United Natural Foods Inc (UNFI) 2004 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to United Natural Foods' third quarter 2004 results conference call. At this time all participants are in a listen-only mode. Following today's presentation, instructions will be given for the question-and-answer session. If anyone needs any assistance during today's conference, press the star followed by the zero. As a reminder, this conference is being recorded today, Tuesday, June 1, 2004.

I would now like to turn the conference over to Mr. John McNamara.

Thank you. Good morning, everyone. Welcome to the fiscal third quarter conference call for United Natural Foods. You should have all received a copy of this morning's press release. If anyone did not, please call Janet Cruise at Financial Relations Board. Her number is (212)445-8453 and we'll send you one out and confirm your name on the distribution list.

With us this morning from management are Mr. Steve Townsend, Chief Executive Officer, and Mr. Rick Puckett, Chief Financial Officer. We'll begin with some opening comments and then we will open up the line for questions. As a reminder, this call is also being webcast today, June 1, 2004, and can be accessed by the Internet at www.unfi.com.

Before we begin we'd like to caution everybody, to remind everybody about the cautionary language regarding forward-looking statements contained in the press release. That same language applies to comments made on this morning's conference call.

Now I would like to turn the call over to Steve. Go ahead, Steve.

Good morning, everyone, and thank you, John. Welcome, everyone, to our third quarter conference call. Joining me on the call today is Rick Puckett, our CFO.

Our actual third quarter net income increased 49% to 8.6 million from 5.8 million for the same period last year. Actual EPS was 21 cents per share. Net income, excluding special charges, increased to 9.2 million or 22 cents EPS. Special charges during the quarter related to the transition of the Wild Oats business back to UNFI. First Call estimates were for EPS to be 20 cents per share.

Obviously, we are very pleased with these results considering the fact that we have been working hard to successfully transition Wild Oats back as a customer, complete the 2 major expansion projects at UNFI facilities and improve our business operations as evidenced by our improvements to our operating margins.

We once again had record sales quarter with revenues of 449 million. This was an increase of 23.5% over the 363 million recorded in the third quarter last year. Excluding the impact of Wild Oats, our comp growth rates were 15.7%. This was an excellent quarter from a growth standpoint, but we do expect to see these growth rates moderate as we move into our fiscal 2005.

Growth trends across our business channels remain strong. Growth in our supernatural channels grew at 44% while growth in our conventional mass market business and independent channels grew at 20% and 9.1% respectively. Overall, our growth continues to exceed that of the industry due to our commitment to providing the best overall customer service and support.

Our current mix of business by channel is as follows: independents represent 43% of our business; supernaturals represent 38%; conventional mass market represents 13%; and our other channel represents approximately 6% of business. Our largest customer, Whole Foods Market represents approximately 23% of total sales while Wild Oats represents approximately 9% of sales.

We completed the transition of the Wild Oats business back to UNFI in early March when the Southern California, Northwest and Denver regions assumed primary distribution with Wild Oats. Overall, we have been very pleased with the transition effort and end result as it came from the extraordinary efforts of both companies. I would like to personally acknowledge the work of Rick Antonelli, our West Region President, who led the UNFI effort.

The integration of our Midwest operations to our East region continues to move forward as planned. Operationally, we continue to make good progress as our fill rates and service levels remain strong and consistent with those of our other facilities. In addition, our building expansion at the Iowa City facility is now complete and we have begun to move into newly expanded space.

Presently we are operating out of the new coolers and freezers, while in the grocery area we are in the process of relocating new product and expanding into this space. I would expect the transition to be completed before the end of June. At that point we will need approximately 2 to 3 quarters to achieve the operating efficiencies we expect to move into once we get into one of our newly expanded facilities.

Our second major expansion project involves our Dayville, Connecticut facility. To date, the construction is completed and we have now installed racking into all our newly expanded space. In addition, we are in process of bringing temperature down in our coolers and freezers, and if all goes as planned we will be fully operational in this facility by the end of August.

On our last call, I indicated that with the resumption of business with Wild Oats we would expect to see downward trends in our gross margins offset by lower operating costs. With these changes, we did expect to see operating margins to continue to improve over time.

