United Natural Foods Inc (UNFI) 2006 Q4 法說會逐字稿

Welcome to the United Natural Foods fourth quarter 2006 conference call. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded Wednesday, August 30, 2006. At this time I'd like to turn the presentation over to Scott Eckstein with the Financial Relations Board. Please go ahead, sir.

Thank you, and good morning, everyone. By now you should have all received a copy of this mornings press release. If anyone still needs a copy please call Samantha Alfonso in our New York office at 212-827-3746 and we'll send you a copy immediately following this mornings conference call.

With us today this morning from management is 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 the comments made on this mornings conference call. With that, I'd like to turn the call over to Michael Funk, please go ahead, sir.

Thank you, and welcome everyone to our fourth quarter and year-end conference call. Joining me today on the call is Mark Shamber, our CFO. Fourth quarter sales were 619.8 million and when adjusted for selling days was a 15.5% increase from the fourth quarter a year ago. Net of our acquisitions, the net growth rate was a strong 14.9%. For fiscal year 2006, sales ended up at 2.43 billion, an increase of 18.8% over fiscal 2005 on a comparable day basis. This was well above our initial guidance of sales growth in the 10 to 15% range.

Our sales by channel numbers continue to show the strength of the independent channel which grew over 14% for the quarter. Growth in the supermarket channel was especially strong at over 30%. Supernatural growth was at 10%, but with several new stores anticipated to open in the near term, we see that growth increasing back up. As a percentage of our total business, supernaturals was 34.7%, supermarkets were 15.1, and independents were 46.3%. Foodservice was 1.8% and the miscellaneous channel rounded out the remaining business at 2.2%. Whole Foods percentage of our total business was at 25.5% and Wild Oats was at 9.2%. Operations reported a consistent performance with fulfillment rates of 98.09% excluding manufacture out of stocks, and on time deliveries, were at at 98.33%. Ex pens for the quarter were 15.6% of sales, an improvement of 20 basis points from the year before. Fuel costs were 115 basis points of expense versus 94 a year ago, an increase of 21 basis points for the quarter.

Additionally impacting the expense numbers for the quarter were a write down of 534,000 for a loss on the sale of equipment from the Auburn, California facility that was vacated last year as well as an $860,000 loss attributed to the start up of an Albert's Produce facility in our Greenwood, Indiana warehouse. These two items impacted the expense number by 22 basis points.

On the technology side, our pick to light and pick to voice installations are scheduled to occur in two facilities over the next two quarters. We are confident that when rolled out nationally we will see significant operational savings based on gains in productivity, increasing order selecting accuracy, eliminating paperwork and printing costs, as well as reducing training time on new selectors by as much as 50%. Once we have the initial installs under our belt we will shoot for installing one DC per quarter until the new program is rolled out nationally.

New increased fuel surcharges were put into place in the western region on July 2, and in the Eastern Region on August 1, which will help us offset increased fuel prices for fiscal 2007. Our CapEx is projected to be 40 to 45 million for 2007 and will include aggressive facility expansions which will include new facilities in the Pacific Northwest, Texas, and Florida to be constructed over the next 18 to 24 months. These new buildings will significantly lower our cost to deliver our customers as well as improved service to those areas of the country. We would also expect to secure new business in those areas with the improved service that we will be offering. Excluding special items, net income increased to 12.7 million for the quarter, $0.30 per share, 9% above last year's 11.6 million or $0.28 per share. We are forecasting sales for fiscal 2007 to be in the range of 2.7 to 2.8 billion, an increase of 11 to 15% and earnings per share to be in the range of $1.25 to $1.30, an increase of 15 to 19%.

Our Select Nutrition division posted it's first profit in Q4 as we had previously forecasted. The implementation of transferring shipments for western customers to our Rocklin, California facility is scheduled for next month. As previously announced we expect this to save the division approximately 20,000 per week in third party shipping costs. We also announced the hiring of Tom [Grulea] to be the General Manager Select Nutrition division beginning September 5. Tom's previous experience includes positions as Director of Operations for Vitamin Shops and Eastern Regional Director of Whole Body at Whole Foods Markets. Tom [Zicky] who formally managed the Select business for us has assumed the role of National Vice President of our Real Estate and Construction and will lead the execution of our new building expansion. We continue to invest in leadership development and strengthening our management depth to assist us with our growth plans for the future.

