United Natural Foods, Inc.
Q4 2014 Earnings Call Transcript

Published: 18 Sep 2014

[Operator:]

Greetings, and welcome to the United Natural Foods Fourth Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) I would now like to turn the conference over to your host, Hunter Wells of ICR. Please go ahead.

[Hunter Wells:]

Thank you, operator, and good afternoon, everyone. By now, you should have all received a copy of the fourth quarter and full-year fiscal 2014 earnings press release issued this afternoon at approximately 4

[Steve Spinner:]

Good afternoon, and thank you, Hunter. Joining Mark and I this afternoon in Sacramento, California are Karl and Scott Berger, who are the Co-Presidents at Tony's Fine Foods, our newest member of the UNFI family. Fiscal 2014 was a very successful year, highlighted by continued revenue growth of over 12% and operating income growth of over 13%. Looking back over three years on a compounded basis, revenue has grown almost 15% and operating profit has grown almost 18%. These results have been highlighted by a team of approximately 8,700 associates driven towards connecting farms and manufacturers to retailers and families. Today, UNFI’s products and services are close to every market throughout the United States and Canada. From organic produce, natural supplements, ethnic specialty and commodity organic to perishable specialty, e-commerce, non-GMO brands, natural proteins, specialty cheese and private label production across frozen, refrigerated and dry, UNFI is extremely well positioned to grow in an industry dominated by high demand and a very strong future. With our almost 15% compounded annual growth rate, creating optimal capacity is of the utmost importance. Anticipating strong demand over a three-year timeline, UNFI launched an aggressive construction schedule which delivered two new centers in fiscal 2014. Racine, Wisconsin is now online and Hudson Valley in New York is now receiving inventory. During fiscal 2015, we will begin shipping from Hudson Valley, serving the New York City metropolitan area and our UNFI Twin Cities facility in Prescott, Wisconsin serving Minneapolis and St. Paul, Minnesota. These facilities provide us with the ability to address capacity issues, grow with new and existing retailers, bringing us closest to the consumers and reduce our miles driven. In our business, managing distribution expense is critical, and having distribution centers close to the customer provides us with a very unique position as the low-cost, high service provider. There are significant upfront costs to open these buildings, including recruiting, hiring, training and receiving, all before a case is shipped. Additionally, when we see volume from an existing facility into a new facility, we temporarily have two buildings operating at less than ideal efficiency. This is a phenomenon that lasts approximately six to 12 months. Expense drag associated with building openings and volume shifts during the fourth quarter was approximately $2.5 million and we anticipate that this phenomenon will continue at a rate of approximately $12 million in fiscal 2015. But despite the short-term impact associated with our construction strategy, in the long-term, UNFI will be in a terrific position to compete for new business, service our retailers and run our network in the most efficient and closest to the customer structure. During fiscal 2014, we continued to make significant progress in our supply chain transformation known as Thrive. Our business and technology teams have been successfully implemented new solutions that support our one company goal and provide us with increased efficiencies across the enterprise. Now three years in, we have a fully implemented national transportation management system, a national procurement system that is fully implemented in the West and will be completed in the East by the end of the second quarter of fiscal 2015, a national warehouse management system that is integrated into both of our business systems and now deployed in five DCs across the country with several planned for fiscal 2015 and a national data warehouse. As we continue our transformation efforts, our focus remains on our customers and our suppliers. In the long term, we are building a company that has robust processes and enabling technologies that allow us to be easier to do business with and supports the continued growth of our industry. For perspective, during fiscal 2014, we converted two existing warehouses to our warehouse management system and brought two new distribution centers online. Additionally, the implementation of our national procurement system in our Western Region increased service level approximately 4%, while reducing overall inventory by 4.7%. Our Eastern Region systems began conversion during the fourth quarter and will be completed by the early second quarter of fiscal 2015. We've also been busy implementing several new customer facing technology improvements. iUNFI, our mobile order entry solution, continues to offer our customers superior intelligence in the aisle, with added real-time information on product status and relevant promotions. This translates into higher fill rates for iUNFI customers over most other ordering methods. This is of key importance for all customers, particularly our independents. So we extended this capability to the Android platform so more of our customers can benefit from this business boosting intelligence while making their replenishment decisions. We now have over 2,000 units deployed. We also launched our new customer portal, which offers new and improved functionality for our customers such as search capabilities, order entry, new item introductions and industry news, just to name a few. We are also committed to further streamlining our services with suppliers to make it easier to do business with UNFI. We've built out a new supplier portal platform and we'll be rolling it out to suppliers early this year. Also, our customers told us that being able to know when their estimated time of delivery will be is extremely important. In response, we developed UNFI Arrive which allows customers to access real-time delivery information for their specific location. This exciting new program is now in test and we look forward to rolling it out across the country. E-commerce is also an area UNFI has been investing in. Since acquiring Honest Green two years ago, we have been building out our service offering to provide our customers every option for delivery, whether to store for retail, to store for consumer or to consumer directly on behalf of our customers, UNFI is building out its infrastructure to support this important and growing channel. By the third quarter of fiscal 2015, UNFI will have approximately 15,000 products available online with complete digital images and standardized attributes through three primary distribution centers across the U.S. We have also had considerable success managing our inbound freight, which improve service level and reduce costs. During fiscal 2014, our utilization of intermodal movement by rail grew over 50% to almost 10,000 loads, which in general, is a much more cost effective solution. Another important component of UNFI’s business strategy is reducing our carbon footprint, and during fiscal 2014, we improved our fleet fuel efficiency by 3.8% year-over-year. We laid plans with the addition of Racine and Hudson Valley to remove 2.8 million miles of distribution, improving both our customer delivery performance, while significantly reducing UNFI’s carbon footprint. Both of these two new distribution centers, along with Prescott, are expected to achieve LEED Gold Certification. We also reduced our electricity and water usage intensity by 11.7% and 14.6% year-over-year, respectively despite our growth. As to the UNFI Foundation, we awarded 51 grants to support organic agriculture this year, a 36% increase from last year. We funded non-profits to allow them to develop new organic farmers conduct research and teach organic farming practices and much, much more, and we funded three main areas, organic food production, research and science, and organic farming education. Looking at the fourth quarter, we had several key short-term factors influencing our results. Service levels, as UNFI has begun ramping up inventory preparing for the 2014 holiday, we are again seeing supplier outages running approximately 1% higher than what our forecasting had anticipated. Perishable categories, in particular, are driving a significant share of this issue, and this was a contributor to our gross margin pressure during the quarter. While we have incurred additional costs on and off over the last few years as a result of these outs, we are confident that the shortages will abate. Additionally, the Tony's acquisition, Canadian FX also negatively impacted gross margin in the quarter. There was some revenue softness during our fourth quarter, which did extend into our first period of 2015. However, during the last several weeks, we have seen an improvement across all of our sales channels. Our numbers reflect a very robust slate of new store openings and continued increasing demand for our products and new customers and across our growing Tony's platform. As our guidance suggests, looking towards fiscal 2015, we remain confident in the growth of the industry and continued demand for UNFI's products and services. A prime driver of our revenue growth in 2015 will be Tony's, fueled by high demand for perishable specialty products and our strategy to aggressively move across the country. We believe that our investment in capacity, infrastructure and people will continue to deliver strong results to our shareholders long term. Based on our estimated net sales for fiscal 2015, our business will have more than doubled over the last five years from $3.7 billion in fiscal 2009 to over $8 billion in fiscal 2015. The industry has also changed quite a bit in the last several years, with competition and a far greater awareness relating to the health benefits of natural and organic products. These changes all benefit UNFI as we are very well positioned to serve the needs of retailers across North America with a broad array of products with distribution centers in every major geography. To demonstrate our new capacity, infrastructure and products, we will be holding an Investor Day at our new facility in Hudson Valley, New York on October 21, 2015 with details to follow. And now I'll turn the call over to Mark Shamber, UNFI's Chief Financial Officer.

