SMITH'S HEADS BACK HOME

ELLIOT ZWIEBACH

SALT LAKE CITY -- After a year of upheavals, Smith's Food & Drug Centers here is endeavoring to travel the road to normality.

Having exited southern California, doubling its size in Arizona and undergoing a financial recapitalization that left it highly leveraged, the 148-unit chain now is trying to bolster its sales base under new leadership.

Al Rowland, named president and chief operating officer in February, told SN that the biggest challenge for Smith's is to recover sales and market share lost over the last few years when the company focused most of its energies on its doomed southern California stores.

One major change for Smith's was the merger earlier this year with Smitty's Super Valu, Phoenix, a unit of Yucaipa Cos., a Los Angeles-based investment group. In the process, Ron Burkle, Yucaipa's managing general partner, was named Smith's chief executive officer.

Rowland said Smith's plans to grow its business by concentrating on marketing and store expansion in its core markets: Utah, Arizona, New Mexico and Nevada.

"Putting a large portion of capital expenditures into California meant we spent less in our core markets, and in the process we lost share," Rowland told SN. "But now, with our exit from California, we have a real opportunity to focus on our growth markets."

Smith's decision a year ago to drop its Ad Match program in Phoenix -- in which it met the lowest prices in competitors' ads -- squeezed sales, he acknowledged. "We knew that move would hurt sales, but we wanted to pursue our own marketing program. And we felt Ad Match was not an appropriate program for us to pursue going forward." Rowland said his goals to strengthen sales include the following:

Spending 12 to 18 months making Phoenix shoppers comfortable with Smith's acquisition of Smitty's Super Valu before converting all the Smitty's stores to the Smith's banner.

Using distribution synergies achieved from the addition of Smitty's to fund promotional efforts in Smith's core markets, while also seeking acquisitions in those areas.

Continuing to expand category management over the next two years.

Grouping home-meal replacement items together within each department, after a five-store test here resulted in sales hikes exceeding 25%.

Smith's 148 stores are in the Southwest: 58 in Arizona (30 existing stores, 28 former Smitty's); 35 in Utah; 22 in Nevada; 19 in New Mexico; five in Idaho; five in Wyoming and four in west Texas. Last year, Smith's sales rose 3% to $3.1 billion. Same-store sales have lagged but are improving -- from a 3.4% decrease for 1995 to a 2.7% drop in this year's first quarter and a 0.9% dip in the second quarter.

During the merger with Smitty's, Smith's did a financial recap in which it repurchased 50% of its common stock, resulting in about $1.4 billion of debt.

According to Rowland, the high leverage means Smith's must pay closer attention to how it spends its money. "What the high leverage does, frankly, is it forces us to do what we would have done anyway, which is to give more thought to all capital expenditures and pay closer attention to return on investment."

As a result, he said, capital expenditures will be cut by more than half this year to $60 million -- compared to $149 million in 1995 and $147 million in 1994 -- and the annual rate of expansion will be slowed to just eight new stores a year instead of 15. "And we have to consider ROI in every area of expense," he added.

Before joining Smith's, Rowland worked 25 years for Albertson's, Boise, Idaho. Yet he does not intend to "Albertson-ize" Smith's. "Doing that would take away some of the character of Smith's, including the larger stores, greater selection and variety of in-store services that appeal to Smith's shoppers," he noted.

However, he said he hopes to combine the best of what Smith's does with the best of what Albertson's does.

"We have the opportunity to take the things I learned in my previous environment, leverage them against Smith's strengths and hopefully end up with the best of both," Rowland explained. "One of Albertson's greatest strengths is its attention to detail and execution. And what always impressed me about Smith's, even when I was a competitor, was its focus on market share and protecting its turf aggressively.

"So if we can combine those strengths of Smith's with Albertson's disciplines, we have the opportunity to leverage both companies' expertise in a very positive way."

Observers attributed the failure of Smith's California entry to external forces, such as the recessionary economy that plagued the area for the past five years, and to internal problems, including high shrinkage and a lack of good locations in concentrated areas.

The 34 California stores accounted for roughly $675 million in sales. Since leaving the market at the end of 1995, Smith's has sold 18 locations to competing supermarket operators and five others to nonfood operators. This fall, Smith's expects to move "a significant number of properties" in a sealed-bid auction designed to sell the remaining 11 store locations and 22 pieces of real estate, Rowland told SN.

Smith's hurt its overall same-store sales, in large part, by devoting too much attention to the California units, according to Jonathan Ziegler, a securities analyst at the San Francisco office of Salomon Bros.

"They took their eye off the ball with California, but they have the ability to turn it around now that California is no longer an issue," he said.

Debra Levin, an analyst at Morgan Stanley, New York, said Smith's same-store sales are currently running flat, "but they're still significantly below the industry average of 2.5% growth." She attributed the declines to heavy competitive activity in Phoenix, which she said remains overstored, and in the Salt Lake City area, where Fred Meyer, Portland, Ore., has opened additional stores and added grocery offerings to existing units.