Our Roots & Fruits acquisition, a division of Albert's Produce improved it's performance and posted a small loss for the quarter. Looking ahead we see it's performance being neutral to slightly accretive for the year. The Indiana produce start up which we invested in last quarter is projected to continue to be dilutive for the next two quarters incrementally less than Q4 with breakeven targeted for early calendar '07. In United Natural Brands division grew at a rate of 51% for the quarter with 2006 sales ended up at nearly 81 million up from 53 million a year ago. We continue to see a number of branded acquisition opportunities that will help us continue to drive the growth of our branded products division. We continue to be focused on building the sales of this division to 5% of our total UNFI sales by end of fiscal '08.

Thank you to all of the Unified associates, customers, and vendors for contributing to a productive 2006. We're all optimistic about continued positive trends in the natural and organic products business and look forward to continuing our leadership position in this dynamic part of the food industry. Now, for some further details on the financial numbers, I would like to turn the call over to Mark Shamber, our CFO. Mark?

Thank you, Michael and welcome to everyone listening in on the call and the webcast. As Michael stated, net sales for the fourth quarter of fiscal 2006 were 619.8 million, a 15.5% increase over fiscal 2005's fourth quarter revenues based on a comparable number of shipping days or 14.9% excluding the acquisition of Roots & Fruits cooperative which occurred in July 2005. Overall net sales increased by 76.8 million or 14.1% compared to fiscal 2005's fourth quarter revenues of 543 million or 13.5% excluding the acquisition of Roots & Fruits. We've made reference to comparable shipping days as there was one fewer shipping day in this quarter compared to the fourth quarter of fiscal 2005. As we've discussed on each of our quarterly conference calls in fiscal 2006 the difference in shipping days from year to year was a result of the Company's adoption of a 5-4-4 format this fiscal year. In total, our fiscal 2006 year had two fewer shipping days. Having now completed fiscal 2006, we will have comparable fiscal periods in fiscal 2007 for comparison purposes on net sales.

Net income for the fourth quarter of fiscal 2006 increased 7.6% to 12.7 million compared to 11.8 million for the fourth quarter ended July 31, 2005. Diluted EPS increased by 6% to $0.30 per share from the $0.28 per share recorded in the fourth quarter of fiscal 2005. Net income for the fourth quarter of fiscal 2006 increased 9% to 12.7 million or $0.30 per diluted share compared to 11.6 million or $0.28 per diluted share excluding special items for the fourth quarter of the prior year. There were no special items for the fourth quarter of fiscal 2006. As detailed in our press release the fourth quarter of fiscal 2005 included 236,000 of income and special items or 146,000 after-taxes.

Gross margin for the quarter was 19.2% compared to 19.4% for the fourth quarter fiscal 2005. The gross margin decline compared to fiscal 2005 was due in part to higher inbound freight costs that we were unable to pass along to customers in the quarter due to timing and low gross margin at our new Albert's Organics location in Greenwood, Indiana. The decline in gross margin over the prior year was offset by lower operating expenses despite the rising fuel costs in the fourth quarter. Gross margin for the fiscal year was 19.1% compared to 19.2% for the prior year, a decline of 4 basis points from fiscal 2005. Operating expenses for the quarter were 15.6% of sales compared to 15.8% for the same period last year. When adjusted for the impact of share based compensation expense recorded during the quarter of 795,000 or 13 basis points, this reflects a 37 basis point improvement over the prior year.

As Michael mentioned, the Company Select Nutrition division was slightly accretive for the fourth quarter while the Roots & Fruits portion of Albert's Organics was slightly dilutive during the quarter. Also, during the fourth quarter, our Albert's Organics division began operations out of our Greenwood, Indiana facility. Negatively impacting operating results by approximately 14 basis points. We would expect this start up operation to continue to be dilutive to earnings through the second quarter of fiscal 2007.

The incremental costs of fuel for the quarter had a negative impact of 21 basis points on operating expenses over the prior year. Also, we incurred a loss of 534,000 during the quarter related to the sale of certain equipment at our vacated Auburn, California facility. These assets had been reclassified to held for sale during the second quarter of fiscal 2006 and as such this loss is recorded in our operating expenses in accordance with the appropriate accounting literature.

Excluding the share based compensation expense, the loss and sale of assets held for sale, and the dilution from starting our Albert's location in Greenwood, our operating income for the quarter would have been 3.97% a slight improvement over the prior year. Although current and prior year operating income round to 3.6% on a GAAP basis, fiscal 2005 represents a 7 basis point improvement over the fourth quarter of fiscal 2005. The Company's effective tax rate for the quarter ended July 29, 2006, was 35.9% bringing the full year tax rate to 37.6%. This decrease in the effective tax rate relates to the Company's utilization of certain net operating loss carry forwards or NOL's during fiscal 2006. The utilization of these NOL's was partially offset by the adoption of FAS 123R share based compensation and the recognition of incentive stock option expenses in the income statement as certain ISO expenses are not deductible for tax purposes. Our effective income tax rate will continue to be effected by the tax impact related to ISOs and the timing of tax benefits related to the associated disqualifying dispositions.

