DALLAS -- Fleming here said last week it is trying to work out some "kinks" in its new distribution arrangement with Kmart -- "kinks" it said developed during the final days of a contract under which both Supervalu and Fleming were supplying Kmart's supercenters.According to Bill Marquard, Fleming's executive vice president, business development, "We're still working out some kinks. We were surprised

DALLAS -- Fleming here said last week it is trying to work out some "kinks" in its new distribution arrangement with Kmart -- "kinks" it said developed during the final days of a contract under which both Supervalu and Fleming were supplying Kmart's supercenters.

According to Bill Marquard, Fleming's executive vice president, business development, "We're still working out some kinks. We were surprised by the gaps the previous supplier left. A company should service its accounts up till the last day of a contract, and we're still trying to fill some of those gaps."

Officials at Minneapolis-based Supervalu could not be reached last week to comment on Marquard's remarks.

Kmart became the sole supplier for foods and consumables for Super Kmart on June 30, the day the shared supply contract with Supervalu expired. During the first 10 days of July, Fleming shipped 28 million cases of product to Kmart, up from 15.4 million cases in last year's second quarter, Marquard said.

Marquard made his comments during a conference call following release of Fleming's financial results for the second quarter and first half ended July 14.

In other conference call highlights:

Marquard said Fleming is moving into the next phase of its Kmart supply agreement -- developing best practices.

Mark S. Hansen, chairman and chief executive officer, said Fleming is testing a new merchandising approach at two Yes!Less stores that combines a limited assortment format with a dollar-store concept.

Sales rose 5% to $3.5 billion for the 12-week quarter and fell 0.08% to $7.6 billion for the half, following the sale or closing of the last group of corporate-owned conventional stores. Net income -- excluding strategic plan charges and one-time items -- jumped 59.7% to $22.4 million for the quarter and 52.9% to $39.6 million for the half.

Hansen said the quarter marked Fleming's official debut as the nation's largest wholesale company, with sales in its distribution segment up 16.4% to $2.9 billion for the quarter. He said about half that growth was attributable to incremental Kmart business and half resulted from continued growth among other customers.

Hansen also said Fleming added more than $650 million in gross annualized new business during the half.

Sales in Fleming's retail segment dropped 33% to $510.6 million during the quarter following the sale or closing of the last 50 conventional stores. Hansen said Fleming has sold or closed all 237 of its conventional stores since the first quarter of 1999 as it has sought to concentrate on price-impact formats.

Comparable store sales rose 1.3% during the quarter.

Gross margins fell 104 basis points to 22.29%, reflecting the company's lower overall pricing position at its Food 4 Less and Rainbow Foods stores, Hansen noted. However, he said the drop was more than offset by a drop of 350 basis points in selling and administrative expenses.

Hansen said Fleming anticipates annual growth of 3% to 4% in its distribution business -- "though we'll always try to do better than that," he noted -- and annual topline growth of 3% to 4% a year, excluding Kmart.

Marquard said Fleming and Kmart are ready to move beyond basic blocking and tackling to begin the second phase of their partnership -- developing best practices.

Toward that end, he said Kmart is moving its foods and consumables merchandising team to Fleming headquarters here "to facilitate coordinating decisions," while moving its own accounts team to Kmart headquarters in Troy, Mich. Fleming is also working with Kmart to integrate item forecasting, new item setups, communications and supply-chain operations to increase profitability, he said.

In other Kmart developments:

Fleming is expanding the lines it distributes to Kmart to include cigarettes and tobacco, Marquard said.

Fleming expects to begin discussions with Kmart this month about supplying general merchandise items to the supercenters, Hansen said.

Hansen also said Fleming is in the process of replacing Kmart's American Fare brand with its own Best Yet line, "and we're seeing unbelievable results in private-label sales, with volume metrics beyond our expectations."

With regard to Fleming's Yes!Less limited assortment chain, Hansen said the company is testing a new approach at two Dallas-area stores in which it's bundling a limited assortment stock-up format with the end-of-the-month convenience of a dollar store, "and we're getting customers who see Yes!Less as a first choice store -- they shop there first, then fill in elsewhere."

According to Hansen, the dollar-store industry is a retail category many suppliers underestimate, although statistics indicate 43% of need-driven shoppers -- those with annual incomes below $35,000 -- shop at dollar stores.

"This is an emerging format that complements our Yes!Less stores, and this is the kind of business we believe will continue to replace the stagnant, declining conventional store business as it aligns itself with where consumers want to buy product," Hansen said.

Fleming plans to develop a franchise model for Yes!Less, he added.

Other highlights of the conference call included the following:

Fleming sees opportunities to expand its business outside traditional growth channels, Hansen said.

Although he said he believes Fleming has opportunities to work with self-distributing chains in the areas of perishables, general merchandise and specialty foods, "those companies fall into a segment of traditional supermarkets that are stagnant, with limited growth prospects," he said. "Their growth is coming in areas like fuel and pharmacy, not consumer packaged goods. Drug stores, dollar stores, supercenters and discount stores are areas where we are focused.

"However, we could offer a package of services for any conventional supermarket chain with self-distribution that would improve their results."

Fleming became the primary supplier for 10 additional Target supercenters late last month, in addition to 17 Target supercenters it already serves as a primary supplier and 11 it serves as a secondary supplier.

Hansen said Fleming sees "tremendous opportunities" in the convenience store area. "That could be a $45 billion market for us. Our national footprint enables us to become the second largest [convenience-store] supplier nationally, behind only McLane."

Fleming has identified approximately 10 of the Furr's Supermarkets it is acquiring in New Mexico and west Texas for conversion to one of its price-impact formats, Hansen said.

Fleming's move to centralization is substantially complete, he noted, with 80% of total procurement needs obtained centrally and 20% locally.

Fleming realigned its retail stores during the second quarter to coordinate with its central procurement operations -- a move Hansen said is expected to reduce product costs further and provide unique merchandising opportunities.

"By aggregating our existing sales with incremental volume, our centralized procurement team could negotiate even more effectively," he said. "At the same time, our warehouse operations teams leveraged the higher volumes to lower overall warehouse labor costs per case, improve productivity and increase efficiencies."

Fleming began distribution during the first half of 200 stockkeeping units of its new value-brand store label, Exceptional Value, with another 70 SKUs in development, Hansen said.