United Natural Foods Inc (UNFI) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the United Natural Foods third quarter 2005 results conference call. At this time, all participants in a listen-only mode. Following today's presentation, instructions will be given for the Q&A session. If anyone should require operator assistance at any time during the conference, press the star zero. As a reminder, this call is being recorded today, Tuesday, May 31, 2005. And I'd now like to turn the conference over to Mr. John McNamara with Financial Relations Board. Please go ahead, sir.

Thank you, good afternoon, everyone. Welcome to the fiscal year 2005 third quarter conference call for United Natural Foods. By now, you should have all received a copy of this morning's press release. If anyone still needs one, please call Janet Jasmine in our New York office at (212)827-3777 and we will send you a copy immediately following the conference call. With us this morning from management are Steven Townsend, Chief Executive Officer, and Rick Puckett, Chief Financial Officer. We'll begin with some opening comments from management, and then we will open up the lines for Q&A. As a reminder, this call is also being webcast today and can be accessed on the internet at www.unfi.com. Before we begin, as usual, we would like to remind everyone 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. With that, I'd like to turn the call over to Steve. Go ahead, Steve.

Good morning. Thank you, John and welcome everyone to our third quarter conference call. Joining me today on the call is Rick Puckett, our CFO. Our third quarter resulted in EPS of $0.26, which is an increase of 24 percent over the $0.21 per share we recorded for the same period last year. Excluding special items, our EPS was $0.26, which is an increase of 18 percent over the $0.22 we recorded during the same period last year. Again, I am pleased with the 24 percent rise in EPS, which came during a quarter where we felt the impact of a number of significant items. These items included the continued rise in fuel and energy costs, which rose again and cost us approximately 1.4 cents. The cost we are presently incurring as a result of Sarbanes-Oxley and the dilution from Select Nutrition acquisition which will continue through the remainder of 2005 or until our integration efforts are completed. We are presently on target to complete our IT integration with Select before the end of our current fiscal year.

During the quarter, we recorded sales of $534.3 million. This was an increase of 19 percent over the 48.4 -- $48.9 million we recorded during the third quarter last year. Excluding the impact of Wild Oats and Selection Nutrition, our comp growth rates in our broad lined distribution business was 14.6 percent. Overall, our comp growth rates continued to exceed that of the industry due to our commitment to provide a diverse selection of products, multiple delivery options and consistently strong service levels and fill rates to all our customers. In addition, we offer a variety of marketing and customer support programs to help our customers drive sales in their own businesses. At the present time, our mix of business by channel is as follows: independents represent 46 percent of our business; super naturals represent 38 percent of our business; the conventional supermarket represents 13 percent of our business, and our other channel represents approximately 3 percent. Our largest customer, Whole Foods Market, represents approximately 26 percent of our total sales and Wild Oats represents approximately 11 percent.

Looking ahead, we are raising our revenue guidance for the year to $2 billion to $2.05 billion from $1.9 billion to $2 billion. During this quarter, we continue to focus on a number of key initiatives. First, implementing our contract with Whole Foods. Second, consolidating our former Minneapolis business through our newly-expanded Iowa City location. This move allows us to offer more products and better service levels to this group of customers. Third, our integration efforts with Select Nutrition. To date, we have made good improvements both operationally as well as from a systems standpoint and we're now approaching break even. As mentioned previously, we expect to complete the IT consolidation by the end of our current fiscal year. Fourth, implementing operational and processes improvements within each division. And fifth, the construction of our new facilities in Indiana and Northern California.

The Indiana facility will increase our capacity in the region while enabling us to better balance sales between our New Oxford, Iowa City and Atlanta facilities. We expect to open the facility in early July and then to transition sales there over the next sixty days. The northern Cal facility will allow us to consolidate operations from our two existing DCs into one building. This will allow us to support the expected growth within the region, while operating more efficiently. We expect this facility to open during our first quarter of fiscal '06, and we will be closing down our two existing DCs during our second quarter. The transition costs associated with etch facility will be approximately $1.5 million.

During the quarter, I am pleased to report that total operating expenses came in at 15.48 percent of net sales, which is a 35 basis point improvement over the 15.83 we recorded during the same quarter last year. Again, this improvement came despite the impact of rising fuel and energy prices, the period loss associated with Select Nutrition, and expenses associated with our compliance with Sarbanes-Oxley and 404.

Overall, our operating margin, excluding special items, came in at 3.6 percent, versus the 3.7 we recorded during the same quarter last year. Excluding the impact of fuel and the loss from Select Nutrition, our operating margin would have been approximately 3.8 percent, which is in line with past results. Also, impacting operating margin were expenses associated with the compliance with Sarbanes-Oxley. Overall, I'm very pleased with these results as they reinforce the success we have had and have realized from our investments and people, facilities, equipment and new technologies.