For the quarter, I'm very pleased to report that total operating margin was 3.7% before special items. This represents a 20 basis point improvement over the 3.5% recorded in the second quarter this year and a 40 basis point improvement over the 3.3% recorded for the same quarter last year. Overall, we are very pleased with these results and they reinforce the success that we realized from investing in people, facility, equipment and new technologies.

Looking ahead, we are very pleased with the progress to date and we remain committed to helping our customers be even more successful. Even with our existing high service levels, we remain focused on improving operating metrics even further in order to benefit all our customers in the channels that we serve.

Over the next 12 months we will focus on the following: Growing our business in all sales channels; growing sales in new channels that include food service and international sales; growing sales of UNFI branded products; continuing to invest in our people, facilities, equipment and technologies to help drive out more cost from operations; and ultimately improving operating margins at each of our divisions. Overall we are very pleased with our third quarter results and how we have positioned ourself for the remainder of fiscal '04 and for the upcoming year.

I would now like to turn the speaking program over to our CFO, Rick Puckett for additional comments. Rick?

Thank you, Steve, and good morning, everyone. As Steve mentioned, net sales were $448.9 million for the third quarter fiscal 2004, an increase of 23.5% over last year third quarter of 363.6 million. This represents a 16th consecutive quarter of record-setting sales for the company.

Net income for the third quarter fiscal 2004, including the effect of special items, increased 49% to $8.6 million, or 21 cents per diluted share. Compared to 5.8 million, or 15 cents per diluted share for the quarter ended April 30, 2003. Net income for the third quarter of fiscal 2004, excluding the effect of special items, increased 48.7% to 9.2 million, or 22 cents per diluted share compared to 6.2 million or 16 cents per diluted share for the quarter ended April 30, 2003.

The special items for the third quarter fiscal 2004 consisted of certain equipment rental and labor costs associated with the start up and transition to the primary distribution relationship with the Wild Oats market. These special transition costs in the quarter amounted to $1 million or $600,000 after tax and are now completed and will not been experienced in future quarters.

In the third quarter of fiscal 2003, special non-cash income was recorded in the amount of $400,000, or $200,000 net of tax related to the change in fair value of the interest rate swaps and related option agreements. In addition, certain labor costs amounting to $300,000 or $200,000 net of tax, relating to the expansion of the Chesterfield facility were recorded to special items in 2003.

The non-cash item from the change in fair value of the interest rate swap agreements was caused by unfavorable changes and interest rate yield curves during the quarter ended April 30 of last year. As previously announced and discussed last quarter, these interest rates swap agreements were ended in December, 2003, and no further special item will be experienced going forward.

On March 17, the company's Board of Directors approved a 2-for-1 split of the company's common stock that was payable in the form of a stock dividend. Stockholders received one additional share of the company's common stock for each share held on a record date as of March 29. The split became effective on April 20, and the applicable share and per share data for all periods included herein and also in the press release have been restated to give effect to the stock split.

Gross margin for the quarter was 19.5% compared to 20.2% for the same period last year. As we have previously discussed, our channel mix of business has shifted, therefore we expect to see lower gross margins offset with lower operating expenses. We expect gross margins to be in the mid-19 range going forward.

Offsetting the lower gross margin, our operating expenses at 15.8% of sales for the quarter, excluding special items, compared to 17% for the same period last year. The 115 basis point improvement is a result of increased efficiencies due to larger delivery quantities, efficiency gains through process improvements and further efficiency gains from the integration of the recent acquisitions into our business.

Excluding special items, operating income was 3.7% for the quarter compared to 3.3% for the same period last year and 3.5% last quarter. The year-to-date operating margin is 3.5% excluding special items. Cash used in operations for the nine months ended April 30, 2004, was $8.9 million. This included the cost of novating [ph] the ineffective swaps of $5.4 million in December and the building of inventory and receivables associated with the Wild Oats business.

Our inventory was at 47 days for the third quarter, well under our target of 50 to 52 days. The DSO for the third quarter was at 22 days under our target of 25 to 27 days. Free cash flow, excluding working capital, was $13.5 million for the latest 12 months ended April 30.