[Mark Shamber:]

Thanks, Steve, and good afternoon, everyone. Net sales for the fourth quarter of fiscal 2014 were $1.76 billion, which represents growth of 7.4% or approximately $122 million over the prior year fourth quarter's net sales of $1.64 billion. In Q4, sales growth related to acquisitions accounted for approximately $64 million or 3.9%. As a reminder, fiscal 2013 was a 53-week fiscal year and that extra week occurred in last year's fourth quarter. Adjusted for the extra week, which represented approximately $119 million in net sales, fourth quarter sales growth was 15.8%. Inflation decreased 9 basis points sequentially, coming in at 1.55% versus the 1.64% rate in the third quarter. On a year-over-year basis, inflation was down 37 basis points as inflation in last year's fourth quarter was 1.92%. On a full-year basis, fiscal 2014 net sales increased by 12% to $6.79 billion or 14.3% excluding the impact of the extra week. Acquisitions contributed approximately $111 million or approximately 1.8% of our fiscal 2014 sales growth. As Steve mentioned, through the first six weeks of our first quarter, our sales growth slowed modestly versus the growth trends in our fourth quarter, although we have started to see trends re-accelerate in the last couple of weeks. For the fourth quarter of fiscal 2014, the company reported net income of $33.4 million or $0.67 per diluted share, an increase of approximately 4% or $1.3 million over the prior year's fourth quarter, which contained the extra week. Net income for the fourth quarter of fiscal 2013 was $32.1 million or $0.65 per diluted share. With respect to breaking down our growth by channel, I'll provide the results discussing growth adjusted for the extra week in the prior year, sales growth adjusted for both the extra week and excluding acquisitions and then the percentage of total sales for the quarter. For example, supernatural sales increased by 10.5% for the quarter adjusting for the extra week, 9.3% also excluding the impact of acquisitions, and represented 34% of sales. Using the same sequencing, supermarket sales growth was 23.5% in Q4, 15.1% excluding acquisitions and supermarkets were 27% of total sales. The independent channel grew at 13.4% in the fourth quarter or 8.4% excluding the impact of the Trudeau and Tony's acquisitions and were 33% of sales in Q4, and finally, food service sales were up 25.4% as acquisitions had no impact and represented 3% of sales. A reconciliation to our actual growth by channel is available on our website. Gross margin for the quarter showed an 88 basis point decline over the prior year's fourth quarter gross margin of 17.3%, coming in at 16.4%. Sequentially, this represented a 29 basis point decline over the third quarter gross margin of 16.7%. Approximately half of the drop for the fourth quarter was due to the impact of the lower gross margin associated with Tony’s Fine Foods. The remainder of the drop was mostly due to customer mix and weakness in foreign exchange rates of the Canadian dollar. Our operating expenses for the quarter were 13.5% of net sales compared to 13.9% for the same period last year. This represents a 36 basis point improvement over the prior year as operating expenses as a percentage of net sales benefited from a variety of areas. As discussed in the press release within our operating expenses, we incurred approximately $0.9 million of additional expenses associated with the acquisition of Tony's. We also incurred $1.5 million of non-recurring expenses associated with the start-up of the Hudson Valley and Racine facilities as well as duplicate rent for our Denver facility. Combined, these expenses represented approximately 13 basis points of expense in the fourth quarter. For the quarter, fuel costs decreased by 2 basis points in comparison to the fourth quarter of fiscal 2013 as fuel represented 73 basis points of net sales in the quarter. Our diesel fuel cost in the fourth quarter increased by approximately 0.3% versus the same period in fiscal 2013, while the Department of Energy’s national average was up approximately 0.9% over the prior year. Share-based compensation expense totaled $1.5 million in the quarter compared to $4.1 million in the prior year's fourth quarter. This led to share-based compensation expense representing 8 basis points of net sales in the quarter compared to 25 basis points in the fourth quarter of fiscal 2013. The decrease in this area was due to lower performance-based long-term equity compensation, driven primarily by the failure to achieve the threshold set forth in our two-year LTIP award, one of which was the performance of the company's stock in relation to the specified comparative group. Operating income for the fourth quarter was $51.3 million, a decline of $4.8 million from the prior year's operating income of $56.1 million. Our operating margin in Q4 was 2.9%, a 51 basis point decline from fourth quarter of fiscal 2013 when the operating margin was 3.4%. However, the benefit of the change in the Denver lease accounting in last year's fourth quarter was approximately 18 basis points or $3 