Looking ahead, I continue to be pleased with our progress to date that we know we have more work to do in helping our customers to be more successful with their businesses. Even with our existing high service levels, we remain focused on improving our operating metrics further. This goal will only help us to better serve all of our customers. Over the next 12 months, we will focus on growing business across all of our sales channels, continue to grow sales and channels such as in food service and international sales. Growing sales of UNFI branded products, continuing the integration efforts with Select Nutrition, implementing a common business system across our broad line distribution business, continuing to invest in our people, facilities, equipment and new technologies which will help us to reduce costs across our businesses. And implementing a common -- and improving operating margins across all of our divisions.

Lastly, I just want to take a moment and thank all the UNFI associates for their dedication and hard work in helping to make our third quarter a successful one for the business. I would now like to turn the call over to Rick Puckett, our CFO. Rick?

Thank you, Steve and good morning, everyone. Net revenue was $534.3 million for the third quarter fiscal 2005, an increase of 19 percent over last year's third quarter of $448.9 million. Subtracting out the revenue for Select Nutrition recorded in the quarter, our net sales increased by 16.2 percent. Our wholesale comp growth rate for the quarter was a very healthy 14.6 percent when backing out Select sales and sales to Wild Oats Markets that were incremental over last year in the quarter. Future quarters will only have Select Nutrition pulled out for comparison purposes. As Steve mentioned, we have changed our current year guidance on revenue from 1.9 to $2.0 billion to $2.0 to $2.05 billion.

Excluding special items, net income for the third quarter of fiscal 2005 increased 17 percent to $10.8 million. Compared to $9.2 million for the quarter ended April 30, 2004. Diluted earnings per share, excluding special items, increased by 18 percent to $0.26 from the $0.22 recorded in the third quarter of last year. Including special items, net income for the third quarter fiscal 2005 increased 24 percent to $10.7 million or $0.26 per diluted share compared to $8.6 million or $0.21 per diluted share for the same period last year.

As detailed in our press release, the only special item recorded in the third quarter of fiscal year 2005 was $114,000 of expense or $70,000 after taxes and resulted in a negligible impact on diluted earnings per share. These charges were related to the closing of our Mounds View, Minnesota facility, which was completed during the third quarter and the new Greenwood, Indiana facility, due to open in July. In the following quarters, there will be additional special items related to the Greenwood, Indiana facility and Rockland, California facility as we transition those into production.

Also detailed in our press release, the third quarter fiscal 2004, included special items of $1 million in net expense or $616,000 after taxes. The special items for the third quarter fiscal 2004 included expenses related to the implementation back to the primary distribution relationship with Wild Oats markets. Also impacting the quarter, but not treated as special items, fuel costs remain very high and had a negative impact on earnings during the quarter of $0.01 per diluted share. Excluding this impact, our earnings would have been $0.27 for the quarter. The higher fuel costs resulted in the year-to-date penalty of 2.4 cents per diluted share. Fuel costs related to last year were even more negative at 1.4 cents for the quarter and 3.9 cents for the year to date. This quarter's impact was negated to some extent by the fuel surcharges that we have in place due to contractual terms. A fuel surcharge has been implemented on the remainder of the business, effective in late May and will offset some of the higher fuel costs expected in future quarters.

Gross margin for the quarter was 19.1 percent compared to 19.5 percent for the same period last year. The gross margin decline came principally as a result of the increased revenue mix of the super natural channel. The decline in gross margin was offset significantly by lower operating expenses, despite higher fuel costs. Gross margin year-to-date is 19.1 percent, as well. We expect gross margins to be in the low 19 percent range going forward.

Operating expenses for the quarter were 15.48 percent of sales compared to 15.83 for the same period last year, excluding special items. The 35 basis points improvement is a result of increased efficiencies due to the larger delivery quantities recognized with the super natural channel customers, and our continued investment in technology and facilities. The incremental cost of fuel for the quarter had a negative 13 basis points impact on operating expenses.

The costs associated with Sarbanes-Oxley are expected to increase over the next quarter as we come to the end of this project. The cost this past quarter were equal to approximately 3 basis points of outside expense.

Excluding special items, operating income was 3.6 percent for the quarter, compared to 3.7 percent for the same period last year. When excluding Select Nutrition and the fuel cost year-over-year, operating income would have been 3.8 percent for the quarter. Select Nutrition continues to improve and we expect to see neutral to positive earnings in the next quarter related to the acquisition.

At this time, I'd like to elaborate on our status related to the requirements of complying with Sarbanes-Oxley in particular, section 404. We're in the testing phases of the project with remediation going on relative to any deficiencies that have been discovered. We do expect to be complete within our timeframe requirements which is by the end of our current fiscal year in July. As mentioned earlier, these costs will be more significant in the final quarter as we complete this project. To date, Sarbanes costs have been minimized as we have done much of the work with internal resources. Still, the costs are in excess of 1 penny per earnings per share and will approach $0.02 before we are completed. The costs have been included in our current guidance.

Cash generated in operations for the nine months ended April 30, 2005 was $1.7 million. Our inventory was at 46 days for the third quarter, favorable to our target of 48 to 50 days. DSO for the third quarter was at 24 days. Favorable to our target of 25 to 27 days. Capital expenditures were $41.2 million for the nine months just ended, equating to approximately 2.7 percent of revenue.

