United Natural Foods Inc (UNFI) 2007 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by and welcome to the United Natural Foods second quarter 2007 conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today on Tuesday, the 20th of February 2007. I would now like to turn the conference over to Ms. Julie Tu of the Financial Relations Board.

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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. And with that I would like to turn the call over to Michael Funk.

Thank you, Julie, and thank you for joining our second quarter conference call. Joining me today on the call is Mark Shamber, our Chief Financial Officer. Our second quarter sales were $668.5 million, an 11.2% increase from the second quarter a year ago. We are comping over a very strong quarter year ago which came in at 17.2%. The two-year comp growth number is 32.5%.

Our sales by channel numbers continue to show the strength in our supermarket business, which increased by 27.5%. The independent channel slowed to 7.8% growth and supernaturals grew at 9.2%. Food service had a growth rate of nearly 41%. While the quarter came in on the lower end of our 11 to 15% guidance for the year we remain optimistic of stronger sales trends the last half of fiscal '07.

On January 15 of this year we began the transition to primary supplier in the Southern California region of Whole Foods to our facility located in Fontana, California. As previously announced, we anticipate this new business bringing approximately $100 million in annual volume to our Western region. The transition of this business involved bringing into Fontana 2900 new items, reslotting 75% of the warehouse and rerouting 60% of the entire routes originating from there. We hired and trained approximately 100 new warehouse and driver personnel.

All this was accomplished in a tight timeframe with minimal impact to our customer base. Fulfillment rates were good throughout the transition. This effort was a major achievement for UNFI, an acknowledgement to Western region management and particularly Michael Michel, Vice President of Western region operations, as well as the many staff from around the country that traveled out to assist and making this happen. It will take a few quarters to gain optimum efficiencies as staff continues to develop.

With the new Fontana business and increasing number of new stores expected to open in the next few quarters we are forecasting sales for the latter half of our 2007 will be in the 13% to 15% range. As a percentage of our total business, supernaturals were 36.2%, supermarkets were 15%, and independents were 43%, food service was at 2%. Whole Foods percentage of our total business was 27.4%, and Wild Oats was 8.8%. Operations were solid with fulfillment rates of 97.98% excluding manufacturer out-of-stocks and on-time deliveries at 98.23% were both slightly improved from the previous quarter.

Expenses for the quarter were 15.4% of sales, an improvement of 65 basis points from the previous Q2 a year ago. During the quarter we sold one of our buildings in Auburn, California that was vacated when we moved to our new Rockland, California location in October of 2005. The sale of the building resulted in recording a loss of $1.46 million. The second building that we continue to own in the same location has been put up for sale and a loss of $756,000 has been recorded reflecting the current commercial real estate market in that area. We further terminated a lease and a portion of unused space in our Minneapolis facility resulting in a charge of 720,000. These onetime expense hits totaled 44 basis points; if we were to factor in these costs our expenses for the quarter would have been 14.9%. Fuel costs were 101 basis points, 3 basis points lower than the quarter a year ago.

As mentioned in our press release this morning, construction has begun on our new warehouse in Richfield, Washington just north of Portland, Oregon. We are on track to complete this facility by late summer of this year. Completion of this location will help us relieve our overcapacity issues in our Auburn, Washington facility, as well as lowering transportation costs for customers located in Oregon and other parts of the northwest market.

In addition, we have signed a letter of intent on a central Florida existing warehouse and anticipate having that facility ready to occupy by the fall of 2007. Our United Natural Brands division growth rate slowed to a rate of 20% for the quarter as a result of delays to some of our new product launches and branded acquisitions. However, during Q3 and Q4 of this year we project to make several branded acquisitions along with a number of new product launches with our existing brands, which will drive the growth of UNB by the end of fiscal '07 to 40% or roughly a run rate of 4% of total company revenues. We anticipate this to have a positive impact on our gross margin.

Net income for the quarter was $10.9 million or $0.25 per share, roughly equal to earnings of $0.25 a year ago. However, factoring out the real estate write-downs previously mentioned brings the net income to $12.7 million or $0.30 per share. Our earnings per share guidance continues to be in the range of $1.25 to $1.30, and our topline sales guidance has been increased on the bottom line to 12.5% to 15% for the '07.