For the fiscal year ended July 29, 2006, net sales increased by 374 million or 18.2% compared to fiscal 2005 were 16.6% excluding acquisitions to 2.43 billion. Based on a comparable number of shipping days fiscal 2006 revenues increased by 18.8% from the prior year or 17.3% excluding acquisitions. Fiscal 2006 net income excluding special items increased 10.5% to 46.1 million or $1.09 per diluted share compared to 41.7 million or $1 per diluted share for fiscal 2005. GAAP net income for fiscal 2006 increased 4.1% to 43.3 million or $1.02 per diluted share compared to 41.6 million or $1 per diluted share for the prior year.

Share based compensation negatively impacted fiscal 2006 diluted EPS by $0.08. Diluted earnings per share for fiscal 2006 excluding special items was above the high end of our initial guidance. Special items for the fiscal years ended July 29, 2006 and July 31, 2005 are detailed in our press release that was issued this morning.

Operating expenses for the full year were 15.5% of sales compared to 15.6% for the same period last year excluding special items and share based compensation, an improvement of 13 basis points. Rising fuel costs yielded incremental or additional operating expenses of approximately 18 basis points for the full fiscal year. Excluding special items and share based compensation, operating income was 3.65% for the year compared to 3.56 for fiscal 2005. Further excluding the impact of fuel costs and the diluted effects of the Select Nutrition and Roots & Fruits integrations, operating income would have been 3.94% for the year.

Cash generated in operations for the fiscal year ended July 29, 2006, was 25.2 million compared to 11 million in the prior year. Our year-end cash flow reflects the proper reclassification of changes in our bank overdraft from operating activities to financing activities. Our inventory levels was at a days in inventory of 47 days for the fourth quarter at the low end of our target range of 47 to 50 days and a 1 day improvement over the fourth quarter of fiscal 2005. DSO for the fourth quarter was at 23 days, favorable to our target range of 25 to 27 days and again, a 1 day improvement over the fourth quarter of the prior year. CapEx was 19.3 million for fiscal 2006, equating to approximately 0.8% of revenue for the fiscal year. As discussed in our press release our fiscal 2007 CapEx guidance is 40 to 45 million.

The company's outstanding commitments under the amended and restated credit facility as of July 29, 2006, were approximately 136.1 million with an available liquidity of 146.8 million including cash and cash equivalents. Our return on total capital was 19.7% and our return on equity was 12.7% for fiscal 2006. Both our return on total capital and our return on equity were negatively impacted due to share based compensation expense by 129 basis points and 51 basis points respectively.

Our press release issued this morning also announced our full year revenue earnings per share and CapEx guidance for our fiscal 2007 year. For the fiscal year ending July 28, 2007, revenues are expected to increase approximately 11 to 15% from fiscal 2006 to a range of 2.7 to $2.8 billion. Fiscal 2007 earnings per diluted share are expected to be in the range of $1.25 to $1.30 per share an increase of 15 to 19% over fiscal 2006 excluding special items. Capitalizing on the ongoing strength and growth of the natural foods industry the Company expects to continue to invest in it's peoples, facility, equipment and new technologies during fiscal 2007. CapEx is expected to be in the range of 40 to 45 million during the year with plans to build facilities in Florida, Texas, and the Pacific Northwest in the next 18 to 24 months. That concludes our prepared remarks. And at this time we would like to turn the call back over to the moderator to facilitate questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our first question comes from John Heinbockel with Goldman Sachs. Please go ahead.

A couple of things. Expense control looks to have kicked into another gear here in the last two quarters, particularly when you factor in fuel and stock option. So I guess my question is twofold. What's driving that, say incrementally from earlier in the year? And then secondly, how sustainable is that into '07? Or do you plan to reinvest some of that benefit in '07, because you would sort of expect to see pretty good margin expansion next year.

Yes, John. Well, as far as the expense reduction of expenses, I mean I think we're going to continue to be able to leverage our growth into reducing expenses and gaining additional efficiencies in the facilities. We have opened the two new facilities in the past year and have still been getting newer efficiencies out of those and obviously what we talked about in the prepared remarks of the technology improvements coming into the business as well as lowering our transportation costs, continuing to look at rerouting, maximizing our trucks, and then ultimately getting these new facilities online in which we can lower the miles that we're driving will I think continue to drive the expense number down.

