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TAKING A HYBRID TO THE NEXT LEVEL

LOS ANGELES -- Smart & Final here has a clearer focus these days.That focus is squarely on its 182 non-membership warehouse stores and 46 cash-and-carry locations rather than on the food-service operations that have sapped much of management's time and the company's profits for the last few years."Everyone talks about value suppliers as being in the best position going forward, and we're clearly a

LOS ANGELES -- Smart & Final here has a clearer focus these days.

That focus is squarely on its 182 non-membership warehouse stores and 46 cash-and-carry locations rather than on the food-service operations that have sapped much of management's time and the company's profits for the last few years.

"Everyone talks about value suppliers as being in the best position going forward, and we're clearly a very solid value supplier," Ross Roeder, chairman and chief executive officer, told SN.

Industry observers have tended to overlook the company's strong performance at store level, Roeder noted, "because of the problems we were having with the food-service operation. But it will be clearer to the financial community going forward how well our stores are actually doing."

Comparable-store sales at Smart & Final have been on the rise for the last 20 quarters, Roeder pointed out, climbing 3.4% in 2002 and 3.9% for the first half of 2003, with expectations they continued to outperform the conventional grocery industry again in the third quarter ended Oct. 5 (third-quarter results are scheduled to be released later this week). Roeder said comps have been so strong "because of a combination of all the programs we run."

Smart & Final sold its two food-service divisions, in Northern California and Miami, over the summer, "and now we're looking at our core business -- the stores," Roeder said.

"What's happening is not so much a restructuring as it is a reorientation or a refocusing. In these turbulent economic times, we've determined it's better to concentrate on the strongest part of our business and not be diverted by the weakest part."

Food service, which accounted for about 19%, or $38 million, of the company's $2.02 billion sales base in 2002, was the major cause of an earnings drop of 43% for the year, Roeder said. It had seemed like a viable enterprise when the company got into it in early 1990s, he added, "and we were making a lot of progress toward getting that business going in the right direction until 9/11. After that it became a lot tougher.

"So we looked at our resources and asked ourselves if we wanted to divert attention and money to businesses that were not strong, or were we better off devoting those finite resources to the stores?"

Smart & Final decided in favor of the stores, and Roeder told SN he believes the company can replace the food-service volume it's lost through additional store volume over the next two or three years.

Jonathan Ziegler, principal in PUPS Investment Management, Santa Barbara, Calif., said Smart & Final entered the food-service business "because it believed there were synergies in purchasing and distribution between a food-service business that catered to larger institutional customers and stores that served smaller businesses."

"That may have been the case when the company operated a food-service business only in Northern California," he said, "but once it got into Florida in 1995 with food service and a handful of stores, that business began to hurt earnings, and the company realized food service was holding back its focus on its core store business."

Now that Smart & Final has unloaded the food-service operations, "they'll certainly have a cleaner operation, but what kinds of synergies they're giving up is an unanswered question," Ziegler said.

"They're certainly giving up losses and the time that management was spending putting out fires, but it would appear they're also giving up buying power by shrinking the size of the company and possibly giving up some overhead efficiencies at their distribution center, though it's possible those synergies never really evolved."

New Directives

Roeder told SN the shift of corporate focus to the stores is one of several moves Smart & Final is making to strengthen its operations. Among others:

Setting up a formal line of succession following the hiring last month of Etienne Snollaerts as president and chief operating officer.

Contemplating expansion of its Smart & Final stores into new areas while shoring up its penetration in existing markets.

Giving consideration to expanding its Cash & Carry operations into Southern California.

Contemplating a possible expansion of its Southern California distribution center.

Looking for acquisitions, despite finding very slim pickings.

What Smart & Final offers is unique in the industry, Roeder told SN. "We supply food and restaurant-quality equipment to business consumers as well as to the general public looking for food for parties, church socials or other large-scale events.

"We've done well for a lot of years because we offer good values, and we're a lot more convenient to shop than a membership club because people can get in and out in just a few minutes," he pointed out.

Another edge Smart & Final enjoys, particularly in Southern California, is that it's been in business for a long time, Roeder noted. "We've been around for 130 years, and we've been in some markets for a long time, though people often overlook that."

But Smart & Final still runs under the radar. "We're one of the best-kept secrets in the industry," Roeder said.

To make its niche clearer, the company began billing itself two years ago as "the smaller, faster warehouse store." According to Roeder, "We'd been trying for years to describe what we do in a simple way, and that really does it."

Smart & Final operates its 182 non-membership stores in California, Arizona, Nevada and northern Mexico. Half the stores' volume comes from small-business shoppers, the other half from consumers, Roeder said

It also operates 46 Cash & Carry stores in Oregon, Washington, Idaho and Northern California that sell exclusively to small-business customers and are closed to the public. Those stores do well, Roeder said, "because as more food-service distributors deem deliveries to smaller companies a burden and drop those companies as customers, more of them are finding our stores."

Ziegler told SN he believes Smart & Final's store concept is "a winner, and the only disappointment to me is that they haven't gone national with it. Casino Guichard-Perrachon [the company's major equity owner] has concentrated on pursuing a very regionalized strategy, and the company has tended to move very slowly on its store expansion."

Snollaerts Named President/COO

However, that could change, Ziegler suggested, if Casino decides to take a more aggressive position on expanding the company now that one of its own, Etienne Snollaerts, has been named president and COO.

Snollaerts, 47, has been a Casino executive for several years, overseeing its North American holdings, which consist solely of Smart & Final. He's also been a member of Smart & Final's board since 1998.

Based in St. Etienne, France, Casino operates supermarkets and convenience stores across Europe, South America and the Far East. It began investing in Smart & Final in the mid-1980s and since 1991 it has owned the majority interest in the company, totaling approximately 17 million shares, or just under 60% of the total outstanding.