We continue to believe our execution of our plan to build new facilities and install new warehouse technologies and developing our branded division sales will strengthen our operating margin over the long-term. And now for further details on our financial numbers I would like to turn the call over to our Chief Financial Officer, Mark Shamber.

Thank you, Michael. And welcome to everyone listening in on the call and webcast. Net sales for the second quarter of fiscal 2007 were $668.5 million, which represents growth of 11.2% or approximately $67.5 million over prior year net sales of $601.1 million. And our two-year comparable sales growth was 32.5%. Year-to-date net sales are $1.31 [building] yielding sales growth of 11.7% over the prior year. After adjusting for the impact of the two Auburn, California facilities and the early termination of the Minnesota facility and the related asset write-off which I will discuss in further detail in a moment, net income for the quarter would have been $12.7 million or approximately $0.30 per diluted share compared to $10.8 million or $0.26 per diluted share excluding special items in the second quarter of fiscal 2006. We reported GAAP net income of $10.9 million or $0.25 per diluted share for the second quarter of fiscal 2007. This compares with GAAP net income of $10.6 million or $0.25 per diluted share for the second quarter of fiscal 2006, which ended January 28, 2006.

Gross margin of 18.6% for the quarter showed an 81 basis point decline over the prior year's second quarter gross margin of 19.4%. The gross margin decline is due to a variety of contributing factors. First, during the quarter our West region was focused on our transition of the primary distribution for the Southern Pacific region of Whole Foods and adding the new SKUs that Michael had mentioned to our product mix. As a result we failed to capitalize on as many forward buying opportunities.

In addition, a number of new customer agreements began during or were in place for the entire second quarter. Next, United Natural Brands, our branded products or private-label division experienced slowing sales growth and consequently UNB has not yielded the incremental margin that was expected.

And finally, we experienced issues during the quarter related to inventory at our Albert's Organics division. The related inventory adjustments at Alberts negatively impacted margin by approximately 9 basis points.

Our operating expenses for the quarter were 15.4% of net sales compared to 16% for the same period last year. While this represents a 65 basis point improvement over the prior year and a 19 basis point improvement over the prior quarter, the quarter was negatively impacted by a number of onetime expenses. During the quarter we recorded $2.2 million expenses related to the sale and planned sale of our facilities in Auburn, California due to the softening real estate market. The facility that had previously been classified as held for sale and other current assets was sold during the quarter for a loss of $1.466 million. We also reached a decision to sell the other Auburn facility during the quarter, and we recorded an impairment loss of $756,000 on that facility based on our expected proceeds from the sale in accordance with FAS 144 accounting for the impairment or disposal of long-lived assets. These losses negatively impacted operating expenses by 33 basis points.

In addition, we terminated the portion of our lease related to unused space at our Minnesota facility for $410,000 and wrote off $310,000 of carrying value of the associated leasehold improvements on that space. This negatively impacted operating expenses by an additional 11 basis points during the quarter. Adjusting out these expenses, operating expenses for the quarter would have been approximately 14.9%, and operating margin would have been 3.7%. This represents 109 basis point improvement over the prior year operating expenses of 16%.

Fuel represented 101 basis points for the quarter, a 3 basis point reduction over the prior year. However, our hedging program negatively impacted our fuel costs by $673,000 or 10 basis points during the quarter compared to a one basis point impact in the prior year.

During the quarter we successfully transition the Whole Foods [cell pack] business and incurred approximately $880,000 in related costs. While certain of these costs are non-recurring in nature, we expect to experience higher than normal operating costs at our Fontana facility during the remainder of the fiscal year as our workforce in that facility gains efficiencies.

We recorded share based compensation expense during the quarter of $1.04 million or approximately 16 basis points in accordance with FAS 123(R).

Our days in inventory was at 47 days for the second quarter, which is at the low end of our target range of 47 to 50 days and represents a day improvement over the prior year. DSO for the second quarter was at 22 days, favorable to our target range of 25 to 27 days and representing a two-day improvement over the prior year.

Capital expenditures were $14.5 million or 1.1% of revenues for the first six months of fiscal 2007 which is currently below our target of 1.75% of revenues. We expect our capital expenditures to increase during the second half of fiscal 2007 as we build our new facility in Ridgefield, Washington. Our CapEx guidance for the full fiscal year remains at the $40 to $45 million level.