As we had discussed last quarter, we expected higher capital expenditures this quarter, resulting from the new facility in Indiana. We also announced the acquisition of the Rockland, California facility in early March. Our full year expectation for total capital expenditures in fiscal 2005 has changed to 45 to $50 million with a change from previous guidance resulting from the timing of the Rockland, California facility.

The Company's outstanding commitments under the amended and restated credit facility as of April 30th were approximately $150 million with an available liquidity of $95 million. Our return on total capital was 22 percent, and our return on equity was at 14.2 percent. In addition, our trailing 12 month EBITDA has increased by more than 24 percent year-over-year. At this time, I'll turn it back over the moderator to facilitate questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] And our first question comes from Ed Aaron with RBC Capital Markets. Please go ahead.

Thanks, good morning. I have a few questions, actually. First on the fuel surcharges, can we expect that that is going to, you know, take away all of the incremental impact that we've seen say over the last quarter, going forward, obviously those weren't in place for the entire -- won't be in place for the entire fourth quarter, but is it fair to say that the entire $0.01 will be taken away by the surcharges?

No, actually the -- the fuel surcharge is actually designed to, you know, offset the fuel cost going forward or at least the increased fuel cost. It's not designed to go back and recoup all that we have experienced to date. So, I would not expect that, Ed.

Yes, I understand that. I guess I'm -- I'm just trying to figure out if it's fair to assume we won't see any incremental negative impact from fuel.

I think it's hard to answer that. I mean if we see another large spike in fuel, it could potentially, you know, have the impact of, you know, again, hitting us. But if fuel prices stay at current level, then we feel this will have offset, you know, the increases that we've seen over the last year in terms of the raise, but we're not trying to recoup the cost that we've incurred in fuel over the last -- over the first three quarters.

Okay. And then my second question, on the new facilities coming online over the next couple of quarters, could you just give us a sense of how much near-term margin dilution we might see from that?

I think we will be in a better position to do that when we do our '06 guidance. We're actually in the process now of kind of pulling together, you know, budgets for '06 and certainly what we expect to see would be initially a little bit of dilution to margin as these facilities come online, but clearly, you know, we need the facilities from a capacity standpoint, both in the east and the west, and as sales get transitioned into them, we expect, as we've seen in the past, with other facilities, after the period of 2 to 4 quarters, we will typically then see our efficiencies pick up in these facilities. So, I really don't see that changing in terms of the impact on operations, Ed. Okay.

And then lastly, could you comment on the change on the balance sheet, in both pre-paid expenses and crude expenses this quarter?

Sure. The prepaid expenses, first of all, there's actually, for the quarter, a bit of insurance that was renewed. You got a spike for that. And there was also some other assets because pre-paid expenses also includes other assets. There were other assets classified as short-term for the period.

On the accrued expenses piece, it's more of a timing in the payroll and its mother items there, Ed. Nothing really unusual there, at all. It's more of a timing issue than anything else. So, not anything unexpected.

Okay. Thank you.

And our next question comes from Scott Van Winkle with Adams Harkness. Please go ahead.

Hi, guys, can you give me a little more exact number on Wild Oats in in the quarter? When I calculated internal growth, x-Wild Oats, I came out with a slightly lower number.

Scott, Wild Oats was transitioning during the third quarter of last year so you would have been hard pressed to get an exact number on your own. But they started in January and actually finished by the end of March in the transition. So, February and March were transition months last year. So, it would be very difficult for you to come to a number on your own. We really haven't tried to share those exact numbers with anyone at this point and I'd rather not do it here.

It's a little too difficult, Scott, to do that, because, as Rick said, we transition Wild Oats in the east in February, then during March we transitioned the facilities in different weeks, you know, across the quarter. It was actually quite difficult in terms of looking at the comp growth rates with the exclusion of Wild Oats.

And am I going to get the same answer if I ask about Select Nutrition?

Select Nutrition is pretty easy because we just bought it.

The Select Nutrition revenue for the quarter, Scott, hang on one second, was $12.8 million.

Okay. Is that a seasonally stronger period for Select because it's kind of the end of the diet season?

No. Not really.

And what have you done there on, you know, your plan to move some of your own nutritional supplement sales out of your facilities into Select's facilities?

Part of that will occur, but, you know, the first steps to that occurring is for us to get them onto the United Business System which will happen, again, by the end of this year. We can then make some process improvement changes operationally to the facility. Once we've done that, we will begin to move some product out of, you know, our major distribution centers and move those into the Select DCs.

And Rick, your comments on the gross margin being down year-to-year because of the mix to mass, sorry, mix to super natural, was it -- is that also the reason for the SG&A decline year-over-year? Was that all of it? Or was there some incremental expense leverage?

Certainly some of that was a result, as I mentioned, in terms of 35 basis points of improvement, on the SG&A line, is a result of the larger delivery quantities.

Sorry I didn't hear that --

-- of lower operating expenses.

And can you -- can you give us a number as to where you are in private label? You know, I'm a big fan of the new beef product.

