United Natural Foods Inc (UNFI) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the United Natural Foods’ Second Quarter 2006 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. [OPERATOR INSTRUCTIONS].

As a reminder, this conference is being recorded today, Tuesday, February 28, 2006.

I would now like to turn the conference over to Ms. Julie Tu from Financial Relations Board. Please go ahead.

Thank you and good morning everyone. By now, you should all have received a copy of this morning’s press release. If anyone still needs a copy, please call [Janet Jazmin] in our New York office at 212-827-3777 and we’ll send you a copy immediately following this morning’s conference call.

With us today this morning from Management are Michael Funk, President and Chief Executive Officer, and Mark Shamber, Acting Chief Financial Officer and the Company’s Chief Accounting Officer.

We’ll begin with some opening comments from Management and then we will open up the lines for questions. 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 would like to turn the call over to Michael Funk. Please go ahead Michael.

Thank you and welcome everyone to our second quarter conference call. Joining me today on the call is Mark Shamber, our Chief Financial Officer.

The second quarter sales were $601.1 million, a 20.4% increase from the $504.7 million recorded in the second quarter of fiscal 2005. This is adjusted for sales days. Excluding acquisitions, our sales growth on a comparable basis was 18.7%. We are once again very pleased with our growth in the quarter for all channels of our business.

Sales growth in the supermarket and independent channels was well over 20% year-over-year, while the supernaturals channel grew in the high teens. Sales growth was consistent across all regions in the country, with growth coming in very strong in both East and West regions, 19 and 20% respectively.

As a percent of our overall sales mix, supernaturals were 36.3% of our business, supermarkets were 14%, independents were 46.4%, and food service was 1.6%. Because of the continued strength in our top-line numbers, we are today raising fiscal ’06 guidance to a range of $2.38 to $2.42 billion. Whole Foods Market was 27.2% of our total sales and Wild Oats was 9.7% for the quarter.

Looking at our operations, we continue to see consistent fulfillment rates in all regions as service levels for the quarter ran at over 97%, exclusive of manufacturer out-of-stocks. On-time deliveries were at 97.4% and other operating metrics remain consistent.

Opportunities for improvement in employee turnover continue to exist, which, when executed, will offer improvements in productivity. Overall, the turnover was reduced this quarter by 3% versus a year ago, making some incremental progress.

New store openings for the quarter included several new independents as well as a new Sunflower Market, the new natural concept store from SUPERVALU, who has signed a supply agreement with UNFI for these markets.

Earnings per share for the second quarter came in at $0.26 for the quarter, excluding the special charge related to the Rocklin opening. This compares to our earnings of $0.23 the previous year, a 13% increase.

Our operating margin of 3.6% net of share-based compensation and the Rocklin charge was impacted by fuel costs net of fuel surcharges that we collected from our customers, as well as our facility expansions, both in Indiana and Rocklin, California. While they’re both making progress, we continue to see higher costs as these facilities ramp up their efficiencies. In addition, the performance of Roots & Fruits, our Albert’s Organics acquisition, was a negative to Q2 earnings, but we are confident of incremental improvement in Q3 and breakeven by Q4.

As part of our initiatives to strengthen our executive teams and improve our regional management, we announced appointments of Mike Beaudry as Eastern Region President and Randy Lindberg as Western Region President. Mike had recently been in the position of Vice President of Operations for UNFI the last several years. Randy Lindberg comes to us after a 26-year career as CEO of Nature’s Best, one of our largest competitors in the industry. Having regional presidents of this caliber is a huge asset for UNFI. Also, coming back as Vice President of Operations in the Western Region is Michael Michel, who was in that position for 15 years prior to leaving in 2003.

We also made some significant investments in management for our Marketing and United Natural Brands division. Coming back as Vice President of Marketing is John Raiche, who had previously worked for UNFI in senior management positions for 13 years. Also, joining us as Vice President of Sales for the branded division is John Anthony, who has a 17-year career with the natural products industry with such companies as Clif Bar, Kettle Foods, and Nature’s Path.

Our United Natural Brands division now accounts for approximately 3% of our sales and distribution. The division is performing with an annual growth rate of 60% currently. We expect our branded products division to account for 5% of our sales by the end of fiscal ’08, a little over two years from now. With additional margins of 5 to 10%, this division is an important piece in helping us achieve greater profitability. We will continue to invest needed resources to achieve our goals in this area.