Capital expenditures were $19 million for the nine months just ended, equating to 1.5% of revenue. The bulk of the capital expenditures were associated with the expansion of Iowa City, Iowa and Dayville, Connecticut. Additional capex will be experienced for these expansion projects in the fourth quarter as they are completed. Therefore, we couldn't to forecast $24 to $28 million in capex for the year.

As previously reported, the company entered into an amended and restated 4 year, $250 million revolving credit facility with a bank group that was led by Bank of America Business Capital, formerly known as Fleet Capital Corporation, as the administrative agent. The amended and restated credit facility provides for improved terms and conditions and provide the company with more financial and operational flexibility, reduced costs and increased liquidity.

The new credit facility replaced the existing $150 million revolving credit facility in place. The company's outstanding commitments under the amended and restated credit facility as of April 30 were approximately $123 million, with remaining liquidity of $98 million.

Our return on total capital was 21% and our return on equity was 13.3% for the latest 12 months. We are raising our guidance to $1.62 to $1.64 billion from $1.6 to $1.62 billion in revenue. This reflects an increase in revenue from last year of 17.4 to 18.8%. We are raising our diluted earnings per share guidance, excluding special items, to 74 cents to 77 cents from the previous 73 to 76-cent level. This reflects a 24 to 29% increase over last year. This reflects a strong performance in the third quarter as well as our continued improvements in efficiencies throughout our company.

Healthcare costs increases will impact our fourth quarter to some degree beginning with June 1 consistent with new company-wide program that will go into effect. The cost increase will come from increased participation in the new plan, not from increased rates as we continue to provide our associates with quality benefits.

We also expect diesel fuel costs to be slightly higher in the fourth quarter but do not expect a material impact on earnings.

At this time I would like to turn it over to the operator to facilitate the question-and-answer period.

Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. If you have a question, please press the star followed by the 1 on your push-button phone. If you would like to decline from the polling process, please press the star followed by the 2, you will hear a 3-tone prompt acknowledging your selection, and you questions will be polled in the order they are received. If you are using speaker equipment, you need to lift the handset before pressing any numbers. One moment for our first question.

The first question comes from John Heinbockel with Goldman Sachs.

Good morning. This is Eric Wiseman sitting in for John. I have a couple of questions. First, in looking at the growth rates in your different customer segments, the conventional mass channel, growing as fast as it has this year kind of stands out as the segment that may be growing at a rate that is above what one might think is a more likely longer-term prospect for that part of the business. Can you talk a little bit about what might be driving this and when the growth rate might moderate to what you think is a more normalized level, or is this kind of current near 20% growth a level that you think is actually sustainable?

Eric, I think when you look at the conventional mass market as a percent of our business, it represents about 13% of our business today. I do think that we have very good growth opportunities in this sector looking ahead. So my expectation is that we will continue to see lower double-digit growth rates in this sector and I think they will exceed certainly what we saw with the independent side where we saw like the 9.1% growth rates.

Okay. So more towards the lower double digits, more lower double digits meaning like lower teens or.

I would say like 10 to 15, looking ahead. We are working right now on our fiscal '05 plans so I don't, we don't have that finalized at this stage. But I would certainly expect this channel for us to exceed the growth that we are currently seeing on our independent side.

Okay, great. And secondly, with respect to your top-line guidance, the 1.62 to 1.64 billion for the full year kind of implies some moderation to, call it no more than a mid-teens growth rate for the fourth quarter. Coming off the third quarter you just had and without having cycled the new Wild Oats business, the number seems a little bit conservative. I was wondering if there might be any other factors affecting the fourth quarter, like an anticipated customer loss or something like that that might be driving this or are you guys just taking more of a conservative approach?

Yeah, I think certainly we are, I mentioned in the comments that obviously the comp growth rates that we saw at 15.7% were very strong for the quarter, and in looking ahead we certainly expect those to moderate over time. I don't know at what point those would begin to moderate, but you can see, I think, some moderation in here when you look at what the growth rates were with the independent sector of the business for us.

Okay. Thanks very much. Sure, Eric.

Thank you. Your next question comes from Carole Buyers from RBC Capital Markets.