Is cases moved per man hour, is that up significantly in the last quarter or two and as a result is labor cost, the bulk of that improvement in the last six months?

I wouldn't say there's any real spike in the productivity. I think it's just more incremental progress that's being made on a variety of fronts.

And do you think -- if you look at what's happened the last quarter or two, how representative is that do you think and is it the plan to reinvest a good chunk of that next year in something, be it probably not pricing but probably something in your distribution operation?

Are you referring to investing in the CapEx?

CapEx, more investing in labor and service and stuff like that.

Yes. Well, we're continuing to focus on improving services to customers in which we gain efficiencies as well and the customers get additional services. There's a constant investment. I think back for the long term, we're managing this business for the long term and you'll expect to continue to see that.

The -- two other things, the Texas facility, what is the thought on that? Should we read anything into that about Whole Foods and does that put you in a position to eventually to take their self distribution in house to you guys?

Well, on Whole Foods I'll make this statement. We've made good progress towards securing a long term relationship and we're optimistic about an agreement being in place well ahead of the expiration of the current contract. We do service their stores in Texas now as a strong secondary supplier out of our Denver facility, so obviously we'll be in much better position to service those stores and could possibly anticipate more business being gained through a Texas location.

All right and then finally, the Accounts Payable looked a little light compared to a year ago. Is that simply timing calendar?

Yes. I mean, a portion of it is timing. Another piece of it is that we do forward buy with working with our vendors to sort of smooth their production schedules and we get buying opportunities from that, so I believe that the large piece of that was just some opportunities that arose in the fourth quarter right really at the end of the fiscal year for us.

Okay, thanks.

You're welcome.

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

Yes, good morning.

Hi, Andy.

Just on the sales, I think people are kind of viewing this as a sales disappointment, but I just want to establish one thing as fact and then go from there. Looked to me like the internal sales really were off about 1% sequentially if you adjust them for the shipping days. Is that the way you're looking at it from 15.9 to 14.9.

You're saying quarter to quarter?

Yes. The growth rate.

Yes. I mean, I would say that's approximately right. It's right in that range.

Okay. And like within the quarter, the three months of the quarter and into the current, in the one month of the current period, was there any further deceleration of the trend or has that sort of stayed there in that close to what you reported? The 14.9?

Are you saying during the quarter, during Q4 was there deceleration toward the end of the quarter?

Yes, like did it start at 16 and go to 14 or 13 or something like that and if you're willing to speak about what it's doing in August?

Well, I think it was -- it started off fairly soft and might have in the middle of the quarter bottomed out a little bit but it was fairly stable overall. I think we are seeing some signs of a little stronger retail business recently, but it's a little too early to comment on the current quarter.

Okay. Well, that's good. That's good to hear. On the gross margin that Mark spoke about, the higher freight cost -- Mark, did you say Albert Organics start up there also impacted gross margin? Or was it some other?

Yes. It was the fuel cost. I mean the fourth quarter, was that run up in fuel during I guess during the latter half of April so during our fourth quarter we felt some of that again because the prices, gas prices jumped up, I want to say maybe $0.30 to $0.50 depending on the region of the country. And then the Albert's division, we did start up operations out of there and the impact that it had on the gross margin is that we have -- certainly you're stocking everything but on the produce side, your code or your spoilage is much higher if you're not getting that sale. So we had some write-offs due to spoilage, inventory that we weren't able to sell in the produce side that hit the margin during the quarter.

Is that, so that's incremental to the to the 860,000 you already called out in the operating cost then, right?

Well, no. It's a portion of that 860, Andy.

So really even though I think the release said it was all in operating costs, it's some how split between the two?

Yes. It may not have been completely clear. The impact was meant to say that the 860 impacted operating income, not that it was all in operating expenses.

Was it more so in the gross margin or in the cost structure?

I would say the split maybe was 60/40.

The gross --

60% in the operating and 40% in the gross.

Okay, thanks. And just staying on this Albert's Organics facility, just seems like a pretty big number, but I guess once you get spoilage out of there -- well, let me ask it this way. In the next few quarters when you expect it to be dilutive, would you be a little more specific? You said it would be less than than 860,000 a quarter. Is it going to be half of that or then half of that again?

Well, I mean--.

I know you can't--.

It's a rough number.

In the middle of your range of your budget?

It probably drops -- our expectation, our forecast would be that it would drop 40 to 50% in the first quarter of fiscal '07 and probably from that number, it might drop another 50 to 60% for the end of the second quarter so that probably in January or February It maybe starts to turn to breakeven slightly accretive but yes, the costs are expected to sort of almost half themselves quarter after quarter.