million. Interest expense in the quarter of $1.8 million was approximately 7.5% lower than the prior year quarter due to the change in our treatment of the Denver lease. The sequential decrease was due to lower average debt levels during most of the quarter, primarily due to lower working capital levels, partially offset by the higher debt levels following the closing of the Tony's transaction in mid-July. Inventory was $835 million at quarter-end as our days inventory on hand averaged 51 days for the fourth quarter. This reflects a day improvement over last year's fourth quarter when we were at 52 days. Our lower days on hand is being driven solely by the impact of the acquisition of Tony's Fine Foods. If Tony's were excluded, we would have been at 52 days, consistent with 2013's fourth quarter. Inventory levels were higher than target based on building inventory levels at our Racine, Wisconsin facility as we ramp up sales volume out of that location. DSO for the fourth quarter increased by about a day to 22 days over the prior year quarter and was up about the same over the third quarter. Capital expenditures were $39.4 million or 2.2% of net sales for the quarter, primarily related to our new facilities in California, Wisconsin and New York. For fiscal 2014, capital expenditures were $147.3 million or 2.2% of net sales, which is in line with our guidance. Outstanding commitments under our credit facility were $452 million at quarter-end, with available liquidity of approximately $151 million, including cash and cash equivalents. Subsequent to year-end, we successfully closed on a $150 million term loan facility, increasing our availability under our credit facility by that same amount. Our leverage at the end of fiscal 2014 increased approximately 1.7 times on a trailing 12 month basis, following the acquisition of Tony's. For the fourth quarter, we generated about $44 million of free cash, although we finished the year in a negative free cash flow position due to our investment in new facilities as we have communicated during the course of the year. As is typically the case, leverage will increase in the first half of fiscal 2015 as we invest in inventory for the upcoming holiday season. As discussed in the press release, we have provided our financial outlook for fiscal 2015 ending August 1, 2015. For fiscal ‘15, we expect sales in the range of approximately $8.13 billion to $8.38 billion, an increase of approximately 19.7% to 23.7% over fiscal 2014. GAAP earnings per diluted share for fiscal 2015 is expected to be in the range of approximately $2.88 to $3.01 per share, an increase of approximately 14.3% to 19.4% over fiscal 2014 GAAP earnings per diluted share of $2.52. Included in our fiscal 2015 earnings guidance is approximately $3 million to $3.5 million of non-recurring expenses associated with the planned opening of our new Hudson Valley, Wisconsin and Gilroy facilities. Finally, we expect our capital expenditures, net of the planned sale leaseback of the company's new Twin Cities area distribution facility in Prescott, Wisconsin, to be in the range of $130 million to $140 million or approximately 1.6% to 1.7% of expected fiscal 2015 net sales. Our new facilities in Hudson Valley, Gilroy and Prescott, along with our continued investments in technology represent the majority of our planned capital expenditures in fiscal 2015. The gross expenditures for the Twin Cities construction are expected to be in the range of $35 million to $40 million. Finally, we expect our fiscal 2015 tax rate to be in the range of 39.25% to 39.75%. At this point, I'll turn the call back over to the operator to begin the question-and-answer session.

[Operator:]

Thank you (Operator Instructions) Our first question comes from Andrew Wolf from BB&T.

[Andrew Wolf:]

I wonder if you'd be able to maybe give us a little more color on the extent of the softening. You gave us a timing which was helpful, and how much it's lowered in July and August and how much it's sort of come back here in September?

[Mark Shamber:]

Yeah, I mean, I think, Andy, it probably slowed 100 basis points to 150 basis points late in the fourth quarter and extended into a couple weeks into our fiscal ‘15 but it seems to have come back, so we've gained 150 basis points that we lost. So we're not exactly sure why we saw softening, but whatever softening was there seems to have dissipated.

[Andrew Wolf:]

So you're back at the old run rate, you’re not saying it's one above it?

[Mark Shamber:]

Correct. We're back at the run rate although for the quarter, we'll have some of that drag associated with it for the few weeks that it hit.

[Andrew Wolf:]

And then, I just wanted to clarify, I heard with regard to -- I think it was with regard to opening new distribution centers, Mark, I think you just gave like a hard dollar cost of $3 million to $3.5 million for this year, and I think Steve referenced $12 million drag and is the $12 million drag more of -- have some hypothetical components to it that are non-cash around estimating the inefficiencies or is that also a gross hard dollar amount?