Hi. Good morning, gentlemen, congratulations. Just a couple questions. Kind of following, piggybacking on that previous question about the mass market. Were there any notable accounts that drove the results in the independent, I mean, in the mass market channel?

No.

No particular change, so that was pretty much all comp growth in the mass market?

No, we've taken on new business and we don't typically disclose the accounts and that sort of thing. So there's some new accounts in there, Carole, but I don't have a really a breakdown of what's the new business versus comp growth. I think we've continued to see good growth rates with our existing customers as well as getting new doors, also.

Okay. And then with respect to the independent channel, you guys have done a good job taking share from Tree of Life. Have those gains started to slow or are we still seeing a lot of market share gains in the independent channel?

I think, again, the things that we've talked about is sort of from our standpoint execution. I think if we continue to execute at a high level, we expect to continue to take share in all the markets we compete in. I think clearly we are focused on doing as good a job as we can for our customers and I think that's really what we will continue to focus on. But I couldn't tell you today were you whether we are continuing to take share from any of our competitors.

Okay. Then on just with respect to the revenue that came from Oats, it was about 45 million, a little higher than I was looking for. Was any of the revenue associated with filling shelves or is this kind of a base that we are going to continue to grow from, or should we see a little bit of a moderation next quarter sequentially?

I think the 45 million is a little a little high, Carol, for what we actually contributed. Keep in mind that we had a secondary arrangement with Oats prior to the contract. So you are only looking at incremental, our analysis of that suggests that somewhere around 25 to $30 million incremental. And I think we had originally said $50 million this year would be what we expect from Oats in terms of incremental sales dollars. So, therefore, the 25 million for the second quarter as they sort of loaded their shelves and stocked everything up was pretty much on track.

So it's more -- because I thought you said that it was 9% of total sales. So you are saying incremental of 25.

That's the run rate. That's a run rate not necessarily for the quarter.

Oh, okay. I gotcha. And then finally, what was the fuel impact this quarter on gross margin?

It was almost nothing. Our fuel cost increased. I think what you found is that diesel fuel is really starting to move after most of the quarter was finished, it started in late April, and is going into May, which is our fourth quarter. So we had almost no impact on fuel.

Gotcha, okay.

Just to add to that. Diesel costs have gone up in pennies where gasoline prices have gone up in nickels. So the impact that you are maybe seeing at the pump is not necessarily what we see in our business.

Okay. Thank you.

Thanks, Carole.

Thank you. Our next question comes from Gary Giblin of CL King. Please go ahead.

Hi. Just wondering, are you able to pass on the pennies in diesel fuel cost increases? Or do you have to absorb it?

Gary, typically if we see price increases on in-bound freight, that does impact our landed cost and we will adjust our landed cost for that. We haven't as yet on our outbound adjusted anything from a pricing standpoint until we sort of see where it settles out.

Okay. And just to beat a dead horse here, the other questions we're asking about the outlook on the fourth quarter. I mean, if you beat this quarter by about 2 cents versus consensus but you are only raising your guidance by one cent so that, I'm still trying to understand, is it general conservatism or was it the specific factors that Rick mentioned in his comments about healthcare costs and diesel fuel costs that made you a little more conservative on the fiscal fourth quarter?

Gary, I think you are absolutely right. The fourth quarter we know will have higher fuel costs that will impact us to some degree. We do not expect a material impact there, but there will be some impact. And the healthcare costs that we are putting in place, the amount of participation in that plan was quite high. And we believe that we should offer employees quality benefits. So those reasons were the reasons that you did not see a 2-cent increase. But we have a range up there. We've raised the range twice now. We want to sort of see how the healthcare costs ultimately will impact us, Gary.

Okay. And did you always envision the Oats start up, ramp-up cost as a special item? In other words, was that understood in the previous guidance? Or is that a later decision to make it a special item?

No, when we announced it back in November we began negotiating the contract, we indicated that there were going to be special one-time charges associated with the transition. So we've been speaking of that really I think since back in November.

Okay. And just finally, in the previous incarnation with Oats, there were inefficiencies and it just wasn't worked out , it wasn't the greatest situation, at least from their standpoint, but now that they've sort of seen the other options and they certainly speak very well of United, but is it an entirely efficient situation from your standpoint or are there still things to work on to make it efficient from the supply standpoint?