Interest expense in the quarter was approximately 15% higher sequentially and approximately 5% higher year-over-year. The sequential increase was driven by a higher average debt level during the quarter, related to increased inventory levels for the holidays. The year-over-year increase in interest expense is primarily driven by the higher interest rates experienced in fiscal 2007 related to the Fed rate increases in the first half of calendar 2006.

The Company's outstanding commitment under its amended and restated credit facility as of January 2007 were approximately $135 million with liquidity of approximately $132 million. Our return on total capital was 19.1%, and our return on equity was 12.2% for the trailing 12 months. These return ratios reflect the impact of share based compensation expense and the Auburn, California and Minnesota facility expenses that were incurred in the second quarter of fiscal 2007.

I would also like to take this opportunity to narrow our sales and earnings guidance for fiscal 2007. Previously we announced that we expect a net sales of $2.7 to $2.8 billion for 2007, representing an 11 to 15% increase over fiscal 2006. At this time we are narrowing that range to $2.74 to $2.8 billion for fiscal 2007 representing a 12.5% to 15% increase over fiscal 2006.

Earnings per share is still expected to increase 15% to 19% to a range of $1.25 to $1.30 per diluted share. Adjusting for the onetime expenses incurred this quarter, we would expect earnings per share for fiscal 2007 to increase 17% to 19% to a range of $1.27 to $1.30 per diluted share.

On our fourth quarter conference call in August we had estimated that share based compensation expense for fiscal 2007 could be in the range of $0.08 to $0.10 per diluted share after taxes. At this time we are detailing the estimated impact of share based compensation expense for fiscal 2007 to be approximately $3.9 million to $4.9 million on a pretax basis, or $0.06 to $0.07 per diluted share after taxes. Actual expenses recorded during the remainder of fiscal 2007 may vary beyond the guidance provided based on factors such as additional equity awards granted to employees and changes in the company's stock price.

That concludes our prepared remarks, and this time we will turn the call back over to the moderator to facilitate any questions.

(OPERATOR INSTRUCTIONS) Simeon Gutman, Goldman Sachs.

On the guidance and if I heard it all correctly, it sounds like you narrowed the sales guidance to the upper level of that range and maintain the earnings guidance; yet it sounds like the share based compensation is coming in a little bit light. What is impacting that? Is it mostly on the gross margin line?

A piece of it is the gross margin, Simeon, but also we are going to have higher operating expenses during the second half of the year in Fontana related to the business that we have transitioned in. So that $880,000 we would expect a piece of that to go away in the third quarter, but at this point I just don't know how quickly that facility will get its efficiencies in place.

And back to your points on gross margin you listed several items that impact it. Where those items already in order of magnitude?

They are in order of estimated magnitude. I can't say for certainty that they work out exactly that way.

But it was the West region and the lack of forward buying was the biggest impact to that line?

I would say yes.

And Michael, what is going on in the independent channel? It's slowdown, is that embedded in the pickup or at least in the better sales of the back half or is that mostly coming from supernatural channel?

Well, I think our estimates on sales for the rest of the year do include new stores in the supernatural channel, primarily. The fluctuation in independent sales is hard to exactly forecast what is happening. It is influenced by their comp growth as well as new stores; on any given quarter if there is a lack of new store activity there it will influence our numbers in a negative way. But overall yes, we have seen this softening in the independent channel the last several quarters. We don't think it is going to deteriorate any further.

But as far as new store openings in the independent channel what is your outlook there?

We don't have a lot of visibility on that, but we would expect there will be continued activity in that channel, and I would be surprised if the growth rate in that channel doesn't increase.

Okay, thanks.

Michael Lasser, Lehman Brothers.

Could you talk a little bit more about the operating expense leverage in like, excluding the onetime items it decreased by 60 basis points quarter to quarter. And yet the one month from the inclusion of additional sales from Whole Foods, would seem to have been inefficient operating expense leverage. And so I guess the question is, how sustainable is that moving forward?