[Steve Spinner:]

It's generally attributed. We got two things going on, right. We've got the cost of opening up new facilities, which is hard, we know what it is, and then the second component is, as we open up these facilities, we're actually seeding volume from existing facilities into the new one. So what we're doing in a sense is we're making both the facilities inefficient. We're transferring volume from one efficient building to a brand new building, which is not particularly efficient because it just doesn’t have that much volume in it yet. So the $12 million of rough estimate of what we think the drag is associated from that movement, the more successful we are, the less the drag, but it's something that we have to do, we do it very carefully. So it's not to negatively impact the service level in the market, but it's a real number.

[Mark Shamber:]

We've always talked in the past about the drag associated with new buildings for the first two to three quarters or three to four quarters from when they open, and so to the question, I mean, it's a hard number in the sense that we can match those facilities up against more matured facilities and see what we're getting for expense leverage in those existing facilities, whether they get exactly there and whether they get there in six months or 12 months, that's really the soft numbers associated with it. To Steve's last comment, if we get there in six months it will be less than $12 million if we were to get there, the full 12 months it’s probably at that number a little higher.

[Andrew Wolf:]

That's really helpful, You're getting more than just the facility that's been opened back to a budget or something, it's also the facility with the transferred costs, which also are now below.

[Steve Spinner:]

It's both facilities, right? Because you're taking volume out and you may have a higher number of people working in the facility than you need until the volume ramps back up.

[Andrew Wolf:]

Okay and I guess the last question is on the diminution or the contraction in the gross margin. When you said about 50/50 between Tony's and the other items, was it sequentially, seems to be how the math work there?

[Steve Spinner:]

That comment on the elements for 4Q was sequentially, so they represented about half of the 29 basis points.

[Operator:]

Thank you. Our next question comes from Karen Short from Deutsche Bank.

[Karen Short:]

Hi, thanks for taking my question. I had to jump off for a second, but in your prepared remarks, did you give the impact on the EPS from Tony's so that we can kind of just back into what your core EPS growth rate is, and I guess the same question I could ask for the top line.

[Mark Shamber:]

We did not Karen, and the main reason being that it's a range, right, so Tony's could contribute greater than expected - aspect of that range or less, and we debated that internally as to how much of that we are going to share. But I think from the elements I think as we go along, we can say sort of what they're contributing on sales and the impact they are having on the margin this quarter, but we don't want to get boiled down as we go through the year as to what part of the guidance was Tony's versus what part was the core business.

[Steve Spinner:]

And just as a follow-up Karen, first of all, one correction. In my comments, I said the Investor Day was October 21, 2015, it's actually 2014, but we would expect to provide a lot more color around Tony's, our strategic plan for Tony's, revenue and related to earnings growth in October.

[Karen Short:]

Okay. Because I mean I guess the reason I'm asking is if I kind of apply a growth rate to Tony's based on what you gave us in your press release when you made the announcement, so if I applied a revenue growth rate to Tony's and then kind of back into your implied core revenue, I don't know that I see really any dramatic change in what you're guiding versus what you previously guided. So, I guess that makes me think there may not really be any change in your core EPS growth rate, but it's hard to know. But if you don't want to go there, that's fine.

[Steve Spinner:]

I was following you all the way until the end. So I would say consistent with the comments that we made with the announcement in May and at the third quarter, I would say that Tony's has -- I mean, certainly saw it in the fourth quarter with regard to the gross margin. I would say that the guidance for next year has been with a lower operating margin. And so if you were looking at it from the standpoint that the numbers didn't necessarily generate the 9 to 12 basis points of expansion that we've historically targeted on a consolidated basis, we probably would have that on the core UNFI business as sort of an operating margin growth along with the expansion of the margin, and then Tony's would be sort of melded into that to give us the range that we have. I mean, that's probably the closest I can get you to without giving the specific numbers.

[Karen Short:]

Okay. That's helpful. And then -- yeah, I think that helps. I may follow up or wait till October 21. And then, in terms of where you saw the deceleration and then the re-acceleration, obviously you just gave numbers in terms of channel growth excluding acquisitions and it seems to be kind of the story that we've seen consistently which is, supermarket seem to accelerate especially on a tier basis, whereas supernatural and independent slightly decelerated on a tier basis. Is that consistent with what you saw into the first few weeks of the first quarter? And then, when the recovery happened, was it kind of broad-based or any color you can give there?

[Steve Spinner:]

I mean I think interestingly, it was across all the channels. It wasn't across any one channel and when it came back, it came back almost equally across all the channels.

[Karen Short:]

Okay. And then, I guess just the last question, Steve, on the last earnings call you gave some comments in terms of the competitive environment and it made us wonder whether you're seeing a greater threat from going direct. I guess, I was wondering it comes up every call in general in terms of the threat of going direct, but is there anything that you're seeing that makes you think that anything's changed on that front?

[Steve Spinner:]

No, Karen. I tried to clarify it during the last call, but I think it was too late. There really hasn't been any change in the competitive environment. The reason we're building these buildings is so that we can be as close to the customer with the most efficient distribution network as anybody in the country and that's what we've done. And so given that that is almost completed, I think we're going to be in an enviable position of being able to win business, retain business, help our customers build their business in a really, really efficient manner, which quite frankly nobody else has. And so, the long way of answering your question is that my point in making that comment was just to say that there is competition out there. Our challenge is to make sure that we're better than everybody else, which I think we are. But in the end, I think the competition from direct or from other distributors is pretty much the same today as it was two, three years ago.

[Operator:]

Thank you. Our next question comes from Rupesh Parikh from Oppenheimer.

[Rupesh Parikh:]

I just had just two more quick questions on Tony's. Is it possible to get their pro forma fiscal 2014 sales? And also is there any noticeable seasonality in Tony's business?