I'm actually very happy with where we are today in terms of our fill rates and service levels. And I do think, too, that we have room to continue to improve. That's a process I think we all take here is that we are doing I think a very good job, but I think that we can continue to work at doing even a better job on behalf of our customers. So I think hopefully that's what you are hearing when you talk to the folks at Wild Oats and, again, our commitment is that we are going to continue to try to improve our operating metrics.

They love you, I'm asking whether you love them at this point? Are they an efficient customer to work with?

Yeah, they are.

Okay. Great. Thanks. Good luck.

Thank you. Next question comes from Eric Larson with Piper Jaffray. Please go ahead.

Good morning, everyone, congratulations. First question is, and this is for Rick, more of a housekeeping question, do you have the same numbers that you broke out for your third quarter year-over-year on all financial instruments and the one-off expenses for Oats for the nine months in both periods?

Actually, I don't have it with me, Eric. I apologize. But I will get back to you on that one. I can certainly give you a call.

Okay, good. And then, I think the next question is really for Steve. Obviously, your internal growth rate or your comp rate, however you want to classify it, has been extremely strong. I don't think anybody expects it to be as strong going forward. But have you seen an acceleration in industry growth? And maybe you are just expecting that to moderate a bit? And then as a back into that question, as you look forward the next 18 months or so, we should see fairly significant increase in Whole Foods square footage growth, which you would probably participate at least with some of that. I guess I'm just curious some of the factors that might be returning that growth rate back to a more normal rate than you've seen in the last few years.

I think starting off, Eric asked the earlier question about, I think we will continue to see different growth rates across the channels. I think certainly we will continue to see good growth rates as we've talked about with the conventional mass market side. I think certainly with the supernatural side with the planned growth that Whole Foods has, that certainly will have a positive impact in terms of our growth rates. But you are seeing, and I have seen some moderation of growth as it relates to the independent business, which for us is roughly 43% plus we have the other categories. So it's roughly half our business falls in there. So, and that's what I'm talking about in terms of some moderation of our business.

So I think certainly we will see growth will differ across the various channels, but I think we will continue to see some moderation of that. I also mentioned that, if you remember the third quarter last year I think it was a quarter that was a little softer because we had the impact of the War. I think Whole Foods and both Whole Foods and United reported out, I think softer sales for the third quarter last year. And I think, so we are comping over against, I think an easier quarter for this quarter, too.

Okay. Thanks. One other follow up, the improvement in your EBIT margins has been terrific. And, obviously you've got new capacity that's going to take sometime to get truly efficient, et cetera. Is 4% over time or a 4% EBIT margin goal still achievable?

Yeah. I mean, I'm actually happy with the progress we've made this year. When you think about, again, taking on the, transitioning the Wild Oats customers back to UNFI, the fact that we've invested to upgrade 2 of our facilities. I'm clearly committed to achieving this and I think the investments we've made have been smart investments that over time will allow us to achieve that operating margin. So, certainly.

Great. Thank you, everybody.

Thanks, Eric.

Thank you. Our next question comes from Scott Van Winkel, Adams Harkness. Go ahead.

Hi, guys. Just a quick housekeeping item. I missed the percentage of sales by channel. Could you give those to me again?

Sure. The current mix is independents represent 43%, supernaturals represent 38, conventional 13, and the other is 6.

In that other, is that mostly retail or how big is the food service piece becoming?

It's not a significant piece yet, but it is growing. Sorry?

It's north of 1%. It's north of 1%. I was going to say 1 to 2%. 1 to 2 points of that is the food service.

Okay. If I could try to clarify the Oats comments, you mentioned the 9% was a run rate, does that mean, did you do 30, 35 million of sales to Oats in the quarter?

That's right.

Okay. And this run rate you're talking about, 9% with Oats, at what percentage completion of taking on the business are you?

We've completely transitioned the business over, Scott.

Okay. So your 9% run rate is done, 100% going forward?

Exactly.

I think you mentioned among your focuses over the next 12 months, a focus on unified branded sales. Can you add a little more clarity to that?