Michael, first of all we only had two weeks of the new Whole Foods sales in our Fontana warehouse not a full month. And it definitely was inefficient business for us. There was a lot of extra cost associated with the startup of that. But we continue to see a number of opportunities to lower our expense line; the things that we have been talking about primarily our new technology being installed, driving our operating costs in the warehouse down, as well as building new facilities out that will lower the transportation costs significantly. So those are the two main drivers that we think have over the next few years significant opportunities to continue to lower the expenses.

So a 14.9% operating expense margin would be a good number to use moving forward?

Well, I think that it is difficult to nail it down to that and say for the rest of the fiscal year, Michael, but I think we will continue to see efficiencies. Whether it is 14.9, whether it is 15, whether it is 14.8 -- depends really on how transportation costs go, where fuel goes, some other efficiencies that we have in place as to when they kick in. But I would tell you that getting down -- we are not so much focusing at this point on the operating expenses on our side. We are more focusing on the operating margin. And so when I say that I think 3.7, 3.6, 3.7 operating margin is consistent that we can achieve? Yes. And can we move further towards the 4% operating margin goal that we have? Yes. How that impacts operating expenses versus cost of sales there could be a little variability in that between quarters.

And with the 673,000 in negative expense from the hedging program, can you update us on your philosophy of hedging and we've seen a decline in oil prices in diesel fuel recently. Have you thought about locking in some more favorable rates as a result?

At this point we have not looked at locking in more favorable rates. There is the spread that has occurred between heating oil and the diesel fuel the correlation has weakened a little bit during this past year, given the fluctuations in prices that have gone on. We still have our existing hedge in place that we currently have through June. So I don't know that I would be rushing to add an additional one at this point but it is certainly something that we keep an eye on and if we feel that fuel prices are moving in a negative direction we would try to limit our exposure in that area.

And Michael, when you are out talking to customers particularly in the independent channel, how often are folks talking about increased competition as a factor that kind of is driving down the sales growth across the board?

Well, it is something that has been mentioned recently by the supernaturals. I don't think it is mentioned as much in the independent channel. I think that channel feels that there is in many cases they are in markets with less competition than maybe the supernaturals that are more in the major metro markets. But I think it does have some impact, the fact that more and more supermarkets are carrying the product. But again as I said earlier, I think there is still plenty of opportunity for independents to effectively compete and grow in the marketplace.

And two last questions, in the mass-market channel can you talk about any new customer wins that you achieved recently?

No, we wouldn't be giving out specific customer information over the past few quarters. We just continue to give, to have strong growth in the existing accounts that we have, as well as getting new doors that are adding to that 27.5% growth. But we tend to shy away from giving out customer specific information.

Okay, and last question, what was the reason for the revision to the share based compensation expense?

I guess I don't understand the question; I mean you are just asking me to repeat what I had said or.

It has come down from $0.08 to $0.10 to $0.06 to $0.07. Why, what is driving it lower? Are you handing out your stock options?

A portion of the higher number last year was attributable to some acceleration of vesting related to the former CEO's departure, and we have not had any incremental expense of that nature in the current year.

Okay.

That is pretty much the difference year-over-year; if you were to look at the expense we recorded in the first quarter of fiscal 2006 related to that onetime event, the number that we are quoting this year adjusted for that is relatively close.

But the revision to the share based compensation expense, that just occurred this quarter, correct? I don't recall that you mentioned that in the first quarter.

No, I didn't and I think you had asked me in the first quarter and I had declined until we actually did the grants in December at which time it becomes clear. I estimated the $0.08 to $0.10 in the August call just based off of the preliminary guidance we had given for fiscal '06 sort of leaving it in that in that same, range. But now that we've got a relatively solid number it will really only change to the extent we do any additional grants for new hires or promotions during the second half of the year. Or if there were any forfeitures that led to a decrease in the expense.

Okay. Thank you for taking my questions.

Greg Badishkanian, Citigroup.

Just have two or three quick questions here. First one, I don't know if you mentioned it, but two weeks worth of business in the South Pacific, is that about 60 basis points to your impact from to sales?

Yes, I mean without getting too specific on it Greg, we had said that we expected the business to be $47 to $52 million for the second half of the year, which works out to a little under $2 million a week. So if you were to approximate that is between 3.8 and $4 million that would get you anywhere from 56 to 61, 62 basis points.

