United Natural Foods Inc (UNFI) 2003 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the United Natural Foods conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference please press star and 0 on your touch tone telephone. As a reminder, this conference call is being recorded.

I would now like to introduce the host for today's conference, Miss Vanessa Schwartz of FRB Weber Shandwick . Ms. Schwartz, you may begin your conference.

Thank you. Good morning, everyone.

Welcome to the fiscal second quarter conference call for United Natural Foods. You should have all received a copy of the press release this morning. If you did not, please call Thomas Walsh at FRB Weber Shandwick at 212-445-8459, and we will send one out to you and confirm your name on the fax or e-mail list. With us today from management are Mr. Michael Funk, chairman, Mr. Steve Townsend, chief executive officer, and Mr. Rick Puckett, chief financial officer.

We will begin with some opening comments and then open up the call for your questions.

As a reminder, this call is also being webcast today, March 4, 2003 and can be accessed by the Internet at www.viavid.com and www.unfi.com.

Before we begin, I'd like to remind everyone of the Safe Harbor statement included in the press release and that the cautionary statements apply to today's conference call as well.

Now, I'd like to turn the call over to Steve - Steve?

Thank you, Vanessa. Welcome, everyone. Joining me today are Michael Funk, our chairman, and Rick Puckett, our CFO.

The second quarter resulted in earnings of 28 cents per share which excluding special charges is at the upper end of the range given of 26 cents per share to 28 cents per share. We recorded record sales with revenues of $338.4 million. This was an increase of 18.6% over the $285.5 million recorded in the second quarter last year. Positively impacting sales this quarter were the Blooming Prairie and Northeast Cooperative Acquisitions. We had BP for the entire three months and we had NEC for only the month of January. If we were to exclude the impact of both BP and NEC and the change in distributors of our former second largest customer, then our year over year organic sales growth would have been 17.4%.

We continue to see solid growth rates in all of the key business channels. Growth in the mass market channel was up 30%, while growth in the independent channel was up almost 28%. Finally, growth in the supernatural channel was unchanged, however, if we exclude the acquisitions in the change in distributors of the second largest customer, then the growth rates would have been 24% for the mass market, 11% for independents and 27% for the supernatural channel. Obviously we continue to be very pleased with the growth and strength in all channels, particularly during the quarter when many companies continue to report soft retail sales.

With our two acquisitions now complete, our current mix of business by channel is as follows. Independents represent approximately 45% of our business. Supernaturals represent approximately 33%, and mass market represents approximately 14%, and our other channel represents approximately 8% of our business. Our largest customer, Whole Foods Market, now represents almost 25% of the total sales. The integration of BP and NEC continue to move along as we expect. Our Western region team led by Kevin Michelle has taken responsibility for the BP operations and is working closely to assist the BP staff in implementing synergies and improving operational efficiencies.

Our initial focus is to execute UNFI's national buying power to improve gross margins while working to lower the warehouse and transportation costs. We continue to -- we believe we can continue to realize operating margin improvements of over 200 basis points over the next several quarters. This acquisition will continue to be neutral to slightly accretive through the end of the fiscal year and then accretive to earnings thereafter.

Our Eastern region team headed up by Rick Antonelli has taken responsibility for the Northeast co-op operation. To date, we have seen market improvements in the area of gross margin while we continue to work on lowering the operating costs. We will continue to operate the NEC facility until our Chesterfield, New Hampshire expansion is completed at which time we will expect to fold the NEC operation into this newly expanded facility. This consolidation should occur in the summer. Because the NEC facility is only seven miles from the New Hampshire facility, we anticipate retaining a significant percentage of the employee base, which will make the move and consolidation simpler.

As noted earlier, we did not purchase the NEC facility when we closed the transaction. As stated previously, we anticipate the acquisition of Northeast to be neutral to earnings for the current fiscal year, and accretive once we have moved into the expanded facility in Chesterfield.

Hershey Import negatively impacted the results this quarter by a penny-and-a-half EPS. We have spent considerable time in the past several months working with the division and we have implemented an action plan with the local management team. Overhead has been adjusted and head count reduced to reflect current demand. Inventory reduction plans have been implemented to provide targeted turns and a skew reduction program has been implemented to provide further warehouse efficiencies.