We are very excited about the results for the quarter and the strong sales trends we are seeing. But even more so, adding to the depth of our management teams with such quality, experienced natural products veterans will be a huge asset for us to drive future results.

I’d like to now turn the call over to our Chief Financial Officer Mark Shamber for further comments on the quarter.

Thank you Michael, and welcome and good morning to everyone listening in on the call and the webcast.

As Michael mentioned, based on a comparable number of shipping days, our sales growth for the quarter was an impressive 20.4% with a wholesale comp growth rate of 18.7%. We make reference to comparable shipping days, as there was one fewer shipping day this quarter compared to the second quarter of fiscal 2005. As we discussed on the conference call for the first quarter’s earnings, this is a result of the Company’s adoption of a [544] fiscal format this year. In total, our fiscal 2006 year will have two fewer shipping days, with our third quarter having two additional days and the fourth quarter having one fewer day than the prior year.

Based on reported results for our second quarter of fiscal 2006, we reported net sales of $601.1 million, which represents a 19.1% increase over last year’s second quarter net sales of $504.7 million. Our wholesale comparable growth rate for the quarter was 17.5%.

The Company reported net income of $10.8 million or $0.26 per diluted share, excluding special items, for the second quarter of fiscal 2006. Net income for the second quarter of fiscal 2006, including the effect of special items, was $10.6 million or $0.25 per diluted share. This compares with net income of $9.4 million or $0.23 per diluted share, excluding special items, for the second quarter of fiscal 2005 that ended on January 31st. GAAP net income for the second quarter of fiscal 2005 was $9.2 million or $0.22 per diluted share.

For the second quarter of fiscal 2006, special items consisted of incremental and redundant costs incurred during the transition from the Company’s formal warehouses and outside storage facility in Auburn, California, into the Company’s new larger facility in Rocklin, California. These special items are detailed in the press release issued earlier today. Special items for the second quarter of fiscal 2005 consisted of certain non-recurring labor and other costs associated with the discontinuing use of the Mounds View, Minnesota facility for broad-line distribution.

Gross margin of 19.4% for the quarter showed a 48 basis point improvement over the prior year’s second quarter gross margin of 18.9%. This gross margin increase in comparison to the prior year reflects improvements in the Select Nutrition division’s gross margin from the prior year and the stabilization of fuel costs during the quarter. This stabilization of fuel costs off of the September and October highs allowed us to better reflect inbound freight costs from vendors in our pricing. Gross margin for the year to-date is 19.3%, and we would expect that gross margins will continue to remain in the low 19% range going forward.

Our operating expenses for the quarter were 16% of net sales, excluding special items, compared to 15.5% for the same period last year. This increase was primarily due to a combination of the share-based compensation expense recorded during the quarter of $945,000 or 16 basis points in accordance with FAS 123R, and an additional impact of 13 to 14 basis points in operating costs and margins related to the integration of the Roots & Fruits acquisition into our Albert’s Organics division.

Our Select Nutrition division remained [dilutive] during the quarter; however, they continue to make progress towards profitability. Also, the [incremental] costs of fuel for the quarter and inefficiencies that are currently being experienced at our Rocklin, California and Greenwood, Indiana facilities each continue to negatively impact margins for the quarter. As we’ve noted in prior calls, it typically requires a 6- to 9-month timeframe for us to achieve optimum efficiencies from opening a new facility. Excluding special items and share-based compensation, operating margin was 3.6% for the quarter. Further factoring in the dilutive effect of the Roots & Fruits acquisition, operating margin was 3.7% for the quarter, consistent with the same period of last year.

Our inventory was at 50 days for the second quarter, which is within our target range of 48 to 50 days. DSO for the second quarter was at 24 days, which is favorable to our target range of 25 to 27 days.

Capital expenditures were $11.8 million or 1.0% of revenues for the 6 months ended January 28th, well within our target of 1.75% of revenues. Expenditures related to completion of our Rocklin, California facility comprised the largest portion of our year-to-date CapEx. Our CapEx guidance for the full fiscal year remains at the $30 to $35 million level.

With the move to the Rocklin facility now completed, we have reclassified one of the Auburn buildings as held-for-sale in accordance with the appropriate accounting literature. This change in classification is the primary explanation for the increase in our prepaid expenses and other current assets as of January 28th and a greater than expected decline in net property and equipment on our balance sheet.

