United Natural Foods Inc (UNFI) 2007 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the United Natural Foods third 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) This conference is being recorded Tuesday, May 22nd of 2007.

And at this time, I'd like the presentation over to Julie Tu with the Financial Relations Board. Please go ahead, ma'am.

Thank you, and good morning, everyone. By now you should have all received a copy of this morning's press release. If anyone still needs a copy, please call Janet Jasmine 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 this morning from Management are Michael Funk, President and Chief Executive Officer, and Mark Shamber, Chief Financial Officer. We'll begin with some opening remarks from Management and then we will open up the lines for questions. As a reminder, this call is also being web cast today and can be accessed on the internet at www.unfi.com. Before we begin, as usual, we would like to remind everyone about the cautionary language regarding forward-looking statements contained in the press release. That same language applies to comments made on this morning's conference call. With that, I'd like to turn the call over to Michael Funk. Please go ahead, sir.

Thank you, everyone, and good morning. Thank you for joining our third quarter conference call. With me today is our Chief Financial Officer, Mark Shamber. Net income for the quarter was $13.7 million or $0.32 cents per share, which was up $1.4 million from the previous Q3 earnings of $12.3 million or $0.29 cents per share. Third quarter sales were $732.5 million, a solid 15% increase from the third quarter a year ago. Factors in the growth rate were increased sales in southern California, as previously announced, which accounted for approximately 3.6% of the growth. These additional sales helped drive supernatural sales to a 20.5% increase over the previous quarter. In addition, sales in the supermarket channel grew by 23% and the independent channel picked up to 8.3% over the previous Q3. Food service grew at just under 20%, as well.

As a percentage of our total business, supernaturals were 37.6%, supermarkets were 14.8%, and independents were 43.7% and food service being 2%. Whole Foods percentage of our total business was 29.1% and Wild Oats was 8.4%. Operations were once again solid with fulfillment rates of 97.58% excluding manufacture out-of-stocks. This is slightly below last quarter's numbers, but we're very pleased with our in-stock performance considering we brought in 3,000 additional SKUs into the southern California market. Our on-time deliveries increased to 98.96%, improving .75% from the previous quarter. Expenses for the quarter were 14.3% of sales, an improvement of 99 basis points from the previous Q3 a year ago.

Our facility in southern California continues to experience inefficiencies from the significant increase in volume that began earlier January. We would expect incremental improvements to be made there as the workforce becomes more experienced and improves productivity. We have two facilities in development scheduled for opening later this year. Our new location outside Portland, Oregon has broken ground. And although weather has set back construction, we anticipate being operational there by December 1st of this year. Our other site located in central Florida is being scheduled for a late summer 2007 opening. This facility will reduce transportation costs by transferring sales from the Atlanta facility. In addition, we'll be installing the fit-to-voice technology, which will ultimately lead to reduced operational overhead and improved productivity. We continue to see opportunities in reducing expenses by leveraging our sales base, continuing to improve our sales volume per delivery, which reduces our operation costs, and installing technology across all of our facilities.

Our United Natural Brands division, growth rate continued at a rate of 20% for the quarter. However, towards the end of the quarter and just after the quarter ended, we made 4 branded acquisitions totaling annual revenue of approximately $12.5 million. In addition, we had some new product launches with some of our existing brands. These new acquisitions, as well as our new product launches, will help us significantly increase sales of our United Natural Brands and help us build toward our target of 5% of total revenue by the end of fiscal 2008. We expect to continue to acquire emerging brands at attractive valuations in order to build our gross margin and earnings potential. Gross margin for the quarter was 17.7%, well below our targets for the period.

Our margin weakness was isolated to our Western Region, where the margin shortfall was attributed to a significant reduction in investment or forward buying, which was well below historical numbers. This impacted overall gross margin by approximately 26 basis points. This can be attributed to the rapid growth the region has just experienced and it is expected that we will build back our investment inventory to previous levels within the next 3 months. In addition, an unusual number of inventory adjustments were made in the quarter, negatively impacting margin by another 26 basis points. Our expectation is to see gross margin return to over 18% by Q4. As we look to complete another year, we are focussed on sales initiatives to continue to broaden, diversify our sales base, continuing to drive down operating expenses through lowering transportation costs, and installing technology to improve productivity, as well as building our branded division to increase gross margin. We look forward to next quarter when we will lay out our fiscal 2008 sales and earnings forecast. Now, for further details on the financial numbers, I'd like to turn the call over to Mark Shamber, our Chief Financial Officer. Mark?