[Steve Spinner:]

I mean Rupesh, we're only going to provide the information we're required from an SEC standpoint, and I'm pretty sure we're not going to need to file their fiscal ‘14. I mean, we referenced that their growth rate, their sales growth as of 2013, September of ‘13 was $713 million. I would say that they pretty much grew in line with the industry. So you can pick where you want to pick from the industry growth level to get a rough number for that. I think that would put you in the ballpark. And then what was the second -- I'm sorry what was the second part of the question?

[Rupesh Parikh:]

Is there any noticeable seasonality in the business for Tony's?

[Steve Spinner:]

I would say that similar to UNFI's business, Tony's is softer in what would be our second quarter like the end of our second quarter, start of our third quarter and they are stronger in the fourth -- our fiscal fourth quarter than UNFI's.

[Rupesh Parikh:]

And then, just shifting topics to inflation, how are you guys thinking about inflation this year for your, I guess, for your business excluding Tony's and then Tony's alone?

[Steve Spinner:]

Yeah, I mean, I think for the last couple of years we've been hopeful that inflation was going to creep up to 2.5%, 3%, it just hasn't done that and we don't see anything in the future that would lead us to believe that we're going to see any significant inflation over the next year or so.

[Mark Shamber:]

I do think we'll start to, because of some price amounts that are already gone, price increases have already been announced. I think that we will in the first quarter trend back towards 2% versus the slow and steady decline that we've seen, but to Steve’s point, I don't see it getting to 3% or if it did, it's probably at the very end of the fiscal year on the non-Tony's.

[Steve Spinner:]

The only change to that is, with the acquisition of Tony's, we now have some inflation associated with proteins that we didn't have as much exposure to in the past. But I'm not sure it's going to move the needle a whole lot when we consolidate our inflation.

[Operator:]

Thank you. Our next question comes from Scott Mushkin from Wolfe Research.

[Scott Mushkin:]

The first thing I wanted to dive into is, looking at the supernatural number that you guys put up I think in the quarter [9.3] [ph] and I think it's kind of the -- about two-thirds or three-quarters of that comp is usually new store growth and the other quarter of it is same-store sales growth. So my question is, one of your largest customers looks like maybe it's stopped growing its comp store sales with you. Does that create business challenges for the company and deleveraging issues or no?

[Steve Spinner:]

Well, I mean Scott, we would never provide any comment on any individual customer. I can tell you that based on a very robust new store opening schedule as you know and so we’re a direct beneficiary of that, but we would never get into any disclosure of any single customers’ same-store comps.

[Scott Mushkin:]

I mean, I wasn’t even trying to get disclosure, but I just want to understand if it creates business pressure for you, if that happens?

[Steve Spinner:]

No, not at all.

[Mark Shamber:]

No, I mean, whether - from our standpoint, the growth is still at a level where we're getting leverage within our facilities from that standpoint, whether it's the comp growth or whether it's new store openings and what that mix shift or what that element of mix might be within our comp, it's still helping us leverage our fixed expenses in the buildings.

[Scott Mushkin:]

Okay. That's what I was really asking, so I probably didn’t ask it right. The second question I have is, I mean, obviously guys are spending a lot and I understand the idea of what you're trying to do, but when does CapEx kind of settle down? Is this like a more normal level of spend that we're going to see? I think you're free cash flow negative this year, you're free cash flow negative, I think, in ‘15 if our projections are right, when do we turn that investment dial back down?

[Steve Spinner:]

That's a great question and I think we've talked about this that ‘14 and ‘15 are going to be our primary investment years and that once we get into ‘16, ‘17 obviously we'll be a much larger company, but we'll go back to a more historical less than 1% of revenue in CapEx, which obviously --.

[Mark Shamber:]

I'd say that ‘16 would be a ramp down from where we are, Scott, and then ‘17 we'd probably be back in the 1% range.

[Scott Mushkin:]

Okay, perfect. My last question is more strategic than anything else. Clearly the business is changing a lot with a lot of these like a Kroger coming into the business, do you think your investments are significant enough where you could convince someone that's taking product directly from the suppliers to consider switching to outsourcing?

[Steve Spinner:]

Yeah, I mean that's certainly part of our hope that because of our access to data, our merchandising in the store, our retail category management, the way in which we move products around the country, because keep in mind that even though the industry has gotten a lot bigger, it still relies very much on what a typical conventional retailer would refer to a slow moving product, and it's very hard for them to make that work and we've got a very efficient model for distributing these types of products. I think the answer is yes, and there is some historical data that would point to the fact that we can have a great deal of success in convincing retailers that we can handle those types of products more efficiently than they can.

[Scott Mushkin:]

Is there an example Steve that you have? And then I'll yield.

[Steve Spinner:]

I mean, I wouldn't get into a specific customer example but there is many, many examples where if you take a very popular line of soups and as these items become more popular, let's say, three of the 30 soups become faster moving and it makes sense for that conventional retailer and keep in mind we're only talking about one-third of our business in this example because that's all it affects. And that retailer says, well it's cheaper for us to move those three SKUs into our captive warehouse. But in the end what the data points to is, because of the way that they have to buy that product, they're out of stocks at shelf go up significantly. And so even if they have to pay a little bit more by having us handle the distribution, they know that their fill rate at the shelf could be 500 basis points, 600 basis points, 700 basis points higher than if they're trying to buy it direct. So whatever savings they might have on the distribution side, they lose because they don't have the product to sell to the consumers, and so I think the more sophisticated retailers have seen that and have gradually migrated, in this example, those three soups back to UNFI.

[Operator:]

Thank you. Our next question comes from Jason DeRise from UBS.