Interest costs in the quarter were higher sequentially and year-over-year. The sequential increase was driven by rising interest rates, the increase in inventory for the Rocklin facility transition, and the purchase of our Greenwood facility. The year-over-year increase is a combination of rising interest rates, an overall build-up of inventory due to increased revenues, and the Greenwood and Rocklin facility purchases.

The Company’s outstanding commitments under the amended and restated credit facility as of January 28th were approximately $173 million with an availability of $103 million. Our return on total capital was 19.7% and our return on equity was 13.4% for the latest 12 months. Both of these return ratios were impacted negatively by 64 to 66 basis points for the impact of share-based compensation expense.

During the quarter, we also made our first repurchases of common stock under the $50 million buy-back program that was originally authorized by our Board of Directors in December 2004. Approximately 229,000 shares were repurchased in the quarter at a cost of approximately $6.1 million.

The press release issued earlier today highlighted the fact that we are raising our full-year sales and earnings guidance. The Company is raising its guidance for fiscal 2006 ending July 29, 2006, with projected revenues increasing to $2.38 to $2.42 billion and projected earnings per share, excluding special items, increasing to a range of $1.05 to $1.10 per diluted share. Previously, the Company had announced revenue guidance from $2.25 to $2.35 billion and earnings per share guidance, excluding potential special items, from $1.03 to $1.08 per diluted share.

At this time, we are also narrowing the anticipated impact of share-based compensation expense to approximately $5.5 million to $6.8 million on a pretax basis, or $0.08 to $0.10 per diluted share after taxes. In November, we had announced that during the 2006 fiscal year we expected to incur approximately $6 million to $8.2 million of share-based compensation expense on a pretax basis, or $0.08 to $0.11 per diluted share after taxes, excluding special items.

Actual share-based compensation expenses recorded during the remainder of the 2006 fiscal year may fluctuate beyond the guidance we’ve provided based on factors such as additional equity awards granted to employees, changes in the Company’s stock price, and actual results in comparison to the underlying assumptions used in estimating the fair value of share-based payments.

With that, our prepared comments are concluded, and at this time I’d like to turn the call back over to the moderator to facilitate questions.

Thank you Sir. Ladies and gentlemen, at this time we’ll begin the question-and-answer session. [OPERATOR INSTRUCTIONS]. Our first question comes from Eric Weissman with Goldman Sachs. Please go ahead.

Good morning guys. First question, I just wanted to dig into the sales guidance a little bit. When you look at your guidance range for the year, it kind of implies somewhere between low to mid double-digits for the second half of the year, which is obviously somewhat below even at the high end of the range from where you are today. So I guess the first question is in the near-term do you still feel pretty confident in the business’s ability to grow sales at a level close to where you are today or is there something that you’re seeing that’s causing you to be more cautious for the second half of the year?

We always have had a conservative approach to our forecasts Eric. It usually keeps us out of trouble.

All right. And I guess as a follow-up, longer term you guys are probably growing at double or more what the overall industry is growing at. So when you look out beyond the next one or two years, so when do you think UNFI starts to moderate back towards the mean or the industry average or do you think that’s still a ways away?

Well, I think that’s a difficult question because the actual industry growth trends that you’re referencing that are maybe more high single-digits or so, I think are combining the whole gamut of products together. The things that we focus on, the perishables, the frozen, the organics part of the business have traditionally grown at a much higher rate than that. So I think we might be comparing apples to oranges on that. So we certainly continue to think our core business is going to grow at a much faster rate than what those single-digit industry reports have shown.

Okay. Okay, and then on a separate topic, I thought it was interesting with SUPERVALU using you guys as their primary supplier for Sunflower. What is it that you guys have and that SUPERVALU doesn’t that caused them to use UNFI as a supplier to Sunflower as opposed to doing it internally?

And then, I guess as a follow-up, kind of given their size and capability as a distributor, how careful do you have to be in that relationship or how worried are you that SUPERVALU will kind of use this relationship to extract learning from you guys on the product side and then surface as more of a competitor down the road?

Well, we think that basically it’s an issue of scale primarily. The products that are in our catalog are 30,000 SKUs. It’s a very SKU intensive business. The turns that we get for our products don’t compare with the conventional grocers. So we believe that this is why companies like SUPERVALU and other conventional wholesalers and supermarket chains that we deal with view us as an important supply partner. It’s not something that they can do economically by themselves. So we look at it as a long-term relationship and we’re very excited about it.

Okay. Thanks guys.