Thank you, Michael. And good morning, to everyone listening in on the call and the webcast. Net sales for the third quarter of fiscal 2007 were $732.5 million, which represents growth of 15% or approximately $95.4 million over prior-year net sales of $637.1 million. Our 2-year comparable sales growth was 37.1%. Year-to-date net sales are 2.05 billion, yielding comparable sales growth of 12.9% over fiscal 2006's year-to-date net sales of $1.81 billion. Net income for the third quarter was $13.7 million or $0.32 cents per diluted share, compared to $12.3 million or $.29 cents per diluted share for the third quarter of fiscal 2006, an increase of $1.4 million or 11.4%. Gross margin as a percentage of sales for the third quarter of fiscal 2007 were 17.7%, which represents a 112 basis point decline from our gross margin of 18.9% for the third quarter of fiscal 2006, which ended April 29th, 2006.

The decline in gross margin in the third quarter was driven by a combination of factors. First, the company's level of forward buying in our Western Region during the third quarter continued to run below our historical levels, negatively impacting gross margin by approximately $1.9 million or 26 basis points. Second, we incurred approximately $1.9 million of incremental inventory adjustments in our east and west regions within broadline distribution during the quarter. Inventory adjustments include, but are not limited to, categories such as inventory that may have spoiled or has passed its sale by date, inventory that has been damaged by Company personnel in the warehouse, and adjustments to inventory selection or receiving errors. Third, a number of new customer agreements were in place during the third quarter that were not in effect during the prior fiscal year. Additionally, unanticipated delays in the completion of our previously announced strategy to acquire emerging brands and launch new products has prevented our branded products division United Natural Brands from contributing the planned level of sales and the associated incremental gross margin expected.

Our operating expenses for the quarter were 14.3% of net sales, compared to 15.3% for the same period last year. This represents a 99 basis point improvement over the prior year and a 60 basis point improvement over the prior quarter, after adjusting for the nonrecurring asset charges that occurred in the second quarter. Fuel costs represented 89 basis points for the quarter, a 6 basis point reduction over the prior year and a 12 basis point reduction over the prior quarter. However, our hedging program negatively impacted our fuel costs by $512,000 or 7 basis points during the quarter compared to a negligible benefit in the prior year. Our current fuel hedge expires in June, 2007. During the quarter, we recorded share-based compensation expense of $1.0 million or 13 basis points in accordance with FAS 123R.

Our days in inventory was at 45 days in the quarter, which is below the low end of our target range of 47 to 50 days and represents a day improvement over the prior year. DSO for the third quarter was at 21 days, favorable to our target range of 25 to 27 days, and a 3-day improvement over the prior year. Capital expenditures were $20.7 million or 1.0% of revenues for the first 9 months of fiscal 2007, which is currently below our target range of 1.75% of revenues. We expect our capital expenditures will increase significantly during the fourth quarter of fiscal 2007, as we build our new facility in Washington and customize our lease facility in central Florida. Our CapEx guidance for the fiscal -- for the full fiscal year remains between $40 and $45 million. Interest expense in the quarter was down approximately 10% sequentially and approximately 10% higher year-over-year. The sequential decrease was due to a lower average debt level during the quarter, due to increases in inventory levels being more than offset by higher sales.

The year-over-year increase in interest expense was again primarily driven by the highest interest rates experienced during the third quarter of fiscal 2007 related to the Fed rate increases that occurred in the first half of calendar 2006. Our outstanding commitment under our amended and restated credit facility as of April 2007 were approximately $126 million, with liquidity of approximately $144 million, including our cash and cash equivalents. Our return on total capital was 19% and our return on equity was 12.1% for the trailing 12 months. These return ratios fully reflect the impact of both share-based compensation expense and the Auburn, California and Minnesota facility expenses that were incurred in the second quarter of fiscal 2007.