What drives that? Is it getting more -- is it getting things running right or do you actually have to go out and get some new customers so you can leverage the facility.

Andy this is actually the first time we've ever done a start up produce facility. We've always had acquisitions to leverage on and so basically you're setting up shop in a new area. You have to have everything in stock and there's extremely high shrink associated with that. So it is a little bit of a new experience for us. The losses were definitely more than we were anticipating which is why we're calling it out, but hopefully we'll get that under control in the next two quarters which is what we're expecting.

Good. And just on the CapEx, you said 18 to 24. Any of these going to be actually opened this fiscal year or it's all -- they are all going to be completed in '08?

Well, yes. At this point we're not sure we would expect at least one will be ready by next summer which is concurrently still in this fiscal year and probably a second one to be well underway. It would probably be a little aggressive to assume that two will be opened by end of fiscal year, but certainly the money that's in CapEx is largely to support two of the facilities and we will be in '08 beginning on the third one, so -- but hopefully that answers your question.

Yes. And just the last question here is Michael, you characterized operations, you used the word consistent. You talked about the on time and in stock and is that consistency like during the period or is it across geographies? Should we interpret this that the western region which had been having issues is essentially fixed?

Well, the issues with -- in the regions weren't necessarily based on service rates or on time delivery which are key metrics for service in the customers. We've always had very stable I think numbers across the country. So there was never any issues there. Our western region we're still focused on increasing our operating margin there. We think there is still opportunity to bring that up and that's ongoing, but from a service level, on time metrics , we're very consistent across the country.

So when that nearly 4% EBIT margin for the quarter that Mark talked about, it's still fair to assume that the east is doing a lot better than that, higher than that and the western region lower and there's a big opportunity in filling that gap across the Company?

Yes. There's definitely that opportunity. The west is still -- has room to move up. The east is operating at an optimum level.

Okay. Great. Thank you.

Okay.

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

Good morning.

Good morning, Ed.

Couple questions for you. I'm circling back to your comment on Whole Foods and hoping to get that contact extension in advance of the expiration. If that were to happen, would you anticipate any changes to your '07 guidance either on the top line, bottom line or both?

Well, I mean, Ed, as you know our current agreement with Whole Foods is in place through the end of calendar '07 which encompasses our entire fiscal '07, but of course when we go through our budgeting process we do try to factor in potential scenarios to the best level that we can at the time. So while our budget reflects expectations for a number of new or modified agreements with our customers, I can't really comment on the impact of potential new deal with Whole Foods until final deal is in place as some of the agreements we negotiate may have more favorable terms than we anticipate and others may have some higher concessions than we budgeted for.

Okay.

But we do try to look forward as we go through the budgeting process.

Okay. My second question was on option expenses and I apologize if I missed this if you covered it earlier, but if you look back at what you said last quarter about where the option expense is going to come in for the full year, it came in quite a bit below the implied number for the fourth quarter. Just trying to get kind of get my arms around that.

Well, I think that it did come in at the low end of the range that we had given for the full year and maybe the run rate for the quarter was expected to be a bit higher. A portion of it is due to when we have forfeitures that folks leave the Company that have options, we get a credit for the expense so that that's part of the difficulty in forecasting it. I think that every company is going to experience. If I was looking forward into '07, I'd say that we would probably start off the year still giving a range of $0.08 to $0.10 for share based comp for the year and then as the year goes along and it gets narrowed we tighten that up one way or the other. The big issue in predicting it is we typically do our large annual grant at or near the shareholders meeting in December and so it's really the expense that impacts the second half of the year is driven by the stock price on that date.

Okay.

So for the fourth quarter, we got some benefit on the expense side due to some forfeitures and going into '07, I'd probably have it in the range of $0.08 to $0.10 but I'd have a much clearer picture once we do our large grant in December. Okay, great. And going back to the top line in the quarter, you mentioned like maybe a percentage a 1% down tick in the internal growth rate, but based on what we had got from the retailers it seemed like the industry growth rate ticked down maybe a couple points more than that in terms of the year-over-year change. Is there something out there in terms of relative market share gain that you saw in the quarter in terms of any new business?

Well, I think what I would point to in the quarter is the supermarket number. We landed a lot of new doors with various chains primarily in the Eastern region so there was a lot of front loading some new sets in the supermarket channel which is why our number spiked up so much, so that I think to a large extent offset the softness in the rest of the retail business.

Okay. Great then just one last question. With your branded products division, can you give us a sense of what the margin profile on that business looks like today and what you expect?

Well, yes. I mean just to real back of the envelope what we would say is that our branded products we would be looking to get about an extra 10% on the gross margin side. So we obviously have incentive to continue to build that business.

