'NO MORE BUSINESS AS USUAL'

DAVID GHITELMAN

MONTVALE, N.J. -- At A&P here, the comeback efforts are far from over.

In an extensive interview with SN, Christian Haub, A&P chairman and chief executive officer, and Elizabeth R. Culligan, president, chief operating officer and member of the company's board, discussed how the venerable 750-store chain (once the world's largest retailer) is looking to use the momentum developed over the last year to take the company "to the next level." Their remarks are supplemented by comments the pair made during a recent investors' conference.

(For more about A&P's 2001 comeback, and for more about Culligan, a relative newcomer to the retail side of the food business, see the stories on Page 29.)

Industry analysts told SN the company faced a variety of problems, mostly the result of insufficient management oversight. For example, new stores were built without adequate concern over return on investment, they said, and older stores were allowed to become run down.

While the company has yet to report a profitable quarter this year or last, Haub said it has achieved five consecutive quarters of same-store sales gains, which he termed "an early and strong sign of improvement."

Wall Street appeared to agree. In 2001, the company's share price rose 240%, the largest gain in the supermarket industry that year and one of the top increases in the overall stock market.

Currently, A&P's management team is concentrating on improving store performance, according to Haub, through five, often overlapping, "key strategies": achieving operational efficiencies, driving out costs, aligning the organization, increasing cash flow and building profitable sales.

Specific areas of focus include:

Revitalizing the store base through an emphasis on remodeling.

Transforming its supply chain, in large part through a companywide technology update.

Building private-label penetration.

Improving merchandising and marketing campaigns.

Instituting performance-based rewards for managers at the store level up through corporate headquarters.

Behind all these efforts, Haub observed, is a commitment to make A&P an organization that can deal with constant change. "'No more business as usual' is the theme throughout the company," he said.

Industry analysts, while impressed by the company's performance last year, told SN A&P still has a long way to go.

However, many said they were now more convinced than at any time in the recent past that the company would actually get there.

Mark Husson, equity analyst, Merrill Lynch, New York, said A&P is "in the third inning" of its recovery. Switching sports metaphors from baseball to the Olympics, he added, "I am not expecting to see A&P standing on the winners' podium, but I do expect them to become a good, strong regional competitor finally developing economies of scale."

Operating stores that customers find attractive is one of the ways A&P is looking to achieve that powerhouse position.

The company's capital program is now focused on "revitalizing our store base," noted Culligan. This means, she said, the company plans to execute more than 75 remodels and open only 25 new stores this year.

The new stores, she added, will be developed with "more discipline" than in the past, with a targeted 20% return on investment.

"We will continue to open new stores," she said, "increasing the possibility of success. And every new store that's successful will enable us to reinvest in more new stores or in remodeling existing stores."

Two of the new stores A&P has opened recently in New Jersey employ a limited-assortment format, including Food Basics, the company developed in Canada. "It has been successful over the last six years in Canada," Haub said. "We are testing it to see if there is a place for it in the U.S. market."

However, a rollout of the format is still far off, he noted. "We have not made any decisions. One store has only been open a few months, the other a few weeks."

Nor is the company looking to consolidate the several banners it operates under. Haub observed that the only banners that serve the same market area are the upscale Food Emporium and mainstream A&P stores in New York and New Jersey, "and we don't see a lot of overlap of those two."

Culligan noted that consolidating the company's three major mainstream banners -- A&P in New York City and New Jersey; Waldbaum's on Long Island, N.Y.; and Super Fresh in the Philadelphia area -- "would make some sense" from a marketing standpoint. (Other banners operated by the company include Farmer Jack's in the Midwest; Sav-A-Center in New Orleans; and Dominion, Food Basics and Barn Markets in Canada.)

However, she added, "Each of those banners has very strong imagery with the consumers. We'd have to be very careful before we make a change like that."

Instead, she explained, the company is looking to "take its market position to a new level." She cited a "very successful" campaign in Canada built around the slogan, "We're fresh obsessed."

She added, "That is what we are looking to do with our other banners."

The company is currently "about halfway through" a four-year, $250 million transformation of its supply chain, according to Haub. When it is complete in 2004, it should add $100 million to A&P's annual operating income.

The program is already producing results, noted Culligan. Improved category management has allowed the company to "rationalize assortments," she said. "We looked at which [stockkeeping units] are fast, which are slow, and through analysis saw that we have a higher share of underperforming SKUs than the competition. So we took out slow-moving items and put in our own private-label products."

Building private-label penetration is one of the key ways A&P is looking to build profitability. Culligan noted that although A&P's Eight O'Clock Coffee is perhaps the oldest, and certainly one of the best-known, private-label supermarket brands in the country, overall A&P lags behind the industry in private-label penetration.

She said A&P only has 12% penetration, compared with an industry average of 16%, and a level of 20% or more at best-of-class retailers. "It is within our ability to drive penetration at least to 16%," she said, adding that each percentage of penetration translates into $5 million worth of operating cash flow.

The company's new technology, an important part of that $500 million supply chain overhaul, is also helping to improve merchandising and marketing at A&P, according to Haub.

"We are trying to be more efficient and effective with our promotions by tracking how much sales lift we get from a particular price cut," he said. "Keeping a database of what's been successful and what's not been successful has helped us to move sales and eliminate inefficient promotions."

Haub added that the company is also trying to do a better job of tracking employee performance. "A couple of years ago, we started offering stock options down to the store management level as a reward for making progress," he said. "We've put more emphasis on measuring progress.