Okay, good. So maybe a little bit over 10.5% internal growth is sort of what I'm getting at. Is that right for the quarter?

Yes, I mean it is one of those things where we always have new customer wins, so factoring out that particular pickup in business, yes, it would have been in excess of 10.5%.

The internal was the sales, but this if you were to exclude that large win, that is what it would have been?

Correct.

That's helpful. Also January, February trends, can you maybe give us some color of what you're seeing out there if you are -- to the extent that you can comment?

I would think sales trends for us overall were fairly stable through the quarter with I think some slight pickup in January. February is continuing to look pretty good. So if we looked at the quarter overall sales did pick up slightly towards the latter part.

Great. That is encouraging. And just with respect to the supermarket channel is it, is the growth coming from the existing stores that you are servicing now, or are the retailers, are they adding space to new stores? Is it new doors in terms of totally new customers that you are getting? If you were to sort of rank it from one to three, how would you -- what is having the biggest impact on that fast-growing channel for you?

I think it is obviously a combination of all of the above, trying to rank it might be difficult here, but I would say generally we are seeing strong comp growth in mature sets that are out there but there is still a large amount of growth coming from new doors, as well. So it's really a combination of all of those things, Greg.

Good. Finally, with respect to food service, this is something you have been talking about for a while. It's about 2% of your business. Can you talk a little bit about the opportunities and sort of what you're seeing in that specific customer channel?

We still see really tremendous demand in several of the food service segments, and we are focusing on it by throwing more resources at it from a sales perspective, as well as adding more SKUs that are specific to the food service category. We have had some wins in the colleges and universities and some hospitals of late, and look to continue to build that segment at a faster growth rate than the rest of our business. So hopefully we will see it be a much bigger piece of our business several years from now.

And the opportunity is still there, you see it because it is growing faster than the overall business, and it is a channel that offers pretty decent growth, you're still seeing?

Yes, has great growth and we think good margin opportunities. We have to adjust in some cases our service abilities to get to those accounts, but for the most part we think it is all doable and we would expect again the channel to continue to grow at a much faster rate than the rest of the business.

Thank you very much.

Scott Mushkin, Banc of America Securities.

Just want to clarify quickly your guidance when you originally -- did that include the incremental Whole Foods business or did that exclude? I always get that confused.

It excluded it.

Excluded it, okay, thanks. Then the second thing is I was wondering there's a little bit of a disconnect between the number you put up there for the supernaturals and what the supernaturals are saying their sales levels are. And I was wondering if you can kind of break it down a little bit for us to what you're seeing out of that channel from an organic standpoint. I think you -- even when you signed the new contract with Whole Foods there was some incremental business, or is that wrong? Outside of the South Pacific?

We had some other smaller amounts of incremental business in the northern California in the Northwest region. But I am not sure there is really that much of a disconnect if -- our growth is really similar to the their comp rate of growth plus the additional new stores that get opened are the thing that really influences our overall number with them. I am not sure that there is really that much of a disconnect.

Okay, that's great. And focusing in on those facilities that you are going to open here, the Washington one, is that a purchase or a lease?

That is a purchase.

That is a purchase, and the Florida, can you give us some context and color around that? I assume that is a lease takeover, or is that incorrect?

We're not ready to announce it officially. As I said, we did sign a letter of intent and we are finalizing negotiations but it should be, it will be a lease building that has been an existing distribution facility. So we will have a minimal CapEx to move into that one.

That sounds like a great opportunity. And you think that's going to be up in -- what did you say?

Fall of '07, you know it is possible both of them could be ready late summer of this year, early fall of '07.

That is clearly good news. Then just getting onto the SG&A, I know we talked a lot about it but that is a huge benefit. If you had to -- (indiscernible) technology it is really just squarely the technology you're putting into some of these facilities? I know out in California you put the Pick-To-Light system in. That is a huge 100 basis point drop in operating expenses, or is it something to do with the structure of the Whole Foods contract or not?