Roeder, 65, has been Smart & Final's chairman, president and CEO since 1999 and a board member since 1977. Four weeks ago he gave up the title of president to Snollaerts -- who also took the title of COO -- to establish a line of succession at Smart & Final. According to Roeder, Snollaerts was selected because of his overall qualifications, not simply because of his ties to the company's primary shareholder.

"We needed a president to back me up, and we looked at a variety of candidates," Roeder explained. "My goal was to make sure there'd be a smooth transition in the company, and Etienne turned out to be the best candidate. He had the right background for the job, and he certainly knew Smart & Final well, which has made the transition easier.

"And we had already worked together for five years, which gave him an advantage over someone who was totally unknown to us."

Roeder said the decision to hire Snollaerts had nothing to do with any dissatisfaction on Casino's part or a desire by it to protect its holding by putting one of its own in management.

One option for the company going forward is to designate Snollaerts as Roeder's successor when he opts to step aside as chairman, Roeder pointed out, "but we're not ready to talk about that now."

As president Snollaerts is responsible for the stores and distribution centers, while Roeder retains oversight of real estate, finance, marketing, human resources and legal, "and the transition of responsibilities has gone better than I could have thought," Roeder told SN.

Roeder said he doubts Casino will seek other U.S. holdings. "Although there have been opportunities presented to Casino over the years, they've chosen to focus on Smart & Final exclusively," he noted.

Future Expansion Plans

Regarding expansion plans, Roeder said the company intends "to continue to strengthen and defend the niche we serve on the West Coast and to continue to expand in all existing markets because there's still plenty of room for additional stores."

Roeder said the company is still going over budgets to determine specific expansion plans for next year, but he estimated the company will probably open 10 new stores and do four to six major remodels and 20 to 25 minor remodels -- about the same as it's done for most of the past five or six years; he said the company also contemplates adding two or three new Cash & Carry locations.

"We'd like to open more stores each year, but economic conditions require that we be more careful," Roeder explained.

"However, while we intend to concentrate on existing markets and make sure we have the proper penetration, we also want to look at strategic expansion opportunities in new markets in the western U.S."

Smart & Final hasn't entered any new markets for several years, he said, opting instead to bulk up its penetration to develop critical mass in such markets as Arizona and Las Vegas, where it had only a handful of stores. "But we're looking at opportunities in adjacent states and elsewhere," Roeder said.

Although he declined to pinpoint where the company might like to expand, he has told SN on previous occasions the company has had its eye on Texas, Kansas City, the Midwest and the Mid-Atlantic region, including Philadelphia, Baltimore and Washington.

"We'll probably stick to expansion in existing markets for the next year or two because we believe we can leverage the business a lot better by growing in those areas, with new stores, relocations and remodels," he said.

While the chain's average store size is 16,000 to 17,000 square feet, newer stores average closer to 20,000 square feet, with some as large as 23,000 to 24,000 square feet and others closer to 18,000 square feet. But 20,000 to 21,000 square feet is optimal, Roeder said, "because we can design the kind of store we like and carry a proper assortment in that space."

Stores carry 8,000 to 9,000 stockkeeping units, "which is probably up a little from our historic average," Roeder said, with increases coming in produce, meat and cleaning supplies.

The company has upgraded its overall assortment over the last several years, he said, "and we've brought each store down to a more localized level by offering a more sophisticated selection geared to the ethnic mix surrounding each location."

Smart & Final uses third-party logistics suppliers for perishables and other commodities except dry groceries, which are supplied to all stores from a single 400,000-square-foot distribution center in the City of Commerce here. "That facility can handle the stores' current volume," Roeder said, "but we'll be looking at that within six months, and a lot of what we decide to do will be determined by whether store volume keeps growing."

It's certainly been growing the last few weeks as a result of the Southern California retail clerks strike that began Oct. 11, Roeder said -- results he said he considers to be "a mixed blessing."

"We're picking up part of the fallout from the strike, and the stores are being overrun with new customers who are willing to accept larger sizes and a more limited selection, and while we love that extra volume, the strike doesn't make us feel good," he explained.

He said the strike has put a strain on the stores and the distribution center.

Roeder said Smart & Final would like to accelerate its store growth by making acquisitions, "but there's no one else like us, and we wish there were because it would give us something to buy."

In the past the company bought a lot of former Standard Paint stores and Liquor Barns, he said. "We look for boxes of 20,000 square feet, but there aren't a lot of those available anymore," he said.

"We've looked at older grocery locations, but most are being marketed as going businesses, whereas we want just the bricks and mortar, so it doesn't make economic sense for us. And we've purchased some large stores from companies like PetSmart and Office Depot and divided them up with other retailers, but it's not easy to find those.

"We aren't looking for Triple-A locations," he said. "We don't need 10 or 15 acres of land on a corner, the way a Vons or an Albertsons does. We need only about 20,000 square feet, and we'd like it to be in an area with good traffic, plus good ingress and egress.

"But as a value supplier, we don't want to burden the company with the cost of those Triple-A sites, so we look for the best possible sites that fit our economic model."

Asked whether the company has any plans to expand the Cash & Carry franchise to Southern California, Roeder replied, "That's been on our radar screen for some time, and while we aren't ruling it out, there's been so much concentration of the Smart & Final name down here that it would be hard to bring that format into this market.

"But we will continue to examine that possibility."

One of the issues in expanding Cash & Carry is distribution, Roeder pointed out. "Those stores carry a different assortment than Smart & Final, so we have to be sure the distribution is available. The Cash & Carrys are supplied by Unified Western Grocers, with some direct-store deliveries, but until the format becomes more saturated, there's no reason for us to deal with the distribution issue."