Oh, good. We like to hear that. Now, we are continuing to see very strong sales trends on the United branded products, you know, our sales growth, you know is in the 50 to 60 percent growth rate in it that and we continue to obviously see this as a real, you know, key part of our goal strategy. And we talk about it I think on every quarter. We are going to continue to be aggressive in terms of bringing out branded products, Scott. So, I'm glad you like the product.

And, Rick, I apologize, I already missed one number. Maybe you said it. Did you give more detail on Q4 earnings? Obviously your guidance for the full year, there's only one quarter left.

We haven't changed the overall year guidance on that, Scott.

And is Sarbanes, you know, going at $0.02 in the fourth quarter, is that higher than where you thought it would be three months ago?

It's actually $0.02 in total. All of it will not occur this quarter, so we had originally estimated when we put the guidance out for this year, that it would be about $0.02, actually and it's kind of held true, but the way we've maintained that, quite honestly, is by diverting a lot more resources internally to that cause. So, you know, two-thirds of the work has been done with internal resources.

But overall, what we're going to spend will be between 1.25 and $1.35 million on it and that's --

That's just outside direct costs.

Outside direct costs. Doesn't include our internal, you know, in-kind service, staff that we've put on the project.

Right, right. And last question, you know, back on Ed's question about accrued expenses, that seems like a big number to be just timing on payroll alone. I mean payroll in the quarter wasn't all of the 82 million of operating expenses, but it was -- I don't know -- I'm not sure I understand how it could just be timing of payroll.

Well, it's not just payroll. It's other items, as well. As I mentioned to Ed, but they are timing related and the other items are more related to the receivables piece and customer moneys going back and forth. Again, it's very, very consistent with how we do business and so on, but the timing of such is just showing this way on a balance sheet, which is a point in time, obviously.

Okay. And I'm sorry, one other question, your second largest customer put in a plan to kind of start selling conventional products in their stores. Is that something that you would handle? Or something that you're not going to touch at all?

Our focus is natural and organic, you know, that's where we're going to continue to focus our business efforts. So--

You are seeing them consolidate more of their vendors onto your trucks though, right?

Yes.

Okay. Thank you.

Thanks, Scott.

Our next question is from Gary Giblen with GMG Capital.

Hi, good morning. Good quarter. Just wondering, as Oats picks up its sales volumes, as it is for now, does that lead to price breaks on wholesale cost to them? In other words, does it cause the incrementally lower margins to you or is it all the same in the way the contract is written?

Basically is the same, Gary, the way the contract is drafted and written. So, you know, we're not going to see any -- any margin erosion or large margin erosion on that basis.

Okay. That's good news. And the -- I mean it's good to see that you put in the fuel surcharge for diesel, but I guess the question that gets -- to beg the question is why did it take so long, given that you have a pretty dominant position, especially in that -- in the independent and supermarket channels. So, was there pushback on that? Or you just want to see how fuel prices evolved?

Part of it is we wanted to see what was happening with fuel prices but at the same time, because we're still operating on three different business systems in our broad line distribution companies, we wanted to kind of evaluate what was the best method for handling a fuel surcharge? We thought we wanted to try to do it systemic, but basically what we found is because of the different business systems it really wasn't possible. So, we decided then just to implement, you know, a basic fuel surcharge, based on delivery or a stop charge. So, it was really more trying to figure out what to do because of the three business systems we have currently operating.

Oh, okay, that helps. And then is the reason you raised revenue guidance but not EPS guidance, is that because Sarbanes-Oxley is more costly? Or is it the facility transition expense is more than budgeted? Or, you know, what -- what would explain that?

Well, we had previously raised guidance, as you know, at the beginning of the year, which, at the time, fuel costs were still not being experienced like we are today. So, essentially, Gary, I would say the fuel costs going forward are still of a concern and we have guidance out there of $0.95 to $1 and we're at $0.72, I think, today. So, you know, I think the guidance is still very real. I don't think we need to raise it at this point.

Sure. Okay. And then just last thing is a bookkeeping question. Is the best tax rate going forward to assume for projection 38.5 or 39? I think the consensus was 39, but you came in with 38.5, which, you know, was helped by almost a penny and a quarter, but what's the real number to project on?

The actual tax rate that we're looking at, given our tax analysis, is around the 38.6 or 38.7 for the year. The reduction of 38.5 will average auto for the year at about 38.7.

Sure. Okay. That's great. Okay. Thanks very much.

Thanks, Gary.

And our next question comes from Greg Badishkanian with Smith Barney. Please go ahead.

Great, thanks. Great job, guys, for the quarter. And a question on the fuel going back to that, have any of your competitors implemented a fuel surcharge?

I haven't seen any yet with it, but our implementation really just began about a week ago so I'm not sure anyone would have a chance to respond at this point.

Right. And also with respect to service levels versus last -- let's say second quarter, you know, how have service levels been trending?

We continue to trend positively, you know, we're probably up -- I don't have exact numbers, but, you know, we look at every week, we're looking at our service levels across all facilities and I would say we're up over last, but, we're definitely up over last. We're seeing obviously marginal increases now because we're actually at a pretty high level for our company. So, I'm actually very pleased with where service levels are today.