Finally, we have put into place some new marketing programs that should begin to drive the top line. Since we have only been in the new facility six months, we need several quarters to see that the initiatives take shape and can positively impact the businesses at this division.

Overall, we are especially pleased with the performance this quarter, especially in light of the challenges that we face with integrating the two new additions to the UNFI family, with the continued underperformance at the Hershey division and with the operational impact resulting from the loss of business from our former second largest customer.

In light of these challenges, we are going to continue to focus on the following, successfully integrating the two new acquisitions into the Eastern and Western regions, we're going to focus on growing sales in all channels and replacing the lost sales, especially in the West region, we'll focus on restoring the Hershey division to the former levels of profitability and growth, and finally, we're going to work on improving the operating margins throughout all of the divisions.

We are especially pleased with the continued sales growth which reflects the customer's confidence in our ability to service them at a very high level. We are pleased with the progress we have made on improving the operating margins. Total operating margin for the quarter was 3.2%. This is lower than the operating margin we reported during the first quarter, largely due to the impact of the recent acquisitions in Hershey. However, excluding the acquisitions and the underperformance at Hershey, the operating margin would have been 3.9%.

That concludes my remarks and I would like to now turn the program over to our chief financial officer, Rick Puckett -- Rick.

Thank you, Steve. Good morning, everyone.

Net income for the second quarter of fiscal 2003 excluding the effective special items increased 4.1% to $5.4 million or 28 cents per diluted share, on the high side of our guidance of 26 to 28 cents. This is compared to net income of $5.2 million or 27 cents per diluted share excluding special items for the same quarter of fiscal 2002. BP was slightly accretive and NEC was neutral for the quarter, a credit to the West and East region teams who are overseeing the integration of these two acquisitions. We believe that the BP and NEC acquisitions will continue to be neutral to slightly accretive for the remainder of the year.

The negative impact of Hershey on our earnings was 1.5 cents in the EPS for the quarter, a two-cent swing from prior year. EPS, including special items was 28 cents per diluted share compared to 27 cents including special items for the second quarter of fiscal 2002. Special items for the quarter total $200,000 in income, or $100,000 after tax with virtually no impact on diluted EPS.

Special non-cash income was related to our interest rate swap agreements and attributable to the changes in yield curves during the quarter, which created an increase in fair market value of approximately $200,000 or $100,000 after tax. We will continue to recognize the swap agreement non-cash item quarterly for the duration of the swap contracts. Whether we recognize income or expense in any given quarter and the magnitude of the item is dependent on the yield curves and the remaining terms of the contracts. Please note that at the time of the expiration of the swap contracts, the cumulative earnings impact will be zero.

In addition, special items included labor costs of approximately $70,000, $40,000 after tax related to the expansion of the Chesterfield, New Hampshire distribution facility. Special items related to the Chesterfield facility will increase in the third quarter and should be complete by the end of the fourth quarter with the total approximating somewhere between $1 million to $1.2 million. We believe that the integration of the NEC operations into the Chesterfield facility will be completed by the summer of this year.

Gross margin for the quarter was 19.5%, in line with our guidance of mid to high 19's. Excluding acquisitions, gross margin was 19.9%. We believe gross margin would be in the mid to high 19's for the remainder of the year. Operating expenses, excluding special charges were 16.3% of sales for the quarter. We expect expenses will remain in the low 16's for the remainder of the year due to the change in the distribution channel mix resulting from a transition of the company's former second largest customer as well as an initial higher expense structure for both Blooming Prairie and Northeast Cooperatives.

Regarding working capital, the day's sales outstanding for the quarter was 25.2 days compared to 27.1 days last quarter. Days at inventory were 51 days this quarter compared to 51.9 last quarter. During the third quarter, we expect to put into place $30 million in additional long term financing secured by real estate. We will use the proceeds to pay down the revolver balance and overall the impact to earnings will not be material, but it will provide us with additional liquidity. Free cash flow was $5.4 million for the six months ended January 31 with the capital expenditures of $1.2 million for the six months ended January 31, representing 1.7% of net sales.

We believe the cap-ex will be between 20 and 22 million for fiscal 2003 with the Chesterfield expansion being the most significant project for the remainder of this year.