Our next question comes from Ed Aaron with RBC Capital Markets. Please go ahead.

Thanks. Good morning. Nice job on the quarter. Michael, I was hoping you could talk a little bit more about the Western Region. When you first came back into the mix a few months ago, you specifically highlighted that as an area of opportunity and you’ve since announced a couple of meaningful management changes out there. Can you maybe give us a sense of what the game plan is in terms of both on kind of gaining more customer accounts or just improving the kind of operations out there and what the plan is going forward?

Well, obviously, strengthening that management team was a huge issue for us and bringing Randy Lindberg on recently as well as Michael Michel as VP of Operations I think is going to be a tremendous benefit to the region. Sales have not been the issue out there. The region has grown very strong. It’s just trying to pick up some margin that has been lost over the last few years there, and I think with the changes we’re making, we’ll be making incremental progress towards squeezing out more margin out of the Western Region previous to on a historical basis what we used to get.

And you mentioned in your prepared remarks about employee turnover and that you’ve started to see that come down. Is there a meaningful difference between turnover levels in the East and the West?

It has had some slight variations. I would say that we did-- have experienced slightly higher turnover in the Western Region. I think that’s now coming fairly consistent in both regions. So it’s definitely a nationwide effort that we’re trying to reduce turnovers, specifically in our operations department, to increase productivity. But the West had gone through a spurt of higher turnover. There’s no doubt about it.

Thanks. Okay. And then just on fuel prices, maybe if you could kind of comment on the-- you’ve given some basis point margin impact in the past and I was wondering if you could do that again this quarter? And then maybe also just remind us what kind of the lag effect is and if fuel prices start to moderate, do you see it immediately on the-- and on the inbound side you don’t necessarily but on the outbound side?

Sure. For the quarter, net of the surcharge that we had implemented, the impact was probably about 4 basis points. From a strict operating expense standpoint it was probably 17 basis points negative. And the reason I break that out is because you’ve got the revenue up top for the fuel, so it’s netting to only 4, but it’s impacting the operating expense line.

From a standpoint, obviously, as you mentioned on the inbound side, we’re much-- it takes a little bit longer. It may take as much as three to four months to accurately catch up with what’s coming in from the vendors from a fuel standpoint. From an outbound side, certain of our pricing from a fuel standpoint is priced every Monday, and so we’re able to reflect that as prices decline. Certain agreements are a little bit longer than that.

Okay, great. And then just, lastly, on the interest expense line, it was a little higher than I was looking for this quarter. What’s a good number to use for the full year?

I’d probably need to follow up with you on that one. I just can’t-- off the top, I think that you’ll probably see some moderation as we’ve worked the revolver down since the quarter, but I probably need to just check with you off line on that as to where I’ve got it going out the rest of the year.

Okay, great. Thanks.

Our next question comes from Scott Van Winkle with Cannacord Adams. Please go ahead.

Hi. Congratulations as well. A couple questions, first, Michael what did you say the percentage of sales to Whole Foods was in the quarter?

Let’s see. It was 27.2 Scott. Let me double check that. Yes, 27.2.

Okay. That’s a pretty significant pickup sequentially in year-over-year. Did you pick up any new business there or just a reflection of their strong growth?

No. I think they had a number of store openings right at the end of our Q1 that obviously matured in our Q2. So I think just strong growth from them, nothing new.

Okay. And as far as all the management additions, and congrats on building out a good team, a lot of the old guard coming back it looks like, are most of these new positions or is there--? Would you say it’s kind of half and half changes and half new positions?

On the Marketing and the United Natural Brands initiatives, those are new positions. We’ve talked about investing in our branded initiatives early on, and so this is consistent with what we’ve previously announced. The regional president, obviously, there was a position open for some time. So they’re not really new positions, but they are filling voids that we’ve had for some time.

Okay. And moving over to Select Nutrition, can you give us maybe a percentage of how far along on the integration or the changes you’re making there to improve profitability, kind of the status?

Well, Scott, I would say as far as the progress goes with Select Nutrition, Q2 we made incremental progress in getting closer to breakeven. We expect Q3 and certainly Q4 to begin to see some positive earnings coming out of Select Nutrition. So we’re making progress. We got closer to breakeven in Q2, and I think certainly by Q3 we should get there.

Scott, in Q2, I mean they cut their operating loss in half. So, I mean, they’re much further along each quarter, but getting those last couple of issues addressed just takes a little bit more time.