All right. And with respect to California. When you closed the two facilities, how much additional square footage will you have? And maybe that's not the right way to look at it because one facility will be more efficient than two. But, how would you look at it from a capacity perspective? How much additional capacity will you have to service the market?

Greg, on a net basis, just using Rockland, it's a couple hundred thousand square feet of additional capacity. It puts us at a 70 percent capacity utilization, sorry, 67 percent capacity utilization. After that Rockland facility goes on board.

The other thing, too, Greg, on this facility is -- is the new facility for us is over 400,000 square feet. So we will actually have additional room to grow into that. Again, with the marketplace we have there, we feel like we need the capacity because of the growth rates we're experiencing in California right now.

Great. And just going to the strong sales growth, you know, this quarter you did 14.6. You were up against a 15 percent comparison last quarter. That's like a 14.5 percent to your average, but when you look at the second quarter of '05 and second quarter of '04, it was 12.3, so you really saw a nice acceleration in the two-year average growth rate. You know, are you still looking at the 8 to 11 percent longer term growth or maybe if -- the trend might be a little bit higher?

No, I think -- we tend to be fairly conservative and as I mentioned earlier, we're in the midst of our budget processing right now. That's something we're looking at and I think as we complete our '06 planning, we will have a better feel for that, but right now we still feel like that 8 to 11 is realistic long-term. But I'm not sure where long-term actually begins for us.

Great, thank you very much.

Thanks, Greg.

And our next question comes from Mark Chekanow with Sidoti & Company. Please go ahead.

Good morning, guys.

Good morning, Mark.

Going back on the fuel surcharge, could you talk a little bit about the format, is this on a per-stop basis or per-order basis? And then also when you look at the magnitude of the surcharge, if your competitors, for the most part, don't institute any type of price increase, are you still price competitive? Or is it nominal when you look at overall pricing?

Mark, there's a couple of models. One is contractual, and that's obviously defined by the contractual terms. The general fuel surcharge that we implemented last week is actually on a per-stop basis. So given the magnitude of that charge on a per-stop basis, it would not put us into an unfavorable position on a competitive basis.

Okay. And then when you look at -- at next year, I know you're still, you know, in the planning process of getting to 4 percent, is that achievable with -- or getting to that level achievable on the current cost or current fuel surcharges? Or has the rise in fuel cost kind of pushed that 4 percent goal out even a little further?

The fuel has certainly impacted us and it's not only the diesel fuel, but being translated through an energy cost because obviously power plants are burning fuel and in terms of making electricity. So, we're seeing it, you know, translate through other parts of our operating expenses. Clearly, this has had an impact on it -- I think Rick has talked about the fuel, we're not talking about energy costs there, but, added really cost us 13 basis points, you know, Select Nutrition was about 11 basis points. You know, clearly the 4 percent is the goal for us, but there tends to be things that happen every year, be it acquisitions or something like fuel or as we put facilities online, which we need to as we invest in our future, if we're not building capacity to meet demand, we will find we will end up getting behind, you know, our opportunity service customers more efficiently. So, we will continue to make these investments, which, in had the long-term, you know, will give us the sufficient capacity to meet demand at the same time and we expect, you know, that as the facilities mature, they're going to become more efficient facilities. We've seen that historically, going back to New Oxford, Atlanta, Chesterfield, Iowa City this year. I expect that when Indy comes online and northern California come online, we will see the same trends happen with those facilities.

Thank you.

Thanks, Mark.

Our next question comes from Eric Larson with Piper Jaffray. Please go ahead.

Good morning, everyone. Nice quarter. Just a lot of the questions have been answered. But I know you're going through the process for '06. You had a big spike in CapEx this year, would you expect that to trend down a little bit next -- you probably will have some in the first quarter for the new facility, but would that trend down, would you think, for the '06 period?

We do think that, Eric. And as a matter of fact, you're absolutely right. It will be somewhat front-loaded as a result of the timing of the Rockland, California facility completion, which was not in our previous guidance. But we will, you know, put some guidance out on CapEx, along with the earnings and revenue guidance for the '06 period. But we do expect it to be lower than this year.

Okay, and it looks like your drawing on your revolver to finance some of the near-term stuff on that?

We currently are, yes.

Eric, the plan is to convert some of the long-term debt, when we've completed the projects.

Okay. And then one final question on -- on kind of the sales, the sales -- now, the third quarter was kind of the last kind of non-apples to apples quarter. I want to be correct on that, with the Wild Oats fourth quarter should be all transition -- should be apples to apples, correct?

Except for Select.

Except for Select, correct, okay. And final question, the acquisition outlook, are you seeing more things out there right now? You know, obviously you can never predict the timing on that, but what -- does it seem to be a little bit better environment for that right now?

You know, as always, we are an inquisitive company and see things, and obviously we don't really comment on them. You know, until they happen. But I don't think the environment has changed at all from the standpoint of what we're seeing.

