NEW ROLE FOR RANDALLS

ELLIOT ZWIEBACH

HOUSTON -- Randalls Food Markets here has entered a new phase of its corporate life. Having evolved from a small family-owned business to a major local chain and then having acquired the Tom Thumb operation in Dallas to become a major regional player, Randalls took on an investment partner last year to provide it with sufficient funding to continue to grow.

With New York-based Kohlberg Kravis Roberts & Co. as its financial partner and majority owner, Randalls now has greater access to capital. It also has more ability to tap business acumen in its efforts to grow into the next century.

"As a partner, KKR has been very supportive and given us what we told them we would need at the front end of the transaction," R. Randall Onstead, chairman and chief executive officer, told SN, "and the results we're enjoying are a direct result of the good relationship between the board and senior management.

"Having KKR as a partner was a natural but needed step in the history of this company to move from an entrepreneurship to more of a classic corporation, and it's been not only an interesting transition but also a great learning experience for me personally."

With future funding secure, Onstead outlined the company's strategic plans for the next few years: * To add approximately 26 new stores in the next two years as it seeks to boost sales to $3.5 billion by 2000.

To set up a self-distribution system within a year or two.

To consider potential acquisitions.

To evaluate fueling stations and drive-through pharmacies at its new stores.

Randalls operates 115 stores -- 53 in Dallas (under the Tom Thumb name), 50 here and 12 in Austin, Texas. Since acquiring the Dallas operation six years ago, Randalls has been strapped for cash to expand and upgrade in an increasingly competitive environment, prompting the sale of 61% of the company last year to KKR, which also owns stakes in Safeway, Pleasanton, Calif., and Bruno's, Birmingham, Ala. (although KKR does not expect to have any holdings in Bruno's once the retailer emerges from Chapter 11).

Besides providing cash to grow, KKR is teaching Randalls how to operate on a more professional basis, Onstead said.

"We've been exposed to a whole new world of decision-making. You don't know what you don't know until someone points it out to you, and because I've been at one company my whole life, I didn't know how other companies make decisions.

"There's a level of analysis now that didn't exist before. Randalls was successful in the past, but competition now is more intense. By using the tools KKR is supplying, Randalls is able to be a smarter operator.

"KKR is an organization that challenges a lot of the decisions we make, forcing us to do a lot of analysis to help us make better decisions," Onstead said.

"In the family-owned environment of the past, Randalls did not do a lot of analysis. We found a site, did a sales model and then built a store.

"But today we go through those calculations and look more closely at the amount we spend and try to find ways to spend less and still put up the best store we can.

"And we measure the results of our investments over time. KKR asks us a lot of questions that require detailed answers, and they've moved us away from a classic family-run business to more of a corporation with investment requirements, which is good for our shareholders and our employees."

In the area of expense management, for example, Onstead said, "Like any other company today, we're looking for ways to take needless costs out of the business, and there are instances where we're shifting dollars from one area of our operation to another to eliminate costs that don't affect the customer.

"We're looking more at details in every way we can, and when we see an expense we can eliminate without hurting the customer, we take advantage of that."

Onstead declined to pinpoint the amount of savings Randalls is experiencing.

According to Onstead, sales have been stagnant for about three years, hovering about $2.4 billion.

"There hasn't been a lot of change in our sales volume recently," Onstead said, "but we will be adding and remodeling stores to get to our goal of $3.5 billion by 2000.

"That's an aggressive goal, but our new-store development plan is very aggressive, with 13 new stores planned in fiscal 1999 and possibly as many in 2000." The impetus for Randalls' aggressive growth is competitive necessity; the capital is coming from KKR.

When it acquired an ownership position in Randalls, KKR pledged $225 million -- $100 million to help pay down debt from the chain's 1992 acquisition of Tom Thumb and the rest as an initial capital investment.

"KKR has enabled us to achieve a stronger balance sheet and the capital we needed to grow the company," Onstead said. Before KKR's involvement, Randalls was opening one or two stores a year and remodeling five or six, he said. During the past year the company has built three new stores and remodeled 24, Onstead pointed out, "and over the next 12 months we will build 13 new stores and remodel 41."

Asked how much money is available from KKR, Onstead replied, "We have unlimited access to capital -- as long as we can justify the investment. It's more than $125 million -- that was just KKR's initial equity investment, and it has certainly helped. But we have a revolver in place that gives us freedom to spend what we need to."

Onstead said new stores will range from 55,000 to 62,000 square feet. They will be similar to the stores Randalls already operates, with a continued strong emphasis on perishables and service.

"We're not adding any new departments, but the stores continue to change as people change what they buy. So we'll keep the banks and video departments, but it's the perishables departments that continue to do well, particularly takeout foods."

The offerings with which Randalls is experimenting include drive-through pharmacies and fueling stations. Randalls has drive-through pharmacies at five stores -- two in Dallas, one in Austin and two here -- and after a year and a half of evaluation, "we're still looking at it," Onstead said.

The chain expects to add its first gas pumps on the parking lot of a store here and of one in Dallas -- both scheduled to open next month.

"From what we've seen at other companies, fueling stations have a nice return for a relatively small investment, and we think it saves people time," Onstead said. "And it's a nice tie-in for people running errands. It's convenient to customers that are already on the parking lots, and it gives us the chance to take advantage of the traffic flow we already have."

While Randalls has its eye out for potential acquisitions, Onstead said the company expects most of its near-term growth to be organic.