And I would assume that Q3 is a seasonally strong quarter for that business correct?

Well, I wouldn’t say necessarily strong for that business. I mean I think it’s a good quarter, but it’s not the strongest quarter.

And, Michael, I guess one last question. On the acquisition front, I think on the last call, or certainly when you took over, a question was asked about did we kind of step back from acquisitions a little bit. You’re talking about margin improvements in the West, you’ve made some very good management additions, you’re working on this private label side. Should we expect to see the same pace of acquisitions going forward that we have seen over the last couple of years?

Well, Scott, I would say we remain an opportunistic buyer for the right deal. We’re not going to pay anything, any premiums just to be in the acquisition market, but we, of course, remain opportunistic, looking for any deals out there that might fit. But there is nothing on the horizon that we can see other than looking at potentially a few small branded acquisitions.

Okay and I’m sorry, one last question. Any thoughts on Canada? I think Wild Oats is opening their first store in several-- their first Capers in several years up on the West Coast. Whole Foods is doing really, really well in Toronto. This is a question I think was asked of Steve a year or so ago about Canada. Do you have any difference of opinion on what UNFI does in Canada going forward?

Well, there certainly is some momentum building up there and we are taking a look at our options on how we can distribute in the Canadian market, so definitely something we’re interested in at the right time.

Thank you very much.

Our next question is from [Omar Esbalston] with Piper Jaffray. Please go ahead.

Yes. Good morning. Could you talk about your opportunities in food service and maybe your goals or estimates for how large a part of total sales that segment could be a few years out?

Well, certainly. The food service division that we’ve been putting some resources into has been growing at a very rapid rate. It still, as you know, is a tiny fraction of our overall business. I think we continue to try and find out the right model for our food service supply. We have been looking at partnering with several other food service distributors as a way to getting our products to the end customer, and certainly we’re moving forward with some agreements on that front. Also, we have hired some food service sales managers and are putting, again, more sales efforts into developing some of the business with universities, colleges, schools, and other food service accounts.

So, we think we can continue to see large growth rates in that business. It’s still-- basically the sales effort in that is still in its-- an infant stage, but we like the potential, obviously, and want to continue to put resources into it.

Okay, great. And then you have strong growth in conventional supermarkets. Are you seeing increases across that channel or is the growth driven by new accounts or maybe [food chains]?

I would say in general we’re seeing growth across the channel.

Okay, great. Thank you.

Our next question comes from Scott Mushkin with Banc of America. Please go ahead.

Hey guys. Some more broad questions here, just looking at what you’re doing and just kind of pick your brains on what you think you can do on the efficiency side if anything. I know we’ve talked about ROADNet in the past, and maybe you can give us a quick update on that, but just in general it seems like there’s some opportunity there to really now that the management team is largely in place to kind of get things going in the right direction, and, of course, that has implications as far as margins go.

Yes, Scott, there are several opportunities for us to drive efficiencies through the business. Some of them have to do with investing in some technology. Others are just streamlining some of the management changes that we’ve been putting through. So I don’t know exactly. There’s nothing to announce right now, but we are looking at several different kinds of programs on the technology side that could add some pretty good returns on the investment, but we’ll be prepared to talk about those over the next couple quarters.

Any thoughts of adding a CIO? I mean, I know we’ve added a lot of management, but is there any thought to that?

Well, we have a National Director of IT, Gary Glenn, who has been with the Company for quite a while. So, effectively, he’s performing the job as a CIO without the title. But we’re satisfied with our progress on the IT front at the moment, so no immediate need in my opinion to add that position.

Great. And then just-- and I don’t know if you know this, but obviously there has been speculation in the market regarding Nature’s Best. Do you have any idea when that contract is up with Whole Foods?

You mean with Nature’s Best?

Exactly.

No. I don’t know anything about the Nature’s Best contract that they may have with Whole Foods. I’m not sure they have one.

And then the final question is there have been, and I don’t know if you want to comment on this, some thoughts that you guys may actually want to extend your contract with Whole Foods beyond-- I think it’s got another two years left in it. Any thoughts on that?

Yeah, we are definitely working with sitting down with Whole Foods right now. We have slightly less than two years remaining on our current agreement. And I think both sides are interested in forging a longer-term strategic partnership. Excuse me. So we are meeting regularly to explore new ways of developing that partnership.

Fantastic. Thank you very much.