[Jason DeRise:]

I'm going to try ask about Tony's Fine Foods. I hope this piece of information you’ll share. How is their customer mix different than yours? Are they over indexed somewhere or under indexed relative to your business?

[Steve Spinner:]

I'll try to give it, because I'm not sure. I think that Tony's folks give their percentages off the top, but I would say that their concentration of supernaturals is probably about half of ours, roughly half of ours, and then I defer to sort of them on the supermarket and independent split.

[Scott Berger:]

This is Scott Berger. The retail upscale environment, which is the way we look at our business by channel and we emphasize value and upscale as our biggest class and it's in the range of 40%, 44% of our revenue, followed secondly by our value retail environment, which is in the high to mid 30s, and then everything else from there is either traditional grocery, smaller independents and food service operations.

[Jason DeRise:]

I wanted -- shifting back to the bigger picture part of the business. There is consolidation going on I'm sure as always in the distribution environment, but there's obviously a bigger one announced lately. Can you share what your thoughts are and how that affects your business as perhaps smaller players start to get larger, your competition I'm talking about. I'll just, sorry I'm trying to be, I should just say it. So Nature’s Best and KeHE, sorry.

[Steve Spinner:]

Listen, I think at the end of the day it’s going to help us. Nature’s Best was a relatively small regional company. It did a good job and we compete with them every day and have for a long time. They’ve always been known as the kind of the local player. KeHE is also a good competitor, but obviously much larger. And so that kind of local small advantage, if you would call it that, is probably gone. But we're ready, we're prepared, and we know where we need to go and we know how to get there, and there's always going to be changes in the marketplace, and one of the things that makes us good is we are is we're pretty nimble.

[Jason DeRise:]

And also there is an acquisition, high-profile acquisition on the producer side of a bigger food company buying one of the main natural players, how do you think that affects your business?

[Steve Spinner:]

I mean if you’re referencing Annie’s I mean again the consolidation in the manufacturing side has been going on for quite some time. They've been in this space as have many of the other big CPG companies. We've got a pretty good relationship with them. And so if anything, again, our mission is to try to get natural organic out to as many hands as we possibly can and if they help us do it, then that's okay. But there's not a lot we can do to control that, so we tend not to worry about it.

[Jason DeRise:]

Okay, thank you. One last question. Could you just share a little bit more on the thought process of why we're not going to get more than the minimum on Tony's Fine Foods? I mean it's the way we have it estimated it’s more than 10% of your sales and it's got a very different P&L structure and cash flow structure. Could you just share why we're not going to get the full detail?

[Steve Spinner:]

Yeah, I mean I think at this point, it's still relatively new, we're still learning the business, we're still understanding the revenue streams, and quite frankly, we don't want to lock ourselves into a box and we think that the disclosures that we provided are probably adequate for you to get the information that you need. And once we get to a point where we're more comfortable with how the Tony's platform is rolling out across the country, looking at the overlap in terms of our sales mix, looking at any potential negatives that might be perceived out of the acquisition, I think then we'll be in a better position to give a really good educated number.

[Jason DeRise:]

Okay, looking forward to when you guys get comfortable there, because it's a very interesting combination.

[Operator:]

Thank you. Our next question comes from Vincent Sinisi from Morgan Stanley.

[Vincent Sinisi:]

Wanted to first ask about the supermarket channel growth. If you could give some further insight into maybe just directionally how much of that growth was coming more from increased volumes, current customers, and then any color in terms of notable new customers that you’ve signed off on that side of the channel?

[Steve Spinner:]

We've never broken that out, Vinnie. I mean we tend to sort of talk about additional volume coming on board if it's in excess of $100 million in the aggregate. So, I could say that as it relates to fiscal 2014 that any new business won was in excess of that and to the extent we lost any business, it didn't exceed that. So, if you look at it from a standpoint of our overall sales, that’s maybe 1%, 1.5%. So I would say that proportionately not a large amount of that business came from new customers. It gets more challenging as it relates to do they add to their SKU assortment or is it just comps, because they're rotating sets, they may do it once a year, may do it twice a year, may do it quarterly as to updating some of the products that they are carrying. But I would say that the majority of it is comp growth or comp growth with inflation, not new customers.

[Vincent Sinisi:]

And then just a follow-up question.

[Steve Spinner:]

Vinnie?

[Vincent Sinisi:]

Can you hear me guys?

[Steve Spinner:]

Yes, we can now. We didn't hear the question.

[Vincent Sinisi:]

Okay, sorry about that. Just wanted to ask that you are doing from, of course, now more recently with the Tony's assortment, but you racked off so many initiatives that you are making from assortment, from technology, from distribution. Can you give us a sense for kind of the advertising or the communication with your current customers in terms of how are you making them aware or more aware of maybe than they would normally be of the new enhancements that you are making to your network?

[Steve Spinner:]

If I get the question right, you're asking how do we help our -- how do we help customers understand to make sure they have the right products on the shelf or how do we make them understand the enhancements to the network?

[Vincent Sinisi:]

To the point that was made earlier about that the benefit of UNFI is that obviously we do have access to your assortments, your efficiencies, your technology. Obviously they will see changes and how they're ordering et cetera, but are you doing any particular kind of communications to really make them aware of what has been done and what is upcoming?