Okay, great, guys.

Thanks, Eric.

And our next question come from Andrew Wolf with BB&T. Please go ahead.

Thank you. On the SKU rationalization, could you quantify what it was in the quarter? Same on Sarbanes-Oxley?

Yes, as it relates to the Sarbanes-Oxley in the quarter it was basically three basis points of external cost so not a lot in this quarter. Most of that will start to appear in next quarter, particularly with the KPMG fees we will experience with the itself, as well as the continued testing that we're going through. So, not a lot of cost in this quarter for Sarbanes, but certainly in the fourth quarter we expect to have more there. As it relates to -- I forget the first part of your question -- the SKU rationalization, yes. It was similar to last quarter, Andy, in terms of impact. It's an ongoing process that we're doing and I think we said 5 to 7 basis points last quarter, it's a similar number this quarter.

Okay. How ongoing is that? And then -- when will you be sort of ramping that down?

I don't ever really see ramp down. I think what we're seeing is probably, you know, a greatest impact that we're seeing is hitting us really over the last two quarters in this quarter and I would expect probably the next two and after that, it will be just as we do a constant evaluation. It's sort of the bottom 10 percent rule, we will continually evaluate, our SKUs as well as our brands and vendors on a regular basis and which we need to do is obviously the real estate that we have is expensive real estate, and we need to know that products are actually moving in our facilities and so it's going to be a continual process, but I think the impact going forward will certainly begin to diminish over the next quarter or two and then it will be a constant where we're constantly evaluating the SKUs and vendors on a regular basis.

Okay. So, is that just the write off, the inventory and throw it out? Or just sort of discounted -- I mean is this just the cost to get rid of stuff you don't want to round?

We basically do all of those things. You know, when we can, we try to get the product back to the vendors for full credit. If we're [discoing] an entire line, we may discount it deeply to move it, then lastly be food banking it. So, there is a process we go through internally to try and move it, you know, our plan is that if we designate an item to be [discoed], that we want to move it out within 90 days to free up the slot for something else.

Okay. And could you give us a -- a budget on the fourth quarter for Sarbanes-Oxley?

Well, as I mentioned before, we expect Sarbanes to cost us a total of $0.02 for the entire project and that started some time ago. It just didn't start this past quarter. So, you know, this coming quarter, it's included in my guidance already for the year. It's probably going to be a penny this quarter. Pretty close.

That would be a lot of direct cost this quarter.

Right, right. It will be two-thirds to a penny, Andy.

Thank you. And on Select, can you quantify -- you said it's dilutive -- it was dilutive in the quarter and will be also in this quarter, in the fourth, can you give us a quantification on that?

Rick said neutral to positive.

-- neutral to positive.

That's what I heard him say. And I said dilutive. So --

Alright, I was confused. Okay.

Yes, you were confused, but I think in reality, until we get Select on to the UNF system and we can begin to make the process improvements, I expect, in reality, to break even of the so, my sense is you're really not going to hear much on fourth quarter, other than for us to say we've now done the IT conversion and working to implement the operational improvements that we'd be doing within the facilities.

Okay, I just have two -- these are more long-term questions. On the transition cost, I just want to check, did you say 1.5 million per --

Facility.

Facility. And could you break out the cash component versus write downs and other things?

Well, there's very little write down, actually, Andy. Because one facility, Indiana, is a brand-new facility. So, you know, 1 1/2 is probably on the top side of what we'd expect on the cash side. It's really, you know, moving the equipment to moving the -- the inventory.

You have also the training wages that go in because we've hired staff that with are going to be training these people will be working in June, even though sales won't be transitioned in there until July. We will be carrying training wages, things like that. And Rockland, it's pretty much move costs, as well as some write down of some of the equipment in the older facilities and things. So, you know, but the million and a half is still -- when I look back at other moves where we closed NAC down or when we moved the two facilities from Atlanta into the one facility, that's approximately where we were.

You'll be breaking these costs out, I assume, as you have in the past?

Absolutely. As we have the quarters.

Okay, lastly on the common system conversion, sort of two questions about that. Could you just broadly speak about the cost and benefit of doing that? And the timing? And sort of the management of risk inherent in this kind of process, there are certain risks and how you plan to manage that.

I will start by saying that this is something that has been ongoing, you know, in -- in August, September this year, we took the Iowa City and Mounds View off of the old [INAUDIBLE] system and moved it over, so it's clearly something we've done in the past, we obviously are very careful about what we do, how we do it, we go through extensive user testing for sure that when we do the transition, that our customers will not be impacted by it and that's certainly something that we're very cognizant of. So, you know, we tend to do it pretty conservatively. The Select Nutrition, you know, we said will be done by the end of the year. We feel like if we do our work and our planning ahead of time, then we mitigate the risks that way. There's always an exposure there. Cost. We don't break costs out because ultimately the cost, for us, is going to be a savings because now we're all using basically the same business practices and the implementation and we tend to see it because we tend to become more efficient because not only with how we operate the facilities, but also how we buy for buildings, we can also become more efficient in terms of doing that.