At this time, I'd like to walk through the updated guidance that was included in our press release this morning. We are updating our projected revenue guidance to $2.75 billion to $2.80 billion for fiscal 2007, which ends on July 28th, 2007. This represents net sales growth of 13-15% over fiscal 2006. In addition, we are revising our GAAP guidance on earnings per share for fiscal 2007 to a range of $1.20 to $1.22 per diluted share. Previously on February 20th, 2007, we had reiterated our GAAP earnings per share guidance of $1.25 to $1.30 per diluted share for fiscal 2007. Excluding the impact of $2.2 million of losses related to our two Auburn, California facilities and $0.7 million in fees related to the early termination of unused lease space and the write-off of abandoned lease holder improvements in our facility in Minnesota, which were both reported in the second quarter of fiscal 2007, we are revising our earnings per share guidance for fiscal 2007 to a range of $1.24 to $1.26 per diluted share. Previously, we had revised our earnings per share guidance for fiscal 2007 excluding these items to a range of $1.27 to $1.30 per diluted share.

Finally, as I mentioned previously, we're maintaining our fiscal 2007 CapEx guidance of $40 to 45 million. There is still the possibility that certain capital expenditures currently planned for the fourth quarter of fiscal 2007 may be delayed during the quarter and, as a result, may not occur until fiscal 2008. That concludes our prepared remarks and at this time, we'll turn the call back over to the moderator to facilitate any questions.

Thank you, sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. (OPERATOR INSTRUCTIONS) One moment, please, for the first questions. Our first question will come from the line of Simeon Gutman with Goldman Sachs. Please go ahead.

Hey, guys. With respect to the forward buying, did you not have the capacity to purchase the quantities that you need to? Or with were there opportunities not available? And why is that going to change so rapidly in the next months?

Simeon, it's really more a factor of focus on the purchasing department's standpoint, capacity is there in general. It's just -- it takes focus and energy to solicit the vendors for the buys. Basically, we overloaded the region with the new SKUs, the new demands of bringing up the southern California business, which basically took their focus away. That largely is completed now, which is why we feel confident we'll be able to refocus our energies on getting back to the historical levels of the forward buys out West.

And you explain the source well of the inventory adjustments -- spoilage, past due. But why was that all recognized in this quarter? Was it not occuring over a longer period of time? So, what -- did something in particular occur in this past 3 months?

We have them every period, Simeon, and I tried to -- I realize that in the press release it wasn't worded as clearly. But this was incremental above what we normally experience. So, I mean, if our east region and west region, just as an example, might normally have, say, $1 million of such adjustments during the quarter, it was $2.9 million in this -- in that example for this third quarter. So, I mean, yes, we have them on a recurring basis. There were a variety of reasons depending on the region and depending on the facility, as to what was behind them. But it's -- it's just was a higher than normal level than what we've experienced typically in the past.

And then what helps that go away? I mean, is it a sell through issue or inventory management, less buying?

I think it's just putting some of the attention to detail back on sort of some of our ops folks, as well as -- I think on the purchasing side, as well, there comes the opportunity to be perhaps buying out with code dates that are a little further out and not necessarily taking on inventory that might have been closer to code.

Okay. And then, Michael, with respect to the independent channel, are you seeing any broad changes as far as mix goes, any categories where there's some business that's moving out of independent into supernatural and supermarket as they expand? Or is it any regions?

Well, I think based on the -- you're talking about the independent natural channel. We saw a nice little uptick of growth this past quarter, which still, I think, indicates that that channel for us is doing very well, doing very healthy. For the most part, that's a comp rate, if you will, for that channel. There's not a lot of new stores, necessarily, in that mix. So I think, in general, it's saying that that channel is holding on to its market share, in some cases broadening geographically into particularly the smaller markets and, overall, is a very healthy piece of business for us.

And based on your observations of talking to customers in that segment, are there -- is there any anxiety as this sort of stepped up expansion occurs with some of the supernatural guys and with the supermarket expansion?