Turning to the remainder of fiscal 2003, we are maintaining our EPS guidance of $1.18 to $1.20 per share before special items. We are maintaining third quarter guidance of EPS of 30 to 32 cents. We expect top line growth to be in the 18 to 22% range including acquisitions for the remainder of the year.

At this time I'd like to turn it over to Michael Funk, our chair, for final comments before opening the floor to questions.

Thank you, Rick.

We have just completed a very difficult quarter involving integrating two major acquisitions, as well as re-engineering our business in response to the loss of our former second largest customer. I want to congratulate our management team on continuing to meet the expectations of our shareholders, even under the most challenging of circumstances. We have also made an extremely smooth transition of our top management during this last quarter, and I am confident that the changes we have made in our senior management will benefit the company in the long term. All of us are excited and encouraged by the continued strength in our top line, which continues to perform well in all customer channels. We look forward to continuing to capitalize on the growth of the natural products industry in the future.

And if any of you are visiting the natural products expo this coming week in Anaheim, please be sure to stop by our booth and say hello. Remember, UNFI is your proxy for the natural products industry.

Now I'd like to turn the call back to the operator to open the floor to your questions.

Thank you. Ladies and gentlemen, if you have a question, at this time, please press the 1 key on your touch tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, if you have a question tilt, please press the 1 key on your touch tone telephone. One moment, please, for the first question.

The first question comes from Scott Mayo of Mayo Capital. Please proceed with your question.

No question.

Thank you. The next question comes from Gary Gidlen of C.L. King.

Hi. Good morning. I wondered if you had -- if you were expecting to pass through fuel costs increases, and if so, can you do that right away, or does it have to be phased in?

Well, our fuel costs represent about 60 to 65 basis points of sales. For 2-2, we didn't see a lot of increase in fuel, but at this point, we have not seen it necessary to pass through any increases in the customers, but going forward, we'll certainly look at that.

But, Steve, you may want to -

I think it's just something right now that we need to monitor, Gary. Fuel prices have increased. But in certain regions, we are --some have increased further and much more quickly in some areas than others. At this point, I think we will be looking really to look at what those are, and looking forward whether or not we need to be -- including these requesting forward.

Sure. Okay. And any changes in the CFO role with Rick on board? Any initiatives in the CFO area?

I think you have seen some things that we talked about in terms of looking at free cash flow. We're looking right now at our balance sheet and the geography of the balance sheet. The initiatives that we're making to put long term debt on the balance sheet is something that Rick is spearheading for us. We certainly -- he has only been on board six weeks and getting up to speed in terms of the business units how we're constructed from a balance sheet standpoint, that's what we're focusing on now.

Okay. Finally, I mean, how is the supermarket or I guess you would call it your mass channel doing in terms of their -- I mean, I realize you're adding customers in that area, but are there same store sales in natural accelerating or decelerating or just on an equal plane? What's the trend there?

We're seeing good growth within many of our existing store chains that we do business with. At the same time we're obviously aggressively looking at new business opportunities for ourselves. I think the composition of the growth rates that we have seen is a combination of new doors as well as, you know, same store growth rates within that and getting products within the existing doors. So, we have been pleased with the efforts we made on the mass market side.

Okay. Very good. Thanks very much.

Thank you. The next question comes from Eric Larson of U.S. Bancorp Piper Jaffray.

Hi, everyone. First question is could you --you cited Hershey imports. Could you review the decline in gross margin in the quarter again. You went fairly quickly through that. I think Hershey imports was one. Did the acquisitions also dilute the gross margins near term a little bit in the quarter?

Yes. We have seen really, you know, a number of problems as a result of the operations at Hershey. Certainly declining sales is hurt. We have had pressure with regard to, you know, gross margin and, you know, with the move into the new facility, we have had increased operating expenses. The initiatives that we have taken, Eric have been to try to bring the business model in line with the volume. We have talked about, you know, adjusting overhead, reducing head counts, those are the initiatives that we have already put into place. We are going to continue working against this. We have a plan in place now with our management group there in terms of how to address the problems. I think we're just going to have to see how it shakes out over the next couple of quarters.

Okay. And what is your ongoing level of revenue from your oldest second largest customer? Is that continuing to have some impact in the current quarter?