It's something we've been talking about in the past as one of our key objectives. For us it represents, again 1 to 2 percent of sales. We think there's opportunity in various categories to introduce products that either don't exist or they are not at the quality or the price points that we feel they should be. And we've been very good at introducing products that have gained quickly in terms of market acceptance. So this will continue to be something that we are going to try to grow over the next 3 to 5 years.

Do you do acquisitions or do you work with co-packers?

We produce our own Hershey facility, a lot of our own products. We do work with co-packers to produce products for us, but again it's really all of the above.

Okay. Rick, tax rate guidance? If you said it I missed it, I apologize.

I think our guidance will remain at around 39%, Scott. That's what it is in our financial records. And our effective tax rate is slightly below that, but it's still not to a point where I can reduce the guidance.

Great. Thank you.

Thank you. Our next question comes from Mark Chekanow with Sidoti.

Good morning. With Whole Foods having such a strong quarter and people looking for, obviously it was mentioned a strong square-footage growth. How can we benchmark your sales versus Whole Foods as a lot of the way they will be expanding, you will see more produce and more prepared foods. Do you still expect to grow inline or above their total sales growth for market share gains? Or do you think their growth with the prepared counters, et cetera, might cause you to slightly lag their total sales growth?

To be honest, Mark, I'd have to go back and look at it. Historically, we've been able to grow at a little faster pace than what Whole Foods has been, but I think it has been as we move categories over to UNFI. Certainly the perimeter of the store has been an area that they've obviously focused on with the produce and prepared foods and things like that, and that's been a very fast-growing area for them, which we participate in only to the point that I think we are secondary in produce in some markets and we do supply some of the commissaries with goods. So I'm not sure I can really answer that one. I think it's one that I'm not expecting any material changes to where the growth rates are, but it could vary some from where we are today.

Okay. And could you also talk about, is Wild Oats something we could be looking at as a $200 million business for you overall in fiscal '05?

I think there is certainly an opportunity for that. We work carefully with them in terms of product selection and products that they want to merchandise in their stores. So I think it's, we gave the guidance at 150 to 200 million, and I think that certainly we are confident that we can be at or around that 200 million level.

Okay. Again, the numbers that you gave you said were run rated. The numbers you just actually gave back out, the sales showing the 43% independent, supernatural, 38, is that a run rate or is that for the quarter?

I look at that -- I typically, when I do that it's sort of our most recent months, because especially with Wild Oats coming in where we didn't have them transitioned for the whole quarter, so I would rather look at it as what the run rates are. Okay. Thanks a lot, guys. Thanks, Mark.

Thank you. Our next question comes from Gregory Badishkanian with Smith Barney. Please go ahead.

Great. Congratulations, guys, good quarter. First question is just related to Wild Oats, can you discuss the progress on the Wild Oats service levels, specifically how much have they improved since you've been servicing them relative to when Tree of Life was their primary distributor?

Again, I would rather focus on where we are today with them and our field rates with Wild Oats today, the UNFI out-of-stocks are running between 3 and 4%. So I am actually very pleased with that. We are working hard with the management at Wild Oats to help drive down some of the manufacture out-of-stocks which again have been running higher between 5 and 6%.

So that's clearly an area that I think we as a company, along with our key customers will begin to focus on is that we need to do mitigate some of the manufacture out-of-stocks. I think part of it is just the fact that the industry is growing so rapidly I think there's just been a supply void of being able to keep up with the growth within the industry. But I think certainly, I think it's incumbent on all of us to help minimize total out-of-stocks and I think we have to address it by addressing each of the components that make up the out-of-stocks, Greg.

Can you discuss how your field level salespeople are using this successful switch over when they are talking to existing or potential customers as a sales point? And is this most effective with a larger customers or with the smaller health food stores?

I think people measure us by how well we perform day in and day out. I think we are not like Boeing or G.E. where we have a backlog of sales. Our sales are sort of driven by the fact if we do a good job today we will get the order tomorrow. I think that's why we are so focused on continuing to improve our operating metrics. And so I think our people focus on where we are today, the improvements that we've made and the improvements we expect to make. I don't think we tend to worry about what one customer or where we stand with one customer. I think we try to, as I mention in here, I think it's important for us to help all our customers be successful and that ultimately is what our goal is.