So, that's typically how we approach it. The long-term is after the Select, then we have, you know, three business systems, looking to do one in first calendar quarter of '06 and probably within 12 months after, we'd be looking to do the last business system. So, clearly getting everybody on the same business system just makes a huge difference just in terms of being able to use best practices and standardize our processes across all distribution centers.

And, Andy, just to elaborate a little bit, it's not like we're bringing in an off the shelf package. We have a system that works very well in the eastern part of the United States and we're actually pushing that system across the country and that's the costs associated with that are really inherent already to our IT department and our budget accordingly. So, not a lot of incremental costs outside, if you will, in terms of outside consultants coming in and doing a lot of work for us.

Okay. Thank you.

Thanks, Andy.

And our next question comes from Scott Mushkin with Lehman Brothers. Please go ahead.

Thank you very much, hi, guys, how are you doing?

Good, Scott.

A couple of questions have been answered, I was thinking of a couple more strategic questions here. Number one, I don't know if you guys have ever done this, but can you go through the economics of the private label programs as far as for you guys that Oats and Whole Foods are pretty dedicated to at this point?

We do that obviously internally in terms of how we look at our branded product and, you know, how it fits into our distribution infrastructure and basically how it complements what we're doing out there with our existing vendors. So, clearly it's an initiative that we've had for really the last three years and one that we feel very, very committed to because we think it's a -- it's a real advantage for us because of, you know, the strength that we have within the distribution areas, you know, it's a benefit for our customers and clearly, we see it a win-win all the way around.

And as far as their programs go, you know, Wild Oats and Whole Foods, how does that breakdown for you guys?

We support the programs, you know, we -- we work with both companies with handling their own private label programs. So, in Select distribution centers. So, that -- that's something we will continue to work with.

And are the economics similar for private label product as they are for -- I know there's a surcharge, but I was just wondering, are the economics comparable to branded -- branded product?

No, not for us it isn't.

The second question is as you look over your portfolio of what you offer, I know you bought Select Nutrition, do you feel like there's anything missing? As far as product offering goes? I guess I would specifically looking at the mass channel where I guess Tree of Life has been talking up their ability to deliver both natural -- organic and natural as well as gourmet. Is that something you would take a look at?

You know, again, we know what we do well and that is we handle natural and organic products. The specialty/gourmet area is a pretty -- it is a very specialty-type area. I don't feel like that's an area that we're going to expand into in any great shape or form and from the standpoint again, there's things I think that even within our categories of products, that we can expand upon. I just look at a category like produce, we have a division that handles produce. I've got 10 distribution centers that I could be running produce out of that we're not currently doing. So, we see an opportunity to continue to grow in existing categories that we already carry without having to break into a brand-new line of business, which is what specialty and gourmet would require to us do.

Do you feel your product line is pretty full now with the Select Nutrition purchase?

Yes.

And then finally, and thanks so much for all of your time, is the Road Net, we didn't get an update on how that's going and what, you know, kind of what's going on there? Maybe you can give us an update on that.

We're still continuing to -- we've had Road Net now in place, we've brought, you know, trained staff on board. We actually have done, you know, a complete review of one of our facilities and actually in the process today of implementing route changes as driven by Road Net. The other thing that we've used it for is with the Indy facility coming online in July, we've actually used Road Net to identify which routes we were going to be moving out of New Oxford and Iowa City into Indy to obviously minimize costs, so, that's the type of investments we are doing today and will continue to do to help drive costs out of the supply chain.

And when do you think you will be fully implemented on the system? Is that sometime in '06?

I see it as -- when you say fully implemented, you know, I think we will be going through, obviously from a facility to facility standpoint with Road Net to do that. I think it will really be on an ongoing basis for to us look at our routing. Because it mixes not only our deliveries but as well as our pickups while we're doing pickups from vendors and things like that. It will be sort of an ongoing process going forward.

It seems to me, because of all the back hauling you guys do do, that this could be a significant situation here. Have you put any basis points around it?

Not yet. Because we're still in the process of just seeing the -- what advantages it offers us today. As we get a better feel for the use of Road Net and how it impacts our business and then we can begin to tie in not only the delivery, but the backlog part of it, we will begin to see that, Scott. So...

Fantastic. Thank you for your time.

Thanks.

And our next question comes from Steven Weiss with Mindflow Capital Investments.

Thank you very much, guys, congratulations on a great quarter. I have a couple of questions. Regarding like supplier sourcing, a lot of you competitors have recently been implementing strategic initiatives to reduce their sourcing costs supplied by establishing a better communication line with those customers and opening a better collaboration? I know you guys have just implemented Road Net and it should help with some of the things like backlog credits. Was interested if you could provide a little color as to how you guys are managing your supply base going forward in terms of better collaboration, better communication in reducing the sourcing costs to provide more [INAUDIBLE].