I think, Scott, one thing that is important is to -- if we look back at what we talked about in the second quarter of fiscal '06 is that the Roots & Fruits acquisition that we had done within the Albert's division was diluted a bit at that time, say for 12 or 13 basis points. And they have since turned around their results. The Select Nutrition division was dilutive at that time, and they are now accretive and generating operating income sort of consistent with some of the other divisions. So a portion of it is certainly from efficiencies that we've gotten, but another aspect of it is really some of the underperforming aspects of the business are now in line with some of the long-standing portions of the business that have been, have always kicked off a good operating income. And so it is a combination of the two.

Is it also the West? I know the West was -- had not as great operating margin as the east. Is that partly what we are seeing here that the West is kind of coming more into line with what is going on with the east, or is that not contributing to this?

This quarter the West was hurt by the transition for Fontana but we have talked about over the last year plus that the West has made steady gains in their operating expenses and their operating income as a result.

And just one final one I guess for Michael. I know you said things picked up a little bit in January, and it is February. I guess where is that coming from, and my second follow-up to that is do you think the business is changing a little bit fundamentally here? Maybe there is some share shift going on to mass, but maybe perhaps we just slowed down a little bit from the huge growth rate we saw for the last 18 months; if you have any comments on that?

Again, the pickup that we've seen is slight. It's nothing major, and I don't look at any fundamental changes. We still look at our two-year numbers as meaningful. When we look back historically there has been the -- quarter to quarter there has been quite a bit of volatility where we've gone from high teens to low teens. Comping over these huge quarters a year ago I think make the comparisons really tough. But certainly the supermarket channel continues to gain momentum. We still think, though, the other channels shouldn't be looked at as going to be underperforming where they have been; that there is still plenty of opportunity. A lot of the overall demand I think in the category is driven by the media and that tends to come and go as the media focuses on various things. So we still feel very comfortable about the forecast for growth in all the channels.

Thanks for taking my questions; actually a pretty good quarter considering the headwinds you had, so thanks.

Edward Aaron, RBC Capital.

Questions with this being the first full quarter with the new Whole Foods contract in place, can you give us any sort of estimate of how much that affected the margin this quarter? I think I probably know the answer to the question but I figured I would ask anyway.

Yes, Ed, you know the answer that one. Yes we wouldn't want to specify what we thought was the impact of that. We will just have to pass on answering that question.

I figured. And then with the new business in the Southern Pacific region it sounds like it kind of hurt some positives and some negatives; you definitely commented that it has gone smoothly but also that there has been some cost pressures with which to some extent I think you were anticipating. So when you look at it for the kind of a contribution to the full-year -- I think when you first took that business on you said that you thought it would be roughly neutral. Is that still where you are for a full year expectation for that incremental business?

I would say at this point that is where we are, Ed. There is a chance that as they get some efficiencies in that facility that it could be accretive for the year, and that we would likely see that in the fourth quarter. But with the expenses that we've incurred they've been relatively in line with what we've expected, so I would expect it to be neutral to possibly slightly accretive if we were able to work out some of those costs by the end of the fourth quarter.

Okay, great. And Michael, I would love to get your sense on what is going on with the private-label business and the category overall? There is a school of thought out there that we are kind of in the early stages of a significant shift toward private-label. Do you see it playing out that way and I would just kind of like to get your thoughts on that.

Remember we don't like to -- I don't like to refer to our branded business as private-label. We are -- our strategy is to acquire emerging brands that are innovative, that reflect new trends in the marketplace and that are not certainly under any one label. It's a diverse selection of brands in a variety of categories throughout the store. So we are just trying to be able to control a good section of brands that can add to our margin and also that leverages our ability to, I think, see information before anyone else does, see trends before a lot of other people do. We do have very good visibility on trends throughout the industry that we are trying to capitalize on. So the numbers I threw out earlier I think are solid. I think we do expect to continue to build that division to about $150 million or 5% of total company revenues by the end of our fiscal '08. And I think it will make a very positive contribution as we continue to build towards that.

When you talk to some of your bigger customers about how they are looking to merchandise their stores, some of them have shifted by varying degrees of magnitude toward more private-label. To what extent do you think that they are looking for smaller, more innovative brands just sort of in even in some cases of alternative to either private-label or to some of the more broadly distributed brands?

I think a key point for most of the natural foods stores is a diverse selection of product and that we've seen a lot of private-label get out there over the past several years. But I think the customers are looking for a wider range, a selection, definitely looking for new and innovative items. And there is a lot of room for the smaller brands that really do add to that diversity for the stores. So I think we are in a -- our timing is good on this initiative and that we will be gaining shelf placement with a variety of channels over the next couple of years.