You don't think that your customers or potential customers look at it and say, well, if Wild Oats switched back to you that you must be a better supplier and provide better service levels? You don't think you can get incremental business just from that?

They may think that. We don't again want to point to what's happening with our competition. I think, again, we focus on the areas that we can help our customers improve, be it merchandising services, be it help them to get better product selection into the stores. Those are the areas where I think we have the greatest opportunity to grow business.

Clearly, one of our key goals from a sales perspective is, if we are doing $1,000 with a customer, our most profitable sales and we can grow that sale from $1,000 to $1,100 or $1,200. So clearly, we're focused on growing our share with every customer, be it whether we are in a primary situation or a secondary situation.

Sure, okay. And with respect to supply prices, I know Hane [ph] recently announced that it was going to raise prices on select items in July. Have you been seeing other grocery suppliers also announcing price increases.

No, but I do expect more to happen, actually. There hasn't been a lot of price increases in our industry over the last 2 years. In fact, last year when we did analysis, the average price increase was like 1.2%. So we didn't see very much for calendar year '03. So I'm not surprised that we are going to, that we are seeing some now and I do expect that we will see more over the next 12 to 18 months, Greg.

Great. How would this impact your margins? Do you just pass that on or would you actually get some benefit from a little bit of the price inflation?

We certainly would pass that on, Greg. There would be a small benefit to us, but for the most part we would pass it on.

Great. Thanks. Thanks, Greg.

Thank you. Our next question comes from John Rolf. Please state your company name followed by your question.

It's John Rolf at Argond. Most of my questions have been answered. The only additional one I had is whether you guys can give us any update on the status of the contract extension discussions with Whole Foods.

Yeah, John, we are now in active discussions with, Whole Foods. Obviously, we've had a partnership with Whole Foods that goes back almost a dozen years. Clearly, we are committed to trying to get contract extension done with those folks and I believe they are as well. So we have ongoing discussions and clearly I think both companies are committed to trying to get something done.

Okay, great. Good luck. Thanks.

Thanks, John.

Next question comes from Andrew Wolf with BB&T Capital Markets. Please go ahead.

Hi. I also wanted to follow up on the sales questions you were getting. Steve, have you seen something in May sales or recent trends that is spurring the kind of, what I agree is fairly conservative sales guidance or is it more of an anticipatory kind of look on what could happen?

No, again, I will just sort of reiterate. I think we are going to see different growth rates by channel, Andy, and I think that we are going to see strong growth rates in the supernatural area. I think we will see moderate to above average growth rates in the conventional mass market side. But the independent side of our business makes up about 50% of our business and I think clearly we are seeing that fall back closer to probably slightly above what we are seeing across the industry, what industry trends are being reported out today. I think there's probably a combination of both.

And again that we are comping over what was a weak quarter for us last year. And I just think that 15.7% comp growth rate is not something that we want you guys expecting as we go forward.

Absolutely. Just to be blunt about it, I just want to diligence the fact that you are not saying something is wrong with May sales?

No, absolutely not.

Okay. In that 9% growth in the independents, which is, like you said, pretty good especially when you look at the 38% year-ago comparison, is any of that coming --, can you split that out between same-store sales growth at the independents, particularly interested in what you think the relative health of the independents is, sort of between their internal growth and your new distribution gains?

I really can't. We don't really have that kind of detailed data to try to break out. I think just anecdotally when I talk to stores, what I'm hearing growth rates really varies across from 2 or 3% to 12 or 15%. Again, I think a lot depends on location, we are seeing stronger growth tends in the west, say, than we are right now in the east. But these are things I can't break down and say what percent is comp growth rate, what's new business and that sort of thing.

And with Wild Oats, it's my understanding that in this quarter you just reported you really didn't have a lot of business in Southern California yet. So can we look for finally some leveraging out of the Fontana facility going forward?

I think you are seeing a little bit of that in these numbers, but I think we have more, we transition the Southern California business back beginning in early March so we only had 2 of the 3 months where it was impacting that. So obviously, a big portion of the Oats business for UNFI is out west, it's between Southern California and Denver where the vast majority of the business is anyway.

