COMMITTED TO RETAIL

GRAND RAPIDS, Mich. -- Spartan Stores is very serious about retailing."We're not looking at retail as a way to support our distribution business -- we're looking at how we can be successful as a retailer," James Meyer, president and chief executive officer, told SN.In just two years, Spartan has transformed its business from a member-owned cooperative with no retail involvement to a public company

GRAND RAPIDS, Mich. -- Spartan Stores is very serious about retailing.

"We're not looking at retail as a way to support our distribution business -- we're looking at how we can be successful as a retailer," James Meyer, president and chief executive officer, told SN.

In just two years, Spartan has transformed its business from a member-owned cooperative with no retail involvement to a public company doing almost 40% of its volume in corporate retail -- and Meyer said he isn't willing to put limits on how much the retail segment can grow.

"We have no predetermined pace of growth," he explained. "We plan to grow retail in a fashion that lets us fully integrate each new company we acquire and make sure it's working properly before we proceed.

"But we're not playing a numbers game where we're trying to achieve a particular number of stores or a specific percentage of total sales in retail," Meyer said. "Our No. 1 goal is to be successful in running the stores we own and servicing the stores we supply."

Spartan's commitment to retail is so strong that it was willing to lose its largest customer last year rather than alter its game plan.

That customer was D&W Food Centers, a 26-unit chain based here whose sales through Spartan totaled about $130 million, or 4% of Spartan's total volume. D&W decided it didn't want to buy from a distributor who was also a retail competitor, and in November it moved its wholesale business to Supervalu.

Meyer said Spartan was able to make up the 4% shortfall through a series of cost-cutting measures, improved efficiencies and an aggressive marketing effort.

Spartan doesn't anticipate any further defections, Meyer added.

"No one else has articulated that kind of dissatisfaction," he pointed out, "and there are no indications we're about to lose another customer, though it could happen. We have strong relationships with all of our larger customers, and none of them is likely to make a move.

"But even if our strategic direction costs us additional business, we believe this is the right way to go."

Gary Giblen, senior vice president and director of research for C L King Associates, New York, said he believes Spartan's retail commitment is solid. "For many food wholesalers, corporate retailing is a necessary evil, except that some companies make it better than an evil and turn it into a growth business, and Spartan is one of those.

"And while some wholesalers talk about corporate retail, they haven't really resolved the issues of potential conflict with independent customers, whereas Spartan is more blunt about it. The fact D&W left indicates Spartan is willing to accept short-term setbacks to fulfill its clear commitment to retail."

In August, Spartan made its biggest retail acquisition yet when it purchased Seaway Food Town, a 73-store chain based in Maumee, Ohio.

According to Meyer, Spartan's immediate goal is to complete the integration of Food Town before seeking additional acquisitions -- although its imminent purchase of Prevo's Family Markets, a 10-store chain based in Traverse City, Mich., indicates Spartan can be flexible if an opportunity arises.

Looking at the long-term future, Meyer said the company's goals include the following:

To double total sales to $7 billion by the end of fiscal 2005 through acquisitions and internal growth initiatives.

To create a virtual chain by strengthening value-based promotional and marketing programs at its corporate stores to enhance sales and earnings for all customers.

To hold onto its volume base by offering an exit strategy to its independent customers.

To utilize the former Food Town distribution center in Toledo, Ohio, as a base from which to expand its wholesale business.

Spartan is an 83-year-old wholesaler serving 118 corporate stores in Michigan and Ohio; 350 independent customers in Michigan, Ohio and Indiana; and 9,600 convenience stores in a nine-state area (Michigan, Ohio, Indiana, Illinois, Kentucky, Pennsylvania, Tennessee, Georgia and West Virginia).

It operates three supermarket distribution centers -- a 1.5-million-square-foot full-service facility here; a 400,000-square-foot dry grocery warehouse in Plymouth, Mich.; and the 750,000-square-foot warehouse it acquired in the Food Town deal that it uses for general merchandise -- "all of which have plenty of room for us to grow," Meyer said.