Our next question comes from [Alex Peterson] with RCM Capital [Markets]-- Management. Please go ahead.

Yes, Alec Patterson. Just sort of circling back to some of the working capital issues, I know you guys are obviously building inventory with the additions of the DCs, but just trying to get a better handle on what we should expect a longer-term run rate to return to on basic working capital, especially the inventory component.

Well, we-- I mean the way the timing sort of played out Alec is-- when the quarter came is that we still had some high levels there that we’re working through. There was some opportunities for buys when we opened the Rocklin facility that we took advantage of. I would think that-- I’ve seen certainly that our days in inventory have gone down. For the quarter, it came out at 50 days, but it worked its way down to 48, and we’ve continued to make some progress on the levels as the sales have picked up.

I would think that we should see-- as the sales continue to grow, obviously, the inventory will grow, but I would think that we’ll get down to probably our historical range of the 48 to 50, and, ideally, if we could get back down to where we were at 46 days, I think that’s what we’d be striving for even though it’s outside the range where we’re comfortable. But a lot of it was with taking advantage of opportunities with manufacturers as we opened up Greenwood and Rocklin, and we’ve worked through a large piece of that for Greenwood. We still had some in there for Rocklin.

Yeah, I guess I’m just wondering circling back, you mentioned how you wanted to try and pay down some of the revolver and maybe that’s an impact on the interest expense in the rest of the year and beyond. But I’m just trying to make ends meet on what looks like an incremental $20, $25 million of CapEx and the current run rate on working capital not exactly generating much in the way of cash to do that. So I’m just trying to get a handle on where that cash is coming from.

Well, and I think the cash as we manage down the inventory levels that-- I mean, obviously the revolver was high at the end of the quarter and we had higher cash levels than we typically have. We’re at the range of $26, $27 million, where typically we’re around $10, maybe as much as $13 million. So certainly on the revolver side that was just a timing issue as LIBOR expired on the Monday after the quarter. But as we work down the inventory levels that will free up the cash flow and allow us to pay down the revolver and generate increased working capital.

So that will be the main source of the cash, the inventory wind down?

Right. I mean the AR has stayed fairly consistent. I think as we’ve grown over the last couple of years, receivables have stayed at 23 to 24 days. So I don’t know that we’d be able to get them much further that there’d be additional opportunity there. I mean, and then, certainly, as I mentioned, we do have the Auburn buildings. We are carrying two sets of buildings right now for Northern California, so there will be-- once we sell those buildings there will be cash coming in as a result of that.

And I know you guys have talked about roughly a 1.5, 1.8% CapEx sales ratio over time. And without trying to pull back the curtains on your game plan here, I mean as you dialogue with Whole Foods on a longer-term relationship, and I know you’ve talked about wanting to fill in geography to help mitigate logistics costs and higher fuel costs, how do we look out over the next two to four years the CapEx requirements, bricks and mortar, to help deliver on those two goals, 1) the mitigating fuel and logistics, and 2) managing the long-term relationship with Whole Foods?

Well, I think we’re definitely as we continue on this growth cycle going to need to construct a new capacity and that could be in the form of expanded facilities or new facilities in different locations. We still think long term that that percentage of CapEx to overall revenue is something we can work with. We may have some years where we’re going to exceed that, but we think on an average basis looking out over the next five years we should be able to stay in that area.

You know one of the big issues about the expansion and use of capital is whether we’re buying the facilities or leasing them, and, certainly, if we choose to lease them, much less capital would be committed to expanding facilities.

Okay, good. Thanks.

Our next question is from Andrew Wolf with BB&T Capital Markets. Please go ahead.

Hi. A lot of questions that I was thinking of were asked, at least in part. So the last question on the cash flow, would you be willing to just tell us what you’re budgeting this year for cash from operations versus last year’s $38 million? Do you think that number is going to be up?

I mean I think-- I think that it’s a trend that we’re currently going in Andy. It should be. There are still some decisions to be made that could impact that. Certainly, if-- to the previous question where our CapEx is going, if we were to open another facility or to start looking into that and start building inventory for it, that we wouldn’t be able to generate as much because we’d start stocking up the inventory before the facility would be ready to start operating. So there’s some potential that depending on the timing as to-- as we look at facilities and how quickly they become available and we’re able to get into them that there could be an impact from that standpoint. But I would say that given where we’re currently heading that it should be at that level, perhaps slightly higher.