"If something comes along, whether or not it is contiguous, we would certainly look at it because we're not opposed to acquiring something," he told SN.

"But we have a full plate right now, with stores to build and remodel and self-distribution to set up, and we're just trying to grow our business and make it as profitable as we can, so from a timing standpoint, it makes sense for us to focus on what's on our plate."

Onstead said Randalls hopes to be fully self-distributing by mid-1999 -- if it can complete a deal to acquire Food Lion's 1.2 million-square-foot full-service distribution center in Roanoke, Texas, near Dallas.

Until it does, the chain is still buying products from Fleming Cos., Oklahoma City, which has been its wholesaler since 1966. However, it took a giant leap toward self-distribution in July when an arbitration ruling enabled Randalls to break its supply agreement with the distributor. Randalls already self-distributes 40% of its needs, including high-velocity grocery items and all perishables except frozen food.

It operates a 150,000-square-foot perishables warehouse here, plus a 200,000-square-foot dry-grocery warehouse that is being expanded by 350,000 square feet -- a project due for completion early next year. Once it buys or leases a frozen-food warehouse -- or builds one, which would delay self-distribution -- Randalls will have sufficient capacity to service stores in Houston and Austin, Onstead said.

Holding up self-distribution is Dallas, where Randalls has a 300,000-square-foot grocery facility. "Although it's been kept up nicely, it's obviously not large enough," Onstead said, "and it's totally land-locked, so there's no room for expansion."

Earlier this month Randalls signed a letter of intent to acquire the former Food Lion facility to replace the existing Dallas warehouse.

Onstead said Randalls hopes to complete a deal in mid-October that will enable it to lease 900,000 square feet of the distribution center, with self-distribution likely to begin sometime next spring.

Onstead said about 45% of Randalls' sales come from stores in Houston, another 45% from Dallas and the balance of 10% from Austin.

Looking at the company's plans in each operating area, Onstead said the company will concentrate most new-store growth in Dallas and store remodeling in Houston and Austin.

Onstead declined to pinpoint the number of new stores planned for Dallas, 250 miles north of here. "But most of our growth will be in the Dallas-Fort Worth metroplex. It's a growing market, and we want to grow with it," Onstead said.

He said Randalls is also looking at 14 to 20 remodelings in the metroplex this year.

Most new stores will be fill-ins and replacement stores for smaller units or ones that are poorly located, he said.

One new store, which opened in Dallas in August, was the company's second Simon David, an upscale gourmet food store with a long history in the Dallas market. While the original store was relocated early in the summer to a 15,000-square-foot unit, the new store is 50,000 square feet and represents "a more modern version of the original Simon David," Onstead said.

"It's a specialty supermarket that caters to the lifestyle of affluent shoppers," he added.

Randalls' Tom Thumb stores have the No. 2 market position in Dallas, with a 22% share, compared with 24% for Albertson's and 15% for Kroger Co.

Onstead acknowledged that Randalls had some problems consolidating the Dallas division after it acquired Tom Thumb -- problems that were largely resolved when Robert Onstead, Randalls' founder and then-chairman, moved to Dallas in 1996 to serve as liaison between the two divisions. "We've learned a lot since then about how to run a company as a regional chain in multiple markets and how to give a division an identity of its own," Onstead said. The competitive situation in Dallas remains stable, he said, "although Kroger has said it will introduce its [upscale] Signature stores in the Dallas-Fort Worth metroplex. But that's something we anticipated when Kroger combined its Dallas and Houston marketing divisions into a single Southwest region, and we already compete with those stores in Houston."

In Houston, Randalls plans 14 to 20 remodelings this year, after completing 24 last year. Onstead declined to comment on how many new stores it might open here. "Most remodelings are fairly major in nature," he said. "We do whatever we need to do at each store to be more competitive, usually within the existing four walls. It can involve anything from a simple paint job to gutting the store completely."

Randalls has the second-largest market share here with 23%, compared with 27% for Kroger, 15% for H.E. Butt Grocery Co./Pantry, 14% for Fiesta Mart, and 6% for Albertson's, a relative newcomer here.

"There are so many competitors here because of the strong economy and the large population base," Onstead said. "Additionally, land is easy to obtain, so there are opportunities for growth. And the economy will be vibrant for some time to come, so the market dynamics are all here."

While the majority of its stores here are designed to cater to a broad spectrum of shoppers, Randalls also operates 10 stores under the Flagship name that cater to consumers in the city's most affluent neighborhoods.

The local market remains fragmented, Onstead said, "and it will probably stay that way for a while. Not much is changing, except the ethnic population has become the fastest-growing segment here and it continues to grow.

"Kroger and H-E-B/Pantry pick up some of that business, but no one does as well with that segment as Fiesta."

According to Onstead, Kroger, with its Signature stores, and Randalls tend to draw a more affluent customer base -- the segment that Albertson's is also targeting at some of its newer locations.

In Austin, 150 miles northwest of here, Randalls' goal is to upgrade its stores, Onstead said. "There are some growth opportunities but not as great as in the bigger cities, and there are still some stores there we need to replace or remodel before we look at opportunities for new locations." Onstead said Randalls plans three or four remodelings this year in Austin -- a market that H-E-B dominates with a 60% market share, followed by Randalls with 18% and Albertson's with 15%.

"Our share is pretty stable there, though we have fewer stores than we used to," Onstead said.