But it would be 10% more on the operating?

Yes. I'm sorry. 10% on the net operating side.

Okay. Great. Thank you.

Okay.

Our next question comes from Michael Lasser with Lehman Brothers. Please go ahead.

Good morning. Could you talk about your process for establishing your initial guidance for the upcoming year? Do you base it on the budgets? Do you base your budget on the budget for your customers and then also what is the assumption for the price of oil or gas in the guidance as well as your tax rate assumption?

Let me just three questions there so I'll take them one at a time.

Sorry.

On the top line, I mean, we do not necessarily look at our customers budgets as much as we do factor in what our historical rates have been and what growth we've seen or we expect as well as new store openings. So if somebody says Whole Foods where they have on their website and we have some visibility into new store openings, we can sort of estimate that and build that into our projections. The second question you said was the fuel prices?

Yes. What's the assumption there?

On the fuel side, we have probably got it in there at around $2.90 a gallon. I don't want to say that it's necessarily a flat $2.90 during the year but we have projected out for the year that we would probably come in at $2.90 a gallon.

And the tax rate assumption?

Tax rate assumption? I've got it roughly at 38, a little under 38, but I hedge that with the comments that I just made to Ed regarding the share based comp is the predictability of to what impact share based comp has on the tax rate is still difficult. We're going into the second year of it and it really is contingent on whether or not employees exercise and hold their options or exercise and sell. So I'd put it out there that it's a roughly 38%. It could be 38.3, it could be 37.7. We increased it at Q3, again based on sort of where it was running and you could see where we ended up for fiscal '06. So if I could give more clarity on that I would, but we're just going to the second year dealing with this so I don't have a lot more visibility at this point.

Okay and just a couple more questions. As far as the 2.90 assumption for a gallon of gas, will the recently revised approach to surcharges where you'll be re visiting them on a monthly basis cover the $2.90 estimate? I assume it will?

Well, no. I mean sort of two things. I don't know that we've said revised looking at it on a monthly basis. We'll certainly look at it as the fuel prices move and whether we feel it's a permanent versus a temporary movement in the prices because obviously you don't want to pass prices along at that level. Pass the surcharge along and then have prices drop or vice versa, have prices drop and rescind it and have them go back up.

With respect to whether that covers the $2.90, it covers a portion of it and it certainly does not cover it completely. The surcharge that we put into effect in May of '05 was when fuel prices were at $2.25, $2.35 a gallon and we put in effect a $10 surcharge. The surcharge now has been adjusted to $15 and the fuel prices we're estimating are $2.90 so we as each year goes along accept that rising fuel cost should be a portion of what we feel should be effected into our operating expenses and then we expect to recover a piece through the surcharge. I don't break that out and I wouldn't break that out, but it's not an expectation that the incremental surcharge is going to cover the full impact of rising fuel prices. A portion of that is baked into our guidance.

That's helpful. And then with respect to the degree which you can comment on the nature of the discussions with Whole Foods, is there a trade off between the speed at which you can get a new agreement in place and the economic concessions you may have to give and how do you view that trade off?

I don't think at this point in time there's any trade off with trying to get a new deal done versus getting economic concessions. Certainly I don't think that would be to either parties advantage to try and push through a deal only to forfeit in the long term for their Company, so it's just a matter of working through different points and making sure that as we try to put a deal into place that we understand what the ripple effect on our side is as well as the ripple effect on their side of any changes in existing terms.

Okay. And then regarding the growth at the supernaturals, it seemed a little bit slower than it had been and you provided some commentary there. Have you maintained your share of distribution with those customers or has the changing composition of sales at those retailers impacted your results?

No, Michael. I don't think there's any major change in the share of our business there. I think it's largely an extent of the comps over a year ago and the fact that there was little new store activity here in this Q that we're reporting. So we don't expect that there's any material changes on our percentage of business with those accounts.

And last question. The growth in the supermarket channel, were there -- you talked about new store openings and some new wins from customers. Were those kind of one off wins or were they from larger chains?

Well, in the supermarket channel, the growth that we experienced in this recent quarter was from a few larger chains in which a number of stores were brought into Natural Food sets. So it was a product of a couple large chains having a number of stores that spiked that number.

Got it. Thank you for taking my questions.

You're welcome.

Next question comes from Greg Badishkanian with Citigroup. Please go ahead.

Yes, great. First question. Just with respect to the 11 to 15% revenue growth for '07, how much of that is internal versus maybe carry forward of acquisitions or new acquisitions?