Observers expect the combination of Smith's and Smitty's in Phoenix to remove some of the overstored nature of that market. Rowland said Smith's has sold one of three Smitty's in Tucson to a nonfood operator and has converted the other two locations to the Smith's banner. The company plans to operate the 25 Smitty's in Phoenix under the existing banner for a year to 18 months, he said, before converting them to the Smith's name.

"It's my experience that the most difficult challenge in any acquisition is to maintain sales volume," Rowland explained. "We always hear the same thing from customers in these situations: Don't change my store. Right now, we're running dual-banner ads in Phoenix, and we want customers to become comfortable with the fact that Smitty's and Smith's are the same company before we make a name change.

"There's certainly no magic to changing the name. But we want to continue to survey customers at both store groups to determine when they will accept a change, and once we feel they will, we'll do the conversions all at the same time."

Because several of the Smitty's stores are roughly 100,000 square feet as opposed to the current Smith's prototype of 55,000 to 65,000 square feet, Smith's may downsize some of the larger units by erecting walls and subleasing the excess space to other operators, Rowland said.

Despite the store-size differences, the product mix at the two companies is very similar, "although Smitty's probably carries more nonfood lines than we do," he noted.

"So we will continue to rationalize the product mix at the two store groups, to identify lines and items that are generating the most profit, with the goal of continuing to carry those lines and eliminating others."

According to Levin, Smith's must find the right product mix to achieve synergies between the two operations. "As Smith's gives up some of the general merchandise that Smitty's carries, the challenge will be to keep the same sales and profitability at those stores," she said, adding that Smith's goal is to capture $32 million in synergies, with $7 million earmarked for heavier promotions or lower prices to keep its stores competitive.

Although the Phoenix division of Fleming Cos., Oklahoma City, had been Smitty's major supplier, Smith's has already taken over supplying the Smitty's stores in all categories except groceries, Rowland said. "And we're negotiating that point with Fleming now, and within a year we anticipate we will supply 100% of Smitty's needs," he added.

Smith's is supplying the stores out of its 1-million-square-foot Tolleson, Ariz., distribution center, which Rowland said "has the capacity to supply our stores and all of the Smitty's, without requiring any backstage capital expenditures, for at least five years." The Tolleson facility, which with the Smitty's stores now supplies 90 units, can handle 100 stores easily, up to a maximum of 130 stores, he noted.

Before the merger with Smitty's, Smith's had expanded primarily by building new stores. Rowland said the company anticipates pursuing acquisitions in its core markets -- Utah, Arizona, New Mexico and Nevada. Each is a growth area, he said, "and each has a projected growth rate above the national average in terms of population and jobs, plus nice geographic diversity, so we don't have all our eggs in one basket."

Smith's is not participating in any ongoing discussions about acquisitions right now, Rowland said. "But there are potential opportunities in each area, and we will continue to watch the market for potential acquisition candidates," he added. "And we're confident that, with the Yucaipa connection, if we find an appropriate acquisition, we can finance it." Yucaipa also controls Ralphs Grocery Co., Compton, Calif., and Dominick's Finer Foods, Northlake, Ill.

Another advantage of its Yucaipa connection, Rowland said, is that Smith's participates in a Best Practices forum with Ralphs and Dominick's "that gives us the opportunity to leverage the potential buying power of all the companies combined.

"It also gives us a chance to benchmark our costs of goods and other expenses with the other organizations and to take advantage of the marketing and management expertise of all the groups."

And Smith's can use any edge it can get. In late July, competition in its Utah home market heated up with the opening of two SuperTarget supercenters, and more units are expected in the coming months.

Yet Rowland said he does not look at supercenters any differently than supermarket competitors. "They have the same or less impact than a good competitive supermarket opening in the same area," he said. "But if we do a good job in our own operations, we can recover any business we might lose."

The first two SuperTargets in the area opened in Centerville and Fort Union, Utah, the latter a suburb of Salt Lake City. The supercenters probably affect five Smith's stores, Rowland said, and a third SuperTarget in South Salt Lake City scheduled to open later this year would affect two more stores.

He said he regards all outlets that sell food as competition. "We are in the consumables business, and we continue to watch the market and identify items that are selling, then adding the ones that are natural extensions of the departments we operate or that are growing in frequency of purchase."

Among those components are home-meal replacement items. Although Smith's has sold meal offerings for several years, it began grouping them together in all store departments earlier this year in a five-store test in Salt Lake City to make it easier for customers to identify them. Offerings include heat-and-eat items in the meat department and service deli, value-added items in produce and quick meals in the grocery section. Rowland said the program went companywide in midsummer after movement at the test sites improved more than 25%

Virtually all Smith's stores operate with an identical combination store format, except four of its 16 Las Vegas-area stores, which operate under a price-impact format called PriceRite Grocery Warehouse. Rowland said the company expects to open at least one or two more warehouse stores in areas outside Nevada in the next few months.

"We don't see warehouse stores as a huge part of our operation, but we are pleased with what we have seen and view it as a viable format going forward."