We are running in the 10 to 15% range. That's where it was last quarter. That's what we're going to look at going forward.

Thank you.

Ten of the previous years.

Of what we had done on a previous basis, correct, Michael.

Got you. That makes sense. Thank you everyone.

Thank you.

The next question comes from Greg Badishkanian of Salomon Smith Barney.

Great quarter, guys. Just a few questions here. The first one is can you talk a little bit about the competitive environment? Obviously, you're growing faster than the industry. You know, are you continuing to take share from Tree of Life because of the issues they're having? And are you seeing any slowdown in taking -- being able to take the chair from them?

I think, the answer to the question when I was looking back at the previous quarter, you know, after acquisitions, taking out acquisitions and removing, you know, the loss in business as a result of our second largest customer, last quarter we reported, you know, sales in the independent channel was up 9%, this quarter we're saying it's around 11%. You know, we still feel that the growth in the industry is running 7, 8%. So, that tells you that we are taking market share from the competitors. I think we continue to compete effectively out there. The fill rates are very good. The -- what we offer customers in terms of fill rate options, deliveries, I think, you know, we continue to really have the strongest array of services. I think that really helps us in terms of our ability to compete for market share. I think that has successfully translated into the ability to take market share from others.

Good. In terms of the overall industry have you noticed that the -- has organics or are there any areas that are fueling the overall strong industry growth?

We continue to see good growth in organics. We're continuing to see that pace out at around 20%. Cooler freezer area, we continue to see, you know, 20, 20-plus percent growth rates in the area of the product mix. I think, you know, we have certain areas, certainly that, are helping to drive sales and those are the areas that tend to be giving us the best growth rates.

Good. Finally, I know the snowstorms had an impact on retailer, certain distributor. Your 30 to 32 cent guidance. That does incorporate the impact from snowstorms?

Greg, this is Rick. Yes, it does. The snowstorms impacted Q3, not Q2, and some of the loss of business that we did see in early February we did pick some of that back up in later weeks. 10, we do not expect it to have a material impact at this point on Q3. It is included, yes.

Good. All right. Great quarter, guys. Thanks a lot.

Thanks.

Thank you. The next question comes from Carol Buyers of RBC Capital Markets.

Good morning. Congratulations. Couple of questions. I was wondering, could you review the Hershey business again. The composition of it is what is causing it to underperform, second, I was wondering could you comment on where the operating margins are for Blooming Prairie and Northeast Co-op, if it differs from your initial expectations?

On Hershey, Carol, we have talked about the erosion of sales. I think from the standpoint, I think some of it has been competitive, you know, alternatives that customers have that has impacted it. We have also changed a bit in terms of our product mix going towards branded products where we had formerly been more of a commodities type. You know, company with Hershey. I think part of it is in terms of the change in direction of the business, but I think, you know, a number of other things have impacted. I think certainly the top line erosion has kind of exacerbated what's going on there, but at the same time, we moved into a new facility, our operational facilities are picking up, and at the same time, again, we have to adjust our overhead in line with that. Those are some of the steps we're taking right now.

I think in answer to the first question, I think that's kind of what has happened with that, and really, you know, as I discussed in my opening comment, you know what we have taken -- the steps we have taken to address that.

Steve, was it more bulk specialty going to more of a United Natural Foods portfolio. Is that the change that we're seeing?

Yeah. Basically, I mean, again, Hershey the mix of business is changing where formerly a lot of it was commodity bulk items that generated and drove the sales. We have come out with more branded product and package products, which takes more handling and have more costs associated with it. I think that's kind of the subtle change that's shifted within the business. That's what we are sort of adapting to now.

Have you changed management there recently?

Not recently. In 1991, we did. We have a relatively new management group there. I think with Rick and I, again, we are spending a lot of time with this division, to try to get it back to the levels of growth and profitability that we have experienced in the past.

It was 2001.

I'm sorry. 2001.

Again could, you reveal where the margins are for Blooming Prairie and Northeast Co-op?