And similar on payables, can you get that back up to a higher ratio of inventories now? It sounds like you’ve got some deals and probably have to buy them forward. So can you get your payables ratio back up?

Mark Shamber. Yes. I mean certainly. I mean we’ve done some-- we’ve implemented some internal systems to sort of help us on the payables side, and I think that we would certainly expect that once we work through some internal issues that came as a result of that implementation that we’d be back at a similar ratio as to where we’ve been.

Great. And, Michael would you comment--? Would you be willing to comment on the four weeks of sales, the trend there since the quarter closed?

Well, Andy, you know we don’t usually typically comment on things outside the quarter, but I would say we’re still pleased with sales trends as they continue throughout ’06.

Okay. And my last question is on pricing. My assumption has been that there is a lag between you getting increased pricing from vendors and increased inbound freight and your ability to pass that through. Where do you think you are in that process? Do the quarter’s [up] gross margin reflect that you completely have passed through some of these product cost increases and other pricing increases [that have] inbound freight or is [there] some more to come?

Well, I think what we’ve said in the past Andy is that when we get these spikes in costs on fuel and inbound transportation that it can take us three to even six months to fully process all those increases through the system. So, looking back at the end of summer’s peak, which affected us quite a bit in Q1, I would say that impact still existed in the early part of Q2, and as we finish Q2 I think we would probably feel pretty comfortable that most of those have been processed through. So we feel as we sit now that we’re pretty well caught up. Although, if we see additional spikes coming down the road, we’ll, of course, have to deal with it again.

Okay. Thank you.

Our next question is from [Daniel Fu] with Citigroup. Please go ahead.

Hi. This is Daniel in for Greg Badishkanian. Good quarter guys. Can you give any more detail on whether you’ll try to eliminate fuel surcharges and pass through [inaudible]. I think you guys mentioned that in your previous conference call.

Yeah, we haven’t made any decisions about eliminating or reducing fuel surcharges. The price of fuel is still higher today than it was when we instituted the fuel surcharge back in May of 2005. So we’re still planning to continue it for the foreseeable future.

Okay. Also, you mentioned that Roots & Fruits will be breakeven in 4Q. Any--? How about the impact in 3Q?

Well, we would make some incremental progress we believe in Q3. I’m not really prepared to say how much, but we know-- we feel very confident of our goal of being breakeven by Q4.

Okay. And our last question, I guess, on the previous conference call you mentioned some transportation initiatives that kind of managed costs. Any update on that?

Well, we’re constantly doing a number of things to lower our fuel consumption. We’re not having anything special to announce today, but we are looking for another facility in Texas that would significantly lower transportation costs in that region of the country. We are implementing some technology. We’ve talked about ROADNet. That’s being implemented in facilities, slowly but surely, being rolled out across the country. Looking at migration of business from one facility to another. For example, there’s business being transferred from our Denver out to our Iowa facility because there is much less miles traveled to certain customers. So we’re constantly fine tuning our transportation division to lower our miles and continue to service our customers in the same way, and there’s a lot of incentive out right now, obviously, to continue to do that.

Okay. Thanks a lot.

[OPERATOR INSTRUCTIONS]. Our next question is from [Michael Prestal] with [In Partners]. Please go ahead.

Hi. Just a quick question about the capacity utilization rate. I think in the past you had said you’re about 68%. I’m wondering where we’re at now.

Well, don’t have actually the current number. It would be probably slightly higher than that, but certainly with the additional two new facilities in Indiana and Rocklin, we’re in much better shape than we were previously. Although, we do have capacity issues in our northwest facility and our Denver facility that we are currently working on. So that’s the area of focus right now.

Okay. And when these facilities are being opened up, is it--? What is the mix that tends to happen between the dry and the frozen and the fresh? Is there--? Are you starting to lean one way or the other as the business continues to evolve?

Well, we’re certainly-- as we open new facilities, we are building bigger freezers and coolers as a percentage of the buildings. We continue to see those categories, the perishables and the frozen departments, growing at a much faster rate than the dry groceries. So we’ll continue to build capacity in those areas.

Okay, great. Thank you.

At this time, there are no further questions. I’d like to turn the call back over to Management for any closing comments.

That’s all we have for today. Thank you for participating in our second quarter conference call and we appreciate your support and look forward to talking to you next quarter.

Ladies and gentlemen, this concludes the United Natural Foods’ Second Quarter 2006 Conference Call. We thank you, again, for your participation. You may now disconnect.