Well, I think everyone in business has anxiety over competition. But the independents, I think, have a niche to fill. Number one, the smaller market niche, of which generally they have much less competition in those markets. And I think they also fill a niche of having additional or increased customer service that the larger stores can't fulfill at the same level. And given our product mix, our product lines, I think the extra customer service is a real valuable piece that can help independents maintain their market share.

Okay. Thanks, guys.

Our next question will come from Greg Badishkanian with Citigroup. Please go ahead.

Yeah, great, thanks. Just a few quick ones, here. If I -- did I hear you right that 3.6% of the growth came from the South Pacific deal?

3.6 of the 15.

Yep.

So roughly, what, 20% of the total growth there.

Okay. Good. So it's still double digit, even excluding that. And when you look at the supermarket channel, how much of your growth is coming from gaining new customers versus just growth in the overall channel? Even qualitatively, if you don't have the numbers.

I would just generalize that the comp growth that we're seeing in the supermarket channel is similar to the independent channel. And that business that's on top of that would indicate new doors or new shelf placements for us.

Yeah, okay. And have you noticed any change, say in April, in terms of your internally generated sales growth trend versus what it was at the beginning of the quarter?

Well, I think -- overall I would say, in general, it's been pretty stable and consistent. I don't think there's any -- there was any noticeable increases for us towards the end of the quarter. It was a pretty, I would say, consistent quarter for us.

Okay, good. And, let's see, I think one more quick one. Have you noticed any changes in terms of competitive pressures in the California market since you've gotten that Whole Foods business in terms of pricing? Or any other types of actions by your competitors out there?

Well, there's aggressive competition out West, as there is in some other markets in the country. I think it's always something we have to be battling. I don't think it's anything material and anything that's going to have any major impact on us. I think we have a long history with the majority of our customers, many of whom are under some kind of contract, and -- as well as decades of relationships with. So there's always going to be people who try and lowball business away from you. But in our case, we feel pretty protected with our long-term relationships.

And for -- in this quarter, you didn't see any like major step-up in competitive pricing from one of your competitors out there, right? Nothing very material in terms of change, right?

Yeah, right. Nothing material, right.

Okay. Good. Thank you.

Okay.

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

Hi, Michael, just wanted to follow up on the sales. Is that still the case, in the first few weeks of May, that you got a pretty stable trend?

Yes.

Okay. Thanks. On the forward buying, the foregone -- the profits left on the table, can you kind of comment on how kind of granular you've gone into looking at what the source of that was? By that, I mean, like, did you -- have you gone sort of buyer by buyer? Or line items or categories and said yep, here's one we've historically -- is it that kind of thing? Or is it more sort of extrapolating from past rates of percents and stuff like that?

Andy, we dug into from a standpoint -- I wouldn't say by buyer by buyer, although we do have the ability to do that. We tended to focus more on the products and then really looking at it warehouse by warehouse and what the levels were by facility going back over an extended period of time, month by month, so that we were trying to factor in any seasonality that may occur about when deals come into play. So, we've dug into it. We have some general ideas as to the categories that it relates to. And we know what steps we need to take in order to mitigate the issues in those categories. But that's, that's sort of the level that we did. We're certainly not trying to single out any individual buyers, by any means. But just trying to understand sort of the root cause behind it.

In terms of the fix, have you seen any substantive progress in results yet?

It's not something that we would see, per se, in a given week, because basically inventory's got to go in there and then work its way through the system and we're not necessarily doing the full P&L on a weekly basis. But we -- we would expect that when we close the month, our fiscal month of May, that we'll see some improvement at that time. So at this point, it's a little bit premature. But I think you can see that there's some improvement, just based on the number of forward buys that are going on.

That's what I meant. Thanks, Mark. And the last question, did I hear you right, Michael, you're going to open a new distribution center late this summer in Florida?

Yes. Yeah. We will make an official announcement with a press release in the next couple of weeks. But yeah, that facility's been planned for sometime. I think we announced that we had signed a letter of intent on our last call. That deal got done and we're moving forward with retrofitting that facility and plan to have it up and running late summer.