It would all be internal unless there was an acquisition during the year. With the close of July, we have sort of annualized all the acquisitions. The last acquisition we had done was the Roots & Fruits. The last distribution acquisition we had done was Roots & Fruits in July of '05. We had done a small acquisition during the course of the year but it doesn't even register on the needle.

Okay, great. That's it. Thanks.

Thanks, Greg.

Our next question comes from Gary Giblen with Brean Murray, Carret. Please go ahead.

Hi, good morning. To take on a new topic, the hospital and institutional business, is that higher, lower, or about equal margin to your existing business mix?

Oh, the foodservice at channel as a whole, I would say, would be on our higher end of our margin profile customers.

Okay. That's great. And given that you are doubling your CapEx and engaging in at least three projects, major projects, would that tend to cause special charges to occur? I realize you don't have any special charges to specifically anticipate, but is that the kind of thing that gives rise to special charges?

Historically, Gary, they have. But I would say that as we've looked into the fiscal '07 year that we have attempted to actually include those in our budgeting for our growth so I would anticipate that unless there was some unique occurrence related to opening those that charges that might have historically been put in special items would just be already baked into the guidance that we've issued today.

Okay. That helps. And do fuel surcharges apply primarily to independents rather than supernaturals? I think that was said in the last call but I want to check that that's accurate.

No. They both have fuel surcharges.

Okay. Even for your largest customers there's a fuel surcharge?

Yes.

Okay. And then just finally, I mean, were your earlier remarks intended to say that there's a meaningful possibility that you would become the primary distributor for Whole Foods in the Texas southwest area once you built your Texas DC?

No, I wasn't suggesting that. I think Whole Foods has a large investment in their facility in Texas, but we again have seen where their stores have used us again as a strong secondary even though we've had to come from 1,000 miles away. So as our service got better by being more local, we would think we would be utilized at a higher rate, but I'm not suggesting that Whole Foods is going to get out of distribution in Texas.

Okay. I got it. That would be nice, but okay. I understand. Thank you very much.

You're welcome.

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

Yes, good morning, everyone.

Good morning.

Just a couple questions. Michael, the growth in the independents continues to be very robust and I think that you touched base a little bit on it the last quarter, but I assume that a portion of that is market share gains as well as sort of same-store sales growth at your independent. Can you talk a little bit about how that might break down between the two?

Yes. We don't have any definitive calculations that we can give you. We can just kind of do some guesstimates on it and I think in the past we've probably had more market share gains on the independent channel than we've had recently, but -- so suggesting that the majority of that growth is incremental comp growth that that channel is experiencing, but I could guesstimate that there's a percent of that growth out of the 14 that would be considered market share gains and I mean, the rest is just pure organic growth.

Okay, good. And then Michael, both Whole Foods and Wild Oats are focusing significantly on private label introductions and products and growing that portion of their business as well. What are the implications, if any, on your business?

Well, it depends, in some cases, in some regions we do supply private label to those chains and so we do receive revenue from those sales. There are some areas that we do not participate in their private label, so theoretically the more business that would get put into those categories, if it was taking away from branded, our branded sales, then it could negatively impact us, but the stores that are being built generally are larger and our percentage I think continues to grow with them. Our ability to supply them with more products continues to grow. So on the whole, we don't see this as a huge deal for us.

Okay. And just a final one, Michael. Whole Foods has a huge pipeline of new stores that are coming out of the back end of their system over the next, again kind of 12 to 24 months. Wouldn't that give you encouragement that maybe you might even begin to see more reacceleration of growth back in the supernatural segment?

Yes. I alluded to that earlier. We think that there's a definitely a supply in the pipeline that's going to definitely accelerate that supernatural category to back where it was historically for us with upper teen growth so we would be anticipating that.

Okay, thank you everyone.

Yes.

Our next question comes from Alec Patterson with RCM. Please go ahead.

Yes, good morning. Just a couple of quick ones, Mark. The interest expense line I'm sorry I missed it in the opening comment. Uptick sequentially, what looked like a general reduction and debt exposure. Is that just purely an interest rate phenomenon?

Yes. It's strictly interest rate driven, Alec.

So we should extrapolate that trend then into '07?

I would say that's fair, yes. Obviously with the adjustments in the debt levels as we go, but yes.

Okay. And then on the surcharges just to be clear, they are meant to offset both the inbound freight as well as your own costs?

No. It's only our own costs. The inbound freight does get reflected into pricing but that's not always instantaneous. There may be a lag of anywhere from a month to three months depending on what products it is and the timing of catalogs.

So back to your opening comment about the freight costs hit -- beyond the 20 basis point hit on gross margin, that's a timing factor we should see a lot of that disappear in the next quarter or two presuming inbound freight costs remain stable?