Okay, great. And then last question could you maybe talk about as you are bringing on some new facilities online over the next 12 months, how do you think about your capital structure and what you think would be an ideal capital structure to maintain as you kind of go through this transition?

I think Ed we tend to take a look at it on a regular basis and really see what is out there in the markets. We have had a good amount of our debt -- we've mostly financed everything through our debt in the past with probably 60% of it on the revolver, maybe a little more than that. And the rest long-term debt secured by the assets. And I think that we remain open to what opportunities are out there. Certainly the revolver has about one year left on it. So we will be reevaluating that as we go into that last year to put something new in place and how we want to approach that. But with liquidity that we've got on the revolver right now and that being relatively cheap debt, I think we tend to look at financing the growth through that structure. But certainly we keep an eye open for other alternatives that may be attractive or may be accretive if we execute them successfully.

Great. Thank you very much.

Ajay Jain, UBS.

Good morning. I know that you guys kind of narrowed down your composite sales guidance across all segments to 12.5 to 15% for the year. But I just wanted to see if I can confirm one of the figures that Michael mentioned in his prepared comments. I think there was a range of 13.5% to 15% that you are projecting for the back half of the year. Is that for the supernaturals channel specifically?

No, that was for the entire business. I think it was 13% to 15% for the latter half of '07.

Okay, got it. So that clarifies that. And then in terms of the Whole Foods business that you've transitioned over in the Southwest, can you confirm whether you expect to be at a run rate level this quarter relative to that 100 million on an annualized basis?

Yes, we would say that that still holds.

Okay, and just lastly, it seems like my last comment or question is that you are adding some additional warehouse capacity to respond to customer demand like with the Washington facility, and that incremental Whole Foods business in Fontana. But you've also clearly had some cost pressures on unused capacity with some of your existing distribution centers. So I'm just wondering are there additional plans for rationalizing your distribution facilities over the balance of this year and into '08 or is there kind of light at the end of the tunnel now?

I would say that with the events that took place during this quarter that with the existing facilities that we have, that is pretty much all behind us, and the facility up in Washington will alleviate some capacity issues that we might have faced had we not put something in place up there. Florida, while certainly not at capacity when we get that up and running, we feel we still feel there is opportunity to take incremental business in that market. But with getting rid of or selling off the two Auburn facilities or claiming to sell one and selling the other, and exiting the unused space in Minnesota, I think that is really it from a facility standpoint where we had excess capacity.

And what about Greenwood, Indiana? Is that -- ?

On Greenwood -- just to clarify -- on Greenwood we exited from the Albert standpoint, but we are still using that facility for our grocery distribution, and that has plenty of -- is doing quite well and has plenty of room for expansion. So there is no issues. That was maybe 10% of the facility was being used for Alberts at that time.

Okay, great. Thank you very much.

Michael Sesko, JPMorgan Michael.

Most of my questions have already been asked, but real quickly as you see the composition of your sales and exchange a little bit is there a way you think about kind of the margin benefits in the different businesses changing at all or and how do you think about that going forward?

Again, I think the way we look at it is not so much on the gross margin side, but on the operating margin side. Certainly our grosses are lower on our larger accounts, but our expenses to service them are also much lower. So we like to believe that our operating margin continues to be strong no matter how the channels grow. In addition, we again with the initiatives on our United Natural Foods brands and our acquiring labels and such, we think we can help strengthen the gross margin, as well. So the channel mix certainly has some impact, but again with other new channels like food service it can help us offset some of the downward pressure on gross margins that we've seen.

Okay, great. Thanks.

(OPERATOR INSTRUCTIONS) Andrew Wolf, BB&T Capital Markets.

Thank you. Mark, on your guidance on earnings did you narrow it to 1.27 to 1.30 because an earlier question suggested you had maintained and I thought I heard you say you narrowed it.

On a GAAP basis, Andy, we left it the same excluding sort of the one timers for the quarter, we narrowed it to 1.27 to 1.30.

Do you mean the $0.05 of basically asset write-downs or the costs associated with transitioning Whole Foods or both?