[Steve Spinner:]

Yes, I mean fortunately, our customers are very well aware of what we're doing and what's happening within UNFI, whether it's through their own sales channels or electronically. They see the benefit every day in terms of number one, the breadth of line, which I think is the single biggest point of differentiation for UNFI. If it's natural organic, specialty, specialty perishable and so on and so forth, we're going to have the greatest selection of any company in the country and then that's a huge point of differentiation. From a distribution perspective, if we're close to them, then they can place the order later and get it earlier, which is another huge point of differentiation, because as soon as you have to start driving hundreds of miles, customer has to place the orders several days earlier and the actual delivery time becomes more difficult to pinpoint. So the closer you are to the customer, the much easier it is for us to provide a higher level of service, and so, they see those things directly as we roll them out. We also have a very sophisticated retail category management group, which uses a lot of our own proprietary data as well as the syndicated data to look at sets, products, by skew, by space allocation within every geography in North America. So that if a customer was looking to redo their cereal sets and was willing to allocate 16 feet and they happen to be located in Tennessee, we could use our retail category management group to provide them every piece of data they would need to make sure that they have the right product shelf.

[Operator:]

Thank you. Our next question comes from Kelly Bania from BMO Capital.

[Kelly Bania:]

First, just wanted to ask about the one-time gain for the quarter. Can you just explain a little bit what that was and just remind us if it was not contemplated in your original guidance?

[Steve Spinner:]

So, the number nets itself out because there were approximately $800,000 or $900,000 or it net outs a bit because there was about $800,000 or $900,000 of write-off that occurred in that line as well. But there was a portion of it that was factored into the guidance. It wasn't fully factored into the guidance because we weren't really sure what the value of the property would be. But as part of the entry into the Wisconsin market, we were given some incentives and part of that was the land that we ended up building the Racine facility on. So that's what the gain was associated with and we will have a similar gain in fiscal 2015 for the new Twin Cities location, which is in Prescott, Wisconsin, not necessarily of the same magnitude, it would probably be $1 million or so less and now, we'll probably have in late in the second quarter or in the third quarter, not sure exactly timing because it basically occurs once the construction is complete.

[Kelly Bania:]

And then just on gross margins, a lot of moving pieces, I guess, in the quarter, but didn't hear much discussion of mix which is usually the focus. So I'm just curious if you could touch on what's going on in the core growth margin in terms of mix right now, and could you also touch on the impact of maybe a slightly slower growth in the supernatural channel? Is that actually less of a mix pressure potentially for you?

[Steve Spinner:]

No, the gross margin component where the Tony's impact was the largest that was about 14 basis points. Second was the Canadian FX, which negatively impacted our gross margin, some of the supply issues that we had, and then the fourth, small but not insignificant was continued customer shift and that customer shift was more towards the supermarkets.

[Mark Shamber:]

But I mean, I think by virtue of how we broke out the sequential decline, I mean, you could see that as Steve just covered the other items that make up half, half of it we said specifically was the dilution based on Tony's having a lower gross margin. The other element was those four items that Steve mentioned. So customer mix was in there, but it was not as huge -- as big of an item as it can be in some quarters.

[Kelly Bania:]

And then was wondering if you can also fill us in on how WMS, sounds like you're up to five now. How that's going, what the specific plans are for fiscal ‘15? And then, just same question on I guess inventory optimization, now that you're I guess in the process of putting that in, in the East, should we expect similar benefits, or any just comments on how that implementation is going, any feedback from your customers as you're working through that?

[Steve Spinner:]

Yeah, so inventory optimization is essentially, not essentially it is implemented in the East. It’s finished in the West. We will complete the DC by DC implementation of inventory optimization in the East, and that should finish the early part of 2015. And certainly, we're hopeful that we'll get the same kind of benefit in the East as we got in the West. As it relates to the WM implementation, we have several scheduled for this week -- for this year. And at this point, we feel like we're pretty good at it. We've got a dedicated team, it does the implementation. We do have some service issues, very, very short-term when we make the conversion, but I think we've been able to really mitigate that risk, and like I said, we've gotten pretty good at it. But we'll continue to knock off a couple -- two to three DCs a year for the next couple of years until we're finished.

[Operator:]

Thank you. Our next question comes from Mark Wiltamuth from Jefferies & Co.

[Mark Wiltamuth:]

Hi, it's Mark Wiltamuth. Wanted to ask on the arc of the earnings accretion from Tony's. Is it going to be something that kind of peaks within two to three years, or do you think you'll get mostly there in this year? And just a little more color there, if you could.

[Steve Spinner:]

No, I think we're going to see the accretion in the first year.

[Mark Shamber:]

I mean, look we would certainly expect to become more efficient and more effective and who knows at what rate we expand geographically or through additional M&A, but I think from the core business, I mean we -- there is not -- there is certainly opportunities to drive some synergies, but it's not as if this business needed to be fixed in any way, shape or form.

[Mark Wiltamuth:]

On the guidance for next year's revenues, are you still assuming something around 13% core growth ex-acquisitions for the core business, and do you have any finger on how much of that growth is going to be coming from new store expansions from those retailers?

[Mark Shamber:]

I mean the new store expansions, we get from some of our customers a pipeline of what they're looking to do, and we try to factor in to the extent that they hit their timelines or their timelines push out a little bit. So we've got a combination that’s built into the guidance or built into our internal numbers that breaks out what's the comp and what we think are going to open for new stores and roughly when we think they're going to open. So sometimes that slips and more often than not it slips versus it accelerates. As it relates to the fiscal ‘15 guidance, I mean, again not trying to get pinned down too much on the ranges but I would say that you're not far - the 13% you're referencing is not too far off from one element of it. The issue becomes, Mark, is we could outperform on the UNFI side, underperform on the Tony's, outperform on Tony's, underperform on UNFI and that's why the range is so wide. As Steve mentioned, there's elements of business that we may be able to gain as well as elements of business that we may lose from sort of some of the shakeout of the acquisition that caused us to set a much wider range than normal.