Correct.

Okay. And then just in the CapEx program, you've got for '07 and I presume '08, should we presume '08 as somewhat similar to '07 in that it's reflecting these particular, these three new facilities?

I think when -- I think that that's probably fair but I would say that it's our expectation at least at this point in time that a large portion of the second facility will be CapEx in fiscal '07 and that there should only be some lingering CapEx dollars that might drift into '08, so I can't say for certain this time until it plays out but I would think that '08 may be a bit of a tick downward because it will only have say 1.25 worth of facilities CapEx in there versus say this year having 1.75 to 2.

Okay. And this doesn't reflect a transition to leasing versus capital spending?

No.

So in other words if you decided to lease some of these facilities instead the CapEx would be likewise reduced from current projections?

Yes.

And not saying you're going to do that.

Right. A switch from buying versus leasing could yield lower costs on the CapEx side.

And then on the working capital, should we expect the same sort of seasonal pattern that we've had before where there's an initial use followed by a general pay back towards the end of the year?

Yes. Certainly as we go into the holiday season during the second quarter, that -- I would expect that to replicate itself, yes.

Okay. Great. Thanks very much.

You're welcome.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our next question will come from Scott Mushkin with Banc of America Securities. Please go ahead.

Hi, guys.

Hi, Scott.

How you doing? A couple questions. First, the Florida facility I think you said you were going to build, how do you guys look at it? That's obviously not a consolidation. It's -- I guess the closest one is up in Georgia. Do you need to have an idea of how much business that's going to throw off or is there an incremental revenue opportunity there as you get into Florida to win contracts that's really not in your numbers, not in our numbers so how do you look that?

Well, there's a lot of analysis that goes into sighting these facilities and certainly, we need a base of business to open the doors and with the growth that we've had in that market, there exists today enough business to justify a facility there and combine with the savings and fuel costs, it makes it attractive out of the gate. So in a sense, we can pay for day one without the expectation of new business, but obviously, the secondary reasons for doing it is to be able to win new business where our location is now much more desirable to win over local accounts.

So as we look towards '08 and that facility is opened I believe Sweet Bay is not someone you've dealt with before which is part of Hanneford and there's some other big players down there, but the potential, those can be meaningful accounts that you could get down there that would actually move the revenue dial substantially.

Yes.

And then second area and I know this is a little kind of off beat topic but I just wanted to understand your abilities and maybe I should know this already, in the health and beauty care area? And that area has been growing quickly and I just also want to know I guess I'll start with that and I had a follow-up question.

Well, yes. We are full supplier of those products. We have full selection of health and beauty category. As you said it's been a category that's been, had solid, midteen growth for several years now, so we participate fully in that category, are generally a full line supplier to our customers in that area.

And then when you look at that area, obviously you guys have done a great job with the traditional grocers in helping them set up sets and what not. Have you been approached by any drug store chains to do a similar thing with them or is that not something that's really taking place?

Well, I think we do have inroads with some of the drug chains and we would group that in our supermarket/mass market business channel, but yes. There is some opportunity for us that we've got and would look forward to more in the future.

Fantastic. Okay all my other questions have been answered. I appreciate your time.

Thanks, Scott.

Thank you, sir. [OPERATOR INSTRUCTIONS] Our next question is a follow-up question from Gary Giblen. Please go ahead.

Yes, hi. Pardon me for splitting hairs but I was just trying to figure this out. If I take one day of the quarter and proportionally figure shipping is even through the quarter, then I would come out with about 15.2% growth, not 15.5% but is there a particular shipping day that was left for this quarter?

Well, I can talk to you off line on it Gary. What I suspect is that you're maybe factoring in 91 days versus 92 days and we only ship 6 days a week so that it's -- we're comparing 78 versus 79.

Oh, yes, well, that would be the difference.

I think that's what the difference would be.

Okay. Sorry to split hairs but I'm glad to know the answer. Thank you.

You're welcome.

Thank you, sir. [OPERATOR INSTRUCTIONS] Management at this time we appear to have no additional questions in the queue and I'll turn the conference back to you for any closing remarks.

Okay, just want to say thank you for your support and interest for United Natural Foods and we'll all see you next quarter. Have a good day. Thank you.

Thank you. Ladies and gentlemen, at this time we will conclude today's conference. If you would like to listen to a replay of the presentation, please dial 1-800-405-2236 or 303-590-3000 with the access code of 11067162. Once again if you would like to listen to a replay of today's conference call please dial 1-800-405-2236 or 303-590-3000 with the access code of 11067162. We thank you for your participation on the program. At this time we will conclude. You may now disconnect and please have a pleasant day.