The company also operates three convenience-store distribution centers in Columbus, Ohio; Louisville, Ky.; and here.

According to Meyer, Spartan's corporate and independent customers control the largest portion of food sales in Michigan, with a 22% market share, compared with 17% for Meijer, also based here, and 12% each for Kroger and for A&P's Farmer Jack.

Corporate stores account for 38% of Spartan's sales, independent distribution also accounts for 38% and convenience stores account for the other 24%.

The corporate stores were not part of the mix before 1999. But surveying the industry landscape in 1998, Spartan decided it had to move into corporate retail or be forced out of business.

"Looking at all the consolidation that was going on in the industry, our board asked itself where Spartan would be if we maintained our historic position of not owning and operating stores," Meyer recalled. "Considering the size of some of our customers, the board didn't see us having the wherewithal to pick up many more large customers, and if our member stores went up for sale, it knew someone else would buy them and we'd lose that business and shrink our sales base. So the board decided we should begin moving into retail."

Industry analysts told SN they believe that decision will extend Spartan's life as a going corporate concern.

According to Chuck Cerankosky, an analyst with McDonald Investments, Cleveland, "Scale matters a great deal, and with consolidation among retailers and wholesalers continuing, companies that can get bigger can do more things with greater levels of efficiency.

"Without its retail strategy, Spartan would not have been able to survive for the long term. But retailing gives it an avenue to grow value for its shareholders."

Giblen expressed a similar thought. "With its new strategy, Spartan probably picked up a new lease on life that's good for at least five years," he said. "Without that strategy, it could have continued to operate for several years, though probably in a declining mode. But now it can grow and build value in the company.

"And it still has a lot of room to continue to do what it's doing for several years."

Meyer told SN he does not expect Spartan to become a consolidation candidate for another buyer. "Of course, if a proposition is presented, we would evaluate it as we would any potential opportunity, but our intention is to do the best job we can for our retail customers, with no focus on selling the company."

Meyer said Spartan was aware of the potential challenges posed by entering corporate retail. "Our board realized from Day One that we might run into a situation where we were at cross purposes with a customer, but that scenario did not make us back away because we realized a move into retail was imperative and would be beneficial to our shareholders."

Over a 20-month period beginning in early 1999, Spartan acquired four store groups from its customer base: Ashcraft's Markets in central Michigan in January 1999; Family Fare Supermarkets here in March 1999; Glen's Markets in northern Michigan in April 1999; and Great Day Food Centers here in December 1999, for a total of 46 locations. All are conventional neighborhood stores averaging 40,000 square feet.

In August, it acquired Food Town, which had not previously been a Spartan customer. Food Town was a publicly traded chain of 73 stores -- including 47 supermarkets and 26 food-and-drug combination stores (one of which Spartan closed) -- in southeastern Michigan and northwestern and central Ohio with annual sales of approximately $650 million.

That acquisition transformed Spartan from a member-owned coop into a public company and boosted Spartan sales on a pro forma basis to $3.05 billion for the fiscal year ended in March 2000.

Sales for the current year, which ends March 31, will be about $3.5 billion, Meyer said, with comparable store sales rising about 5.8%. He said earnings are expected to increase $1.25 to $1.30 per share to nearly $3 -- ahead of analyst predictions of $1.18 per share -- and earnings before interest, taxes, depreciation and amortization are expected to rise about 3%, up from 2.6% a year ago.

Meyer said he attributes the sales hike to the company's marketing program, plus a 1% boost following the move from a six- to a seven-day operation at 16 units of Family Fare and Great Day in the Grand Rapids market.

Still pending is the acquisition of Prevo's, which will add about $50 million to Spartan's corporate sales base. Meyer said the acquisition is expected to close this month.

As it continues to grow its retail sales base, Spartan believes its position as a wholesaler gives it an edge in lining up potential acquisition candidates, Meyer said. "As independent customers make the decision to go out of business, we feel we're uniquely positioned to capitalize on that to build our retail segment," he explained.