We don't generally discuss that. I think we kind of gave you, you know, an overview of what the impact has been. I think, you know, from the standpoint, you know, BP is going to be slightly accretive to earnings through the remainder of the year. As Kevin and his team have more chance to impact the operations there, we'll see more gin, operating mar jibs continue to improve. As far as any for NEC, we're really working to, you know, have that thing be neutral to earnings until we can move it into the Chesterfield, facility, at which point we think it would be accretive to earnings thereafter.

Thanks.

Okay. Thank you, Carol.

Thank you. Again, ladies and gentlemen, if you have a question, at this time, please press the 1 key on your touch tone telephone. One moment, please.

The next question comes from Mark Hansen of Glen Hill Capital.

Hi. How are you. Two questions if I may. the first relating to the facility that you expect to do in the third quarter. If I remember correctly, the expectation was originally that would be done in the second quarter. I just wondering what change there and the second question is related to, you know, where the bad debt reserves stood at the end of the quarter. Thanks.

I'll do the first question. The Chesterfield expansion is actually ahead of schedule. All along the building was expected to be completed in March. We actually received CO on the building mid February. So, we're moving ahead with, you know, having to begin operating out of some of the newly expanded areas of the facility. We have to review line racking and what was the older part of the grocery area, and we will actually be shipping out of the cooler freezer area. I believe starting next Monday, so we are running ahead of schedule in terms of the Chesterfield expansion, Mark.

I meant in terms of the bank facility. The long term facility. I think that was supposed to --according to the queue was supposed to happen in the second quarter. That's the question.

Mark, you are correct. That is attributable to my coming on board about that time. What I chose to do is to take a little more time and go out and solicit additional bidders on that particular line, or that particular term loan and have been very successful in getting some more favorable rates. So, the time that it's taken me to get on board and get to a point where I feel comfortable with these long term commitments has resulted, I think, in a lower interest rate going forward.

Very good. Okay. Then, as relates to bad debts, at the end of the quarter.

The bad debt reserve, we are still very well accrued there, so there's no issues from my perspective.

You don't have the number, though, available?

It runs around 7.5% of total receivables.

7.5, okay.

Thank you.

The next question comes from Scott Van Winkle of Adams Harkness.

Congratulations on the quarter, guys. A couple of questions. First, probably following up on Carol's question, look being at the margins of Blooming Prairie and Northeast Co-ops, you indicated that the margin would have been 3.9% if -- instead of 3.2 if you excluded the acquisitions and Hersheys. Can you break out how much impact was from Hershey's and the acquisitions?

3.6% on operating income. I think we said 19.9% on gross margin.

Oh, okay. It was the 40 basis points impact from the acquisitions and Hershey's on the operating margin?

Basis is 19.9%.

Okay. And, Rick, did you hedge fuel costs at all?

Acquisitions of BP and NEC, we take out the impact of Hershey, it was 2.9% in terms of what the operating margin would have been. The actual margin was 3.2, but if we exclude the acquisitions and Hershey, it was 3.9%.

Okay. I was looking if you could break out what of that 70 basis points was Hershey's, versus what was the acquisitions?

NEC, as we point out, Hershey costs a penny and a half as it relates to the impacts. I don't have the breakout in terms of what that is at this point.

Do you hedge fuel costs at all?

(audio gap)

At this time we have a question from Douglass Pratt of Wells Capital.

Hi. I had a little problem --technical problem. The sound went off for a bit. Someone I believe asked you about fuel costs. I did not hear the answer to the impact and also, could you tell me where that comes into the P&L. I assume it's split between costs of goods sold and operating expenses.

Actually, the in-bound freight could go into costs of good sold. We're able to pass that along as we incur it. The outbound freight and fuel costs is what I referred to when I talked about 60 to 65 basis points of revenue. And the question from Scott had to do with do we hedge fuel, the answer was no. We do not. We will be reviewing that as we go forward, but at the present time, we do not.

What sort of -- so, cogs you pass on immediately. Do you have any -- you probably don't, any sort of surcharge that you add to outbound? I guess that's just your cost, right?

That's correct.

Thank you. Good quarter.

Thank you. At this time, we're showing no further questions.

I'd like to turn the program back to management for any concluding remarks.

Yes. Thank you. On behalf of the nearly 4,000 UNFI employees and associates, we want to thank you for your interest and support of United Natural Foods. That concludes today's conference. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may disconnect. Good day.