the stores are considerably smaller than membership warehouse clubs, "a shopper can be in and out in 20 minutes, compared with one to two hours at a club store," Roeder said.
Securities analysts contacted by SN said Smart & Final faces a stiff competitive challenge from Costco Wholesale, Issaquah, Wash., which operates membership warehouse clubs up and down the West Coast.
According to Jonathan Ziegler, San Francisco-based managing director of Deutsche Banc Alex. Brown, New York, Smart & Final's pricing is not as sharp as Costco's, "and Costco has the advantage of having membership fees," he said to SN.
However, Smart & Final has its own edge, he added. "Its stores are smaller, so they're easier to get in and out of, and it has more convenient locations and a broader assortment of food-service products. So for a small retailer whose time is as important as money, he can definitely do a lot of his business at Smart & Final with less investment of time."
However, Ziegler said, he believes Smart & Final could benefit from broadening its appeal a little more to general consumers. "The membership clubs create excitement, and they have a very broad appeal. Smart & Final has not addressed that market as well as it could, and I see that as an opportunity," Ziegler said.
Chuck Cerankosky, an analyst with McDonald & Co., Cleveland, offered a similar viewpoint. "Smart & Final needs to adjust its merchandising either to broaden or narrow its appeal," he said.
"While Costco certainly doesn't have the breadth of product that Smart & Final does, Costco is enjoying double-digit comps at a time Smart & Final's comps have been slipping.
"Smart & Final's approach to the business customer seemed to work for a long time, but in the last few years the combination of competition -- from companies like Costco and Safeway -- and a variety of merchandising issues -- including selection, price, promotions and management -- have put pressure on Smart & Final sales and its ability to attract more customers."
Smart & Final expects to expand its sales base later this year by offering more than 5,000 stockkeeping units of equipment and supplies over the Internet, Roeder said. "We probably won't sell much heavy equipment -- mostly knives, plates, pots and pans," he pointed out.
He said the company expects to use a third party for deliveries.
"We want to get our feet wet before we explore other options," Roeder said. "The Internet has changed retailing forever, there's no question about that. The question is, where does it go from here?
"With Peapod struggling, the shakeout is beginning to happen, and there are still a lot of questions about where these Internet-based companies are going. Smart & Final is not going to be on the cutting edge and bleeding like many of those companies, but we are aware of e-commerce and we will examine ways to utilize it."