[Mark Wiltamuth:]

And then on the fourth quarter, did you come in a little better than expected on taxes? Because I know versus our model, you definitely came in a little better. Where was it versus your internal expectation?

[Steve Spinner:]

It was probably modestly a bit better. There were a couple of opportunities by virtue of where we had some profitability on the state side that allowed us to use some NOLs that we did not have originally factored into the model. So, it was a little bit stronger, but it wasn't dramatically off from what we had thought.

[Mark Wiltamuth:]

And lastly, I think you said you were preparing to do some delivery on behalf of retail customers. How does that work? Is that coming right out of your DC to a consumer and how are you going to do that?

[Steve Spinner:]

Yes. So, we'll deliver via e-commerce several ways. Today, for example, for a lot of business to business e-tailers, we deliver directly to the consumer, but UNFI is invisible to the consumer. We're doing it on behalf of another retail customer, and so we do that today. And so, with the additional e-commerce platform, we will be able to offer 15,000 SKUs, where through a retailer's website, they can have UNFI fulfill for the consumer directly to the store, they can have UNFI fulfill directly for the consumer through the store’s website to the consumer’s home and several other ways. It's all through our existing customers. We're not selling the consumer direct, but we're providing the retailers with every e-commerce options that they could potentially need.

[Mark Wiltamuth:]

And have you seen a lot of uptake of this, is this building, or where do you stand on it?

[Steve Spinner:]

Yes, I mean it's building. It's still relatively small for us, but we certainly think that it's going to get bigger and we need to make sure that we have a platform to deliver it.

[Mark Wiltamuth:]

Okay, thank you very much and we'll look forward to seeing you in October.

[Steve Spinner:]

Thanks. And operator, I think this probably has to be our last question. I know there's a half-dozen folks still in the queue and we haven't got through everyone, but we're already past the hour.

[Operator:]

Thank you. Our last question comes from Meredith Adler from Barclays.

[Meredith Adler:]

Thank you, it's Meredith Adler. Most of my questions have been asked, but I'd like to go back to your comment, Steve, about already seeing some out of stocks. You think you can work through it, but can you talk a little bit about what you do, because in the past, we know that there was some incremental expense by moving product around between DCs or you ended up with more inventory, just to make sure this didn't happen. But you've already got some out of stocks, so how do you think you’re going to be able to mitigate this?

[Steve Spinner:]

Yes, I mean, Meredith, it's predominantly in categories that have a relatively short shelf life. So it's really not like we can move those products around the country, and I do believe that it's going to be short term. I think going back to the last time it happened we were somewhat unprepared and we made a conscious decision to move the freight around the country during the holidays in order to make sure that there was a reasonable service level. But we learned a lot from that experience and don't see us being in that situation again without a lot of support from our suppliers. So, the two periods really aren't comparable because, I think, the last time that it happened, it wasn't good for anybody, but we did what we had to do. We learned a lot like I said. In this period right now, we haven't seen a significant fall off. We just noticed that there's been some increased out of stock across certain categories and we're working closely with those manufacturers to ensure that we have supply, and like I said, I feel pretty good that we will.

[Meredith Adler:]

And then, I want to go back to the gain and I was just wondering where does the gain show up, is that in other?

[Steve Spinner:]

Yeah, it's below the line in other. I think it's called other income or other net.

[Meredith Adler:]

And are some of these one-time costs netted against what shows up in that other line or are they in SG&A?

[Steve Spinner:]

No, let me identify it. So, any of the non -- what we talk about is non-recurring, but we don't break out of the P&L. So costs associated with the start-up of Racine, costs associated with start-up of Hudson Valley, the deal related costs as well as the dead rent for Denver, those are all within operating expenses in SG&A. In other expenses or other income net, you've got the gain, you've got the write-offs of CapEx projects that didn't continue, didn’t get finished. And then you also have any -- I think it's expense this quarter, but any non-cash expense associated with revaluing the balance sheet at month-end associated with the Canadian dollar and movement of the dollar. So on the actual income statement, it's showing those three items are all netted into that line item.

[Meredith Adler:]

And when you think about the earnings of the company, do you think about the gain as being something that is really earnings or is it just kind of a one-off thing? Although you said it's not one-off because it's going to happen again with Prescott.

[Steve Spinner:]

Yes, I mean, I think -- I personally view it as earnings. I mean it's a strategy that we implemented as it relates the way in which we build our buildings. Like Mark said, it’s going to happen again in Prescott and it may happen again in future buildings.

[Mark Shamber:]

Yes, I mean in some respects, the incentives that we may get in different communities, some of them are above the line, some of them are below the line, but as Steve mentioned in doing the ROIs and the models, they factor into the decision as to where to build a location and whether to own it or to lease it or do a sale leaseback scenario.

[Meredith Adler:]

And then, you did mention, I think you'll do a sale leaseback on Prescott?

[Steve Spinner:]

That’s our plan, yes.

[Meredith Adler:]

Is there any other plan for Racine or Hudson Valley at this point?

[Steve Spinner:]

We were asked a lot about that last year. So, both of those facilities were mortgaged as part of the $150 million term loan facility that we did. So we've financed those buildings through a term loan that goes through 2022.

[Meredith Adler:]

Okay. That's right, I think you told us that and I forgot. Okay. Thank you very much.

[Operator:]

Thank you. I will now turn the call over to Steve Spinner for closing comments.

[Steve Spinner:]

Thanks again for joining us this morning. For information regarding our October 21, 2014 Analyst Day, please contact Katie Turner at ICR. We look forward to seeing you at Hudson Valley, New York. Thanks everybody. Have a good evening.

[Operator:]

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.