The asset write-downs, not so much the Whole Foods cost.

Okay, so first call is at $0.30, which it probably will be, then we are talking $1.27 to $1.30? Is the guidance?

Correct.

Okay. The other thing is just a technical thing, but you did say in the release that you reclassified one of the Northern California facilities to other assets from fixed pp?

Yes, from property --

How much was that?

It was about $6 million, roughly.

Okay, so $6 million, so otherwise your cash flow -- and that hurts your cash from operations by $6 million, but okay, got it, the way you report it.

Right.

And Michael, on the gross margin you alluded to -- two things on UNB. One, did I hear you right that the goal for '08 is 5% but the goal for this year is 4%?

What we said before, Andy, is that by the end of fiscal '08 we would want to be at a 5% of total revenues on a run rate basis. And at the end of '07 we want to be at a 4% run rate.

I mean is 1% annual increase in mix a long-term goal, or is it just sort of '08 is pretty far out but you want to give yourself something --.

That is our short-term goal. I think we still have -- we will update that as we get into next year. But it is a bit aggressive, but we think there is a number of the smaller acquisitions out there that we can grow, as well as the new product launches that I mentioned on our existing brands. I feel pretty comfortable that we can get there.

And if you get there what does that mean for gross margins given I think you expect supernaturals to kind of perk up a bit, but using kind of this quarter's run rate with something maybe a little higher growth at supernaturals are you going to -- would the addition of increased UNB business into the mix essentially stabilize out your gross margins? Is that what you are planning for?

It is hard to say exactly, but in general the extra margins on the growth side we get from branded are maybe 8 to 10%. So you can maybe do the math and make your own speculation.

And the last thing is in answering an earlier question the 14.9% that you achieved on the expense ratio, I think Mark you kind of alluded to it kind of as a general new run rate. Obviously it's going to vary a bit, but longer-term as yet facilities and I think continue to exploit other technologies and get levered, continue to potentially lever your scale. Is this 14.9 sort of the number that can be improved upon longer-term?

I would say yes. Based on what we said where we feel we're going to have pressures on the margin side, we feel that we can more than offset that with efficiencies on the operating margin on the operating expenses and hence the operating margin, so we still feel there is opportunity there to bring that down over time.

Thank you.

Michael Krestell, M Partners.

One quick question also relating to the margins. In the past you've spoken about availability of supply and having an excellent long-term relationships and not really seeing any movement there as far as being able to get goods in. Has anything changed in the last quarter? Are you seeing the supply still available, and is that having an impact on margins?

I wouldn't say there is any significant impact on margins by the -- on he supply side. There remains occasionally short supplies of some organic commodities, but in general it is nothing significant and nothing material.

Thank you.

Scott Mushkin, please go ahead with your follow-up.

A quick follow-up. When you open these facilities I know when previously you guys used to exclude those startup costs, so I was wondering as we get out this is going to be your second quarter next year -- we're going to have two facilities coming online. Is that going to be -- is that going to challenge your expense structure as we get into the first and second quarters of '08? Or is that not the right way to think about it or will you just exclude it like you used to?

We're probably not going to exclude it, Scott, so it will impact us to some extent. I think that it is a little bit different when we are opening up new facilities versus when we sort of relocated which has been a couple of instances of that nature. So it may cause a bit of a dip or maybe no improvements during that quarter, but until we get closer to it, it is tough to estimate what that could do.

I would just add to that, Scott. It does depend on where we are opening facilities. We've talked about Florida and Texas in particular as opportunities for us to significantly reduce our transportation cost. So in those examples I think out of the gate they can be accretive offsetting some of the startup costs that we typically have with new buildings because of the significant amount of miles that are reduced.

That is good color. Thank you.

Management, there are no further questions at this time. Please continue with any closing comments.

Thank you all for your participation in the quarter call, and we look forward to talking with you next quarter. Thank you.

Thank you ladies and gentlemen. This does conclude the United Natural Foods second quarter 2007 conference call. If you would like to listen to a replay of today's conference you may do so by dialing 1-800-405-2236 or 303-590-3000 using the access code 11083000. (OPERATOR INSTRUCTIONS) AT&T would like to thank you very much for your participation today. You may now disconnect.