Great. And one last question probably more for Rick. Rick, can you quantify what you expect the healthcare plan participation to cost you on an annualized basis? And the same question for fuel? You said it's not -- I think you said it wasn't material but I'm not sure how you would define that.

On the healthcare costs, Andy, we expect that with the participation that we have in the new plan that our overall costs will increase by about $2 million next year. But given that, we still, today is the first day of the plan. So we are self-insured so we are not sure exactly what the losses are going to come out. But our best estimates are $1.5 to $2 million increase next year.

As it relates to fuel, the fuel costs has started to increase at the end of April and beginning of March but seem to sort of been settling out right now across the country. Again, our fuel cost is about 67 basis points of sales. And it's just not moving enough to really have a significant impact on operating income.

Thanks. So the fuel is a lot less -- likely to be a lot less of an impact than the 2 million that you are currently looking for in the healthcare?

We are not sure where fuel is going to wind up. But if you could tell me that that would be great, I could then answer your question.

Yeah, we would dial right in our forecast, Andy.

Assuming today's prices, let's assume prices stay pretty high, but were there.

Yeah, I think that, assuming today's prices it's not a huge percentage above where we were at the end of third quarter.

I think our expectation, what we are expecting is that it's going to go up, but just now we are measuring it in pennies and then it should stabilize and hopefully begin to come down. That's sort of the assumptions we are going to be building into our '05 plan.

Great. Thank you.

Thanks, Andy.

Ladies and gentlemen, if you have an additional question, please press the star followed by the 1. If you are using speaker equipment, you will need to lift the handset before pressing the numbers. The next question comes from Bob Coleman with Gardner, Rousseau & Partners. Please go ahead.

Yes, good morning. Just a quick question, with the tremendous growth in this channel, not only regionally but nationally, are you seeing any product allocations being derived from the manufacturers to the distributors to the retailers? Both on the private label side and the national branded issues?

Ask the question again, Bob, I want to make sure I have it right.

Are you seeing any product allocations where the manufacturers are unable to produce the product on a timely basis as it has in the past? I mean, this channel has experienced tremendous growth in the last 12 to 18 months. And my concern is that the manufacturers are not building manufacturing capacity against the demand.

Yeah, I think you hit on something I mentioned in one of the other comments I made, which is that we are seeing higher levels of manufacturer out-of-stocks than we have seen over the years and it's remained in that 5 to 6% range total out-of-stocks, which is unexceptionable not only to us, but also obviously our customers. So it is something that we are working with manufacturers on to see if we can improve this. But I do think you're right, it has to do with the growth that's being experienced across the entire natural organic channels.

Do you find that these manufacturers are going more direct to the retailer with the growth of Albertson's, Krogers's, and others becoming a larger component of the sales in this channel?

We haven't seen that at this stage. It's certainly something that, it's one of the risk factors certainly that we look at and certainly we work at making sure that we bring other value to the relationship with the customers so that they don't feel the need to try to go in that way.

But the other side of that is we are the largest customer to many of our suppliers and I think that as a result I think it affords us the ability to get the best pricing out there from our manufacturers and I think we work very hard to partner with our vendors as well. I think that's always a threat but it is certainly something that is not new today or different today than has been in the past, or do I expect it to be different in the future. I really expect it will always be there.

Then finally, just a point of clarification, that 6 to 7% out-of-stock number, if you were just to look at key products, the fastest moving products in the channel, would that out-of-stock number be a much higher number as in relation to its position in the sales?

No, I don't think so.

All right. Thank you.

Gentlemen, we have no further questions at this time. I would like to turn the conference back over for any closing comments.

Thank you, John. On behalf of the nearly 3,800 UNFI associates I just again want to thank you all for your continued interest and support in our company and the industry that we serve. Thank you and have a good day today.

Ladies and gentlemen, this concludes the United Natural Foods third quarter 2004 results conference call. If you would like to listen to a replay of this conference, dial (303)590-3000, or 1(800)405-2236, you will need to enter the access code of 579570 followed by the pound sign. Once again, thank you for participating in today's conference. At this time you may now disconnect.