"We have a performance management program in place that starts with myself, and company objectives and cascades through operating positions down to the store level.

"We review what progress has been made on a quarterly basis. This is part of our major alignment effort. Everyone knows what they are working on, and everyone is working on the same thing. It's had a tremendously positive impact."

Analysts told SN they are also more positive about the company. Adler observed that the company still faces serious challenges. "Their store base is less profitable than it ought to be," she said. "They don't generate the sales per square foot or margins they ought to."

But she went on to note A&P's many positives. "Although the stores are skewed at the low end, they are not dogs that are pulling down the business," she said. "They've got the demographics. They've got the locations. They're running the stores better."

Perhaps the biggest question hanging over A&P is whether it will be around long enough to become a power player, or whether, once it begins to generate profits on consistent basis, it will be sold to some larger outfit.

Haub said he is certain A&P's parent company, the German retailer Tengelmann Group, has no intention of selling. (The Haub family has a major ownership position in Tengelmann. Haub's father is a former Tengelmann chairman, and the current chairman is a cousin.)

"A&P represents about 50% of the size of Tengelmann, and Tengelmann sees it as a growth opportunity in North America," Haub said.

Adler pointed out that A&P is a "completely self-funded" company that actually sends capital back to its corporate parent.

"I do not believe Tengelmann is a seller," she said. "That can change, but right now I think they have no interest in selling. "

In contrast, Murphy said A&P would be "a logical consolidation candidate" in a few years, assuming its recovery continues. "But when you have large ownership by one family, it's a difficult thing to call."

[Please see Page 6 for a story about A&P's fourth-quarter and year-end financial results.]

Anatomy Of A Comeback

MONTVALE, N.J. -- Look at the performance over the last two years of the stock of A&P here, and you will see an almost-perfect V, bottoming out toward the end of 2000.

Christian Haub, A&P's chairman and chief executive officer, told SN that late 2000 found the company headed toward a crisis. Its stock price was steadily descending, fueled in part by concerns about A&P's liquidity that Haub termed "overblown." (Haub and some industry analysts also note that second-half 2000 was a tough time for retailers -- as he put it, for "any company that did not have a dot-com after its name.")

But he also credited the company's precarious position with providing some of the impetus to begin the turnaround process.

"The change process, which had been under way in some areas, accelerated," he told SN. "It had a galvanizing effect on the organization and helped us turn around."

From outside A&P, the view of what was wrong with the company was extremely dire. Mark Husson, equity analyst, Merrill Lynch, summed up the situation succinctly.

For "the best part of a decade," he told SN, management was characterized by "a lack of any information about the business they were operating, real estate discipline was appalling, and there was a culture of failure."

Observed Meredith Adler, equity analyst, Lehman Brothers, New York, "I think even A&P would acknowledge they were undermanaged. The organization wasn't disciplined enough, capital expenditures weren't disciplined enough, and they didn't leverage their size enough.

"They were very fragmented. There wasn't a focus on best practices, and there wasn't really a focus on the customer.

"They only managed to survive because they operated in a protected market." (Protected, that is, from Wal-Mart supercenter competition in the Northeast, home to approximately half of A&P's store base.)

The turnaround began, according to Husson, "when Christian Haub took over the job of CEO [in 1997] and realized the business was in a tailspin. His fix was expensive and time-consuming, but you can't rebuild a rotten house. You have to tear it down and build it over again."

While Haub didn't talk in such dramatic terms, he acknowledged that one major focus since he joined the company has been "rationalizing of assets."

The first round of rationalization under his direction occurred in late 1998, when A&P closed 127 stores in two "underperforming" markets: Atlanta and Virginia.

The second round took place in the first few months of 2001. "At the beginning of last year, we looked at every single store in the entire portfolio," recalled Elizabeth Culligan, A&P president and chief operating officer. "The largest percentage were stores that were growing and delivering profits. There were also stores that we could make profitable in the future.

"Then, there were these 39 stores. Some were new, some old, but they were not going to deliver profitability. We needed to close those stores."

The company does not expect to have to repeat that experience, Culligan observed. "That work has been completed now," she said. "We close a few stores every year, but nothing out of the ordinary."

Although the closings cut into the company's top line, they also gained A&P a lot of credibility in the investment community.

Jack Murphy, equity analyst, Credit Suisse First Boston, said A&P's "capital planning process" had been in dreadful need of repair. "They had opened a number of stores without rigorous return-on-investment-capital discipline," he told SN.

However, since last year's closings, Murphy noted, "New stores are being agreed upon not just by the real estate people but the operations people as well.

"That needed to be fixed, and it has been fixed."

Executive Profile

Elizabeth R. Culligan, A&P

JOB TITLE:

President, chief operating officer (Promoted to this position in February, Culligan is currently the highest ranking woman in the retail food industry.)

JOB HISTORY:

Joined A&P in January 2001 as executive vice president. Named to board, March 2002.

PREVIOUS COMPANY/JOB TITLE:

Nabisco International, president

QUOTE:

"We don't underestimate the challenge we have ahead of us, but we have made good progress and feel very good about that."

WHAT OTHERS SAY:

"She's very low-key, not razzle-dazzle, but a big piece of the turnaround." -- Meredith Adler, equity analyst, Lehman Brothers

"I'm not sure how much store experience she has, but she talks more sense in retail than most people who have been in retail all their lives." -- Mark Husson, equity analyst, Merrill Lynch