We've tried to work with on the supplier side, you know, utilizing things like UTC net and other products like that. What I'm finding that is that not many of our suppliers are in a position, you know, to utilize that at this stage. So what we're doing is trying to build the infrastructure so as -- to the point in time to we get there we would be able to work with them on that process, Steve, so that's kind of what we've done. Now, obviously, a lot to report at this point, but I think it's due in 'part to the fact we just don't have a lot of suppliers that are quite ready for it.

Are you guys planning on consolidating your supplier base or are you happy with the supplier --

You know, we have done that. We talked earlier about the SKU vendor rationalization and we are going through that process of going from product category to product category and looking at the number of vendors and products that we're carrying in there and actually beginning to identify, you know, those that we really want to keep and those that may not make it because we're not getting the product movements on the slots we're giving up. So, that's clearly something we've gone through, that we mentioned earlier that we expect this to be in place really on an ongoing basis going forward, but we will continue to see it really at the level we have really for the next two quarters and afterward we just think it is going to be a standard process that we go through in terms of category management.

When you talk about suppliers you want to keep are you talking about keeping some kind of scorecarding? Is that how you're managing that base?

Yes, exactly, we look at movement, we look at support, new items that they've come out with, how they're supporting those, how they're supporting products at retail, you know, I mean it is a process that we go through.

And their fill rates as well.

Are you modeling that supply base to figure out cost trade outs? I know you talked about backlog credits earlier, are you guys placing cost models in place? Is that what Road Net is for?

We know what it cost us to, you know, carry a product and what the movement is, the gross profit dollars that we generate from it, the marketing support we get from the vendors. There is a whole host of thing that we're evaluating.

Sounds like you guys are way ahead of the game. Final question, what's been your supplier feedback? Are they pretty responsive to this?

I think, you know, I think the good ones are because they feel like we're challenging them to be good. We talk all the time about our focus and helping our customers be successful. We're really looking at it the same way here. You know, we want the vendors to really work as hard as their business as we are at ours.

Great. You know, I really like what I'm hearing. Continued success down the road.

Thank you.

And we have a follow-up question from Scott Van Winkle. Please go ahead.

Hi, guys, actually my question was asked, but here's another one. Publix is starting a new chain called GreenWise, and Wild Oats is doing a store within a store, with stop and shop. Is this stuff that you guys might pick up?

You know, it's certainly things that we're looking at. We work with Wild Oats on their formats. We do business with some of these other chains that are looking more at the natural organic side of the business. So, clearly, I think we will be playing a role in there somehow, we're not sure how yet, but we expect to be playing a role in here.

Thank you.

Thank you.

We have a follow-up question from Gary Giblen. Please go ahead.

Hi, guys, just wondering if you have any unusual amount of customer attrition or, you know, lost of independent business? Because I notice your total revenues were sort of in line with the higher estimates but the natural, organic growth was quite a bit higher. It makes me think some customers went away or -- or failed or something like, is there anything going on like that are or is just an error of estimates out there?

I think it's just the range of estimates you have out there. We were very happy with the increase in sales for the quarter. You know, we were happy enough that we raised guidance for the remainder of the year, so, you know, we're seeing the growth really across all the channels that we do business with. So, there's no -- you know, nothing -- no abnormality happening in terms of, you know, customer erosion or any particular channel, again, we're seeing good growth across all the channels.

Yeah, okay. Great. Are you still gaining significant supermarket share? Or is that kind of stabilizing?

I think the percent of sales for us, you know, in the supermarket business is about where it was last quarter. I think the growth that we're seeing there is paralleling what we're seeing across our other channels.

Okay, great, thanks so much.

Thanks.

And ladies and gentlemen, if there are any additional questions, press star 1 at this time. [ OPERATOR INSTRUCTIONS ] And we have a follow-up question from Ed Aaron. Please go ahead.

Thanks, just a quick follow-up question. On your mix of business, what percent of it would you consider to be in the perishables categories today.

Perishables, if you look at frozen and perishables, it's about 33 perscent or so, 33 to 32 percent.

Do you have a rough guess of total industry dollars that are in that category?

We don't. We don't. That tends to be a strong category for us, we have more capacity really than anybody else in the area. It's also been a high growth area for us. This is -- in terms of the total industry, I don't have those numbers anywhere.

It will be interesting to see if the natural food merchandiser comes out in June with the annual industry look and see if they detailed in that kind of respect. But that's due out, I think, with their next issue.

What was their percentage on a year-over-year basis can do you have that off hand?

It's been roughly about a third of our business.

Hasn't changed very much. A couple of basis points.

Okay, thank you.

And, management, we have no further questions at this time. Please go ahead with any closing comments.

Thank you. And just want to thank you for taking time today to review with us our third quarter results, and I just want to say on behalf of the nearly 3800 UNFI associates, I want to thank you for your continued interest and support for our company. So, thank you and have a great day.

Ladies and gentlemen, this concludes the United Natural Foods third quarter 2005 results conference call. If you would like to listen to a replay of today's call, dial in at (303)590-3000, or 1-800-405-2236 and enter the passcode of 11030291. Those numbers again, (303)590-3000 or 1-800-405-2236 with the passcode of 11030291. You may now disconnect and thank you for using ACT Teleconferencing.