Spartan's goal is to make its corporate stores function as a chain, Meyer noted -- retaining the existing name on each acquired group but bringing improved efficiencies and technology to those operations, and also to its independent customers' stores, to reduce costs and strengthen operations.

"Part of our retail marketing network approach is to make our store base larger than it is by operating like a self-distributing chain, with a combination of corporate stores and independent stores owned by different retail operators," he said.

Most corporate stores have a conventional format, with a high-low promotional approach that positions them as alternatives to supercenters, Meyer said. "That's the business we know, and we will stick to it," he declared.

However, a potential area for format growth could come from The Pharm, the food-and-drug combination stores with an everyday-low-price format that were acquired in the Food Town deal. Those stores, which average 29,000 square feet, have an increased focus on nonfoods and seasonal merchandise, although 90% of the stockkeeping units are identical to a conventional store, Meyer said.

"We're learning how to make purchasing decisions to support those EDLP operations, and we're also studying the format with an eye toward converting existing stores or building new ones," he explained.

However, he said the company isn't ready to reveal its long-range plans for The Pharm format yet.

"Right now our capital dollars are focused on acquisitions. With our consolidation effort as vibrant as it is, we want to be able to take advantage of that, so we're not looking at organic growth on the supermarket side, at least through the next fiscal year. But a couple of years out, we might be ready to commit capital to new stores."

Some of the money for acquisitions will come from a $100 million shelf registration that Spartan filed in January, intended to enable the company to replace $15.3 million of outstanding unregistered promissory notes and provide flexibility for additional financing needs.

Meyer said he sees the Great Lakes region as Spartan's prime target area for retail growth "because with the infrastructure we have in place, we believe we can leverage ourselves in that area to a greater degree than we do today.

"And we think it makes sense to grow in concentric circles instead of in a patchwork quilt pattern across the U.S. -- though if the opportunity presents itself and fits within our distribution capabilities, we would look at expanding our geographic base."

Spartan's acquisition criteria include stores than will add 5% to 10% to top-line growth annually and be accretive to earnings within 12 to 24 months, Meyer said. "We want good stores -- the No. 1 or No. 2 operator in each marketplace -- because we are not turnaround experts," he explained.

Giblen said he believes geography is working in Spartan's favor as it seeks to expand corporate retail. "Other than Meijer, its wholesale customers don't have a lot of chain competition, and they tend to be the best operators in their towns, so as some of them decide to sell their businesses, Spartan will be able to pick up some very successful operations and then make them more efficient in their backstage operations."

Food Town had a good consumer franchise, Giblen added, "but it was not efficient in backstage operations, and that's something Spartan is able to add to those stores."

The Toledo distribution center that Spartan picked up in the Food Town acquisition is south of Spartan's traditional marketing area in Michigan and may provide a platform for the distributor to seek greater geographic diversity, Meyer noted.

"It's possible we could use that facility to expand our wholesale reach, though that's not a goal until we align our store systems. But we believe that facility provides an opportunity for us to make contacts with other companies that could enable us to grow our wholesale business at the same time we're growing our retail business," he said.

Spartan had considered building a warehouse in northwest Ohio prior to the Food Town deal, Cerankosky pointed out, "and it even purchased the land. But now it has the real thing. And while it will continue to make smallish retail acquisitions like Prevo's, it can be more efficient at leveraging its distribution capacity if it can attract additional wholesale business."

Although Spartan plans to keep its eyes peeled for additional acquisition opportunities, Meyer said its primary short-term goal is to complete the integration of Food Town "because it's imperative that we have a successful integration before we go on to seek other deals.

"If an opportunity presented itself, we would certainly consider it. But if we stub our toe with Food Town, then our goal to be a viable acquirer of additional retailers would be significantly damaged, so our preference is to get Food Town behind us before we add to our otherwise full plate.

"But the acquisition of Prevo's demonstrates that we won't let ourselves be sidelined if an opportunity comes along, though we would proceed cautiously."

Spartan expects to begin seeing synergy savings from the Food Town integration during the next fiscal year, Meyer said -- savings that are expected to total $6 million by March 2002.