Just last thing on that. When you spec out the return on that -- hello?

Yes.

Sorry, there's just a bit of an echo here. When you spec out your return on investment, how would you look at it -- the majority of the return coming? Is it from, like Portland, where you're going to make a return by lowering your cost structure on the existing book of business? Or is it -- is there an opportunity there with new customers that might be pretty substantive going forward?

Andy, I would say from a standpoint of making the decision to go into Florida, it was done based on the return that we would get from the existing business and the savings that we would achieve. We certainly feel that there's an opportunity to win new business there, as well. But in making the decision to get into Florida and the size of the facility and things of that nature, that wasn't -- the new customer base was not sort of factored into that facility.

And lastly, in terms some of the costs just to get into the facility and not the capital costs, but those that flow through the P&L. I assume you're absorbing them in the current quarter, how about in the quarter -- in the fourth quarter, what about the quarter you reported, as well? Could you talk a little about how much versus what you just reported and what we're looking for in the fourth quarter? If there's any decent-sized costs from the Florida facility and/or Portland in there.

I would say that with respect to Florida, there were almost no costs in the third quarter. I would say that they were negligible, if anything. Certainly for Portland, we have started to build out some of the management team that will be running that facility, so we've incurred some costs there. But I think we've talked about in the past that -- historically, we had broken out what might have been the cost to get a new facility up and running and some of the incremental. And we sort of built that into our guidance going forward. So it's not something that we would necessarily be looking to try and cull out. We would just say that it's already been built into the guidance. So for the fourth quarter, I would say -- I have to admit that I don't know the status of the lease and what sort of free rent period may exist or anything in order to get that building up and running. But I would say that the costs that we expect to incur in both facilities in the fourth quarter would already be factored into the guidance for the period.

Okay. Thank you.

You're welcome.

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

Thanks, good morning. I'm just -- just trying to understand a little bit further just how unusual the inventory issues that you faced were this quarter. Just with the industry growth having slowed somewhat and then the new Whole Foods contract having been put into effect a couple of quarters ago. There's arguably just less margin for error in your business. I'm just trying to get my arms around the extent to which, these types of issues may have actually been felt on some occasions in the past, but weren't as disruptive to the numbers because the environment was different then than it was today. Could you help me understand that? Thanks.

Well Ed, I think some of these things happened in the past. I would liken the recent southern California business to a $100 million acquisition that we made. And in the past, when we've done larger acquisitions, in many cases there's some price you pay, some area of focus that gets dropped off that has an impact on the business. And that's how I categorize this, is that we just went through a large simulation of a large chunk of business. Our western region had -- it was all hands on deck to make it happen in a short period of time. And we loss some focus on the basic things that we do normally well day in and day out. So, in that case it's very unusual. But in the past, when I can remember doing some other large acquisitions, where we take your staff and have them refocus on assimilating acquisition, it's not unlike some of those experiences in the past.

Okay. Can you maybe -- can you look at the overall kind of operating margins of the western region versus the eastern region? Is there a dramatic difference right now between the two?

Yeah, there's a material difference between the two that we're addressing. And certainly, we feel like the two major divisions can be operating at similar -- similar margin levels. And we have definitely a lot of room to continue to improve out in the western region.

Okay. Thank you.

(OPERATOR INSTRUCTIONS) Our next question will come from Jason Whitmer with Cleveland Research Company. Please go ahead.

Hi, good morning. Michael, I wanted to ask you on the mix of your load to mid teen sales growth. How much of this would you attribute to share gains versus sort of the pace of the end market? What does that look like today, what has that been historically, and what's your outlook on that?

Are you talking about the overall growth rate that we've -- that we're forecasting?

Yes.

Well, we've basically had an 11-15% growth rate for this year that we felt was representative of our baseline growth rate with all of our channels averaged in. We certainly are -- we're pulling together our '08 plan that we'll be discussing on next quarter's call. Right now, it feels like we're in a very stable, consistent sales cycle, roughly at what we're experiencing today. So our outlook at the moment would be that we continue to see these trends. We're seeing the strong supermarket trends that we don't see that slowing down. We certainly see the new growth planned in