"To achieve those savings, we need the Food Town integration to be completed. We've already acquired and integrated four other customers, so we have a good understanding of what we need to do -- although the systems integration with those four was modest because they were already using the same systems."

Spartan has already completed the installation of its payroll systems and centralized perishables procurement for the Food Town operation, with centralized grocery systems expected to be integrated by the end of this month and new front-end systems scheduled for installation at all Food Town stores by September, Meyer said.

The integration of Food Town is on target, he added. "We're seeing positive sales trends as we move our marketing programs in, and we've improved the stores' in-stock position, which has also led to sales increases," he said.

Meyer said Spartan is taking the opportunity, while it integrates Food Town, to simultaneously consolidate purchasing for all segments -- retail, wholesale and convenience stores -- through its corporate offices.

As with its previous acquisitions, Spartan intends to make few changes in the Food Town operation, Meyer noted. "There's some merit in putting our own stamp on the stores, not just to make them similar but also to show we are fully committed to them," he explained. "But because each store group operates in different markets, there's no common footprint."

According to Cerankosky, "Spartan's stores operate in very different demographic areas, from the upscale suburbs of Toledo to more rural settings in Michigan and Ohio, and what it's ultimately trying to do is address those differences while finding economies of scale in distribution, administration and private label that can improve margins for the entire company."

Meyer acknowledged there are definite differences in merchandise selection at each store group, "but one thing we're pursuing in the retail division that can be beneficial to all our operations is putting in a premium private label line," he said.

Spartan is establishing a three-tier program for corporate and independent customers, consisting of Home Harvest, a value line; Spartan, a quality line; and Bayberry Farms, a new premium line.

Spartan introduced Bayberry Farms at Thanksgiving, using the label for fresh turkeys, meats and delicatessen items. While the label appears on only a handful of products currently, Meyer said Spartan plans to expand it to 100 to 200 items over the next few years in a variety of fresh and packaged products.

Besides introducing the premium label, Spartan has also been upgrading perishables and grocery offerings at its corporate stores, with the intent of rolling those programs out to its independent customers, Meyer said.

Spartan is also changing, he said, its direct-store delivery receiving practices, adopting a system that was used by one of the acquired store groups and is now being rolled out to additional corporate stores, "and it will eventually be made available to independent customers as well," Meyer pointed out.

Spartan also plans to modify its marketing effort by making adjustments in the loyalty card program that Food Town, Glen's and Prevo's offer "so the card will be universally accepted across all of our corporate stores," he said.

As it becomes more involved in retail, the ways Spartan traditionally looked at distribution are changing.

"As a retailer, we understand that the focus for our corporate stores and those of our customers needs to be on the sell rather than on the buy, and we've brought to center stage the fact that we don't make money till the product moves out of the front of the store," Meyer said.

"So we recognize the need for us as wholesalers to do what we can to help our customers sell merchandise because we're living it as retailers ourselves. We're no longer sitting with customers in a consulting role -- now we operate every day just like they do, and that helps us in talking with customers."

To reinforce its retail focus, Spartan has hired executives with retail experience to run its retail operations, rather than promoting people with wholesale backgrounds, Meyer said.

"We've assembled a group of people, some with retail experience at Spartan but others whose careers have been primarily in retail elsewhere, and empowered them to come back to people on the wholesale side and say what is and isn't working," he explained.

Those people include Dave Staples, executive vice president and chief financial officer, who came to Spartan from Kmart Corp., Troy, Mich.; Joel Barton, executive vice president, sales and marketing, from Raley's Supermarkets, Sacramento, Calif.; Sally Lake, vice president, marketing, who came up within the Spartan organization; Rick Corbitt, vice president, finance, for the retail division, from Kroger Co., Cincinnati; Ross England, vice president, store operations South, for the retail division, from Raley's; Gary James, vice president, Spartan retail store operations, from H.E. Butt Grocery Co., San Antonio; Sheridan Lewis-Rardin, vice president, food service operations, retail, also from H.E.B.; and Pat Kameen, treasurer, from Geisinger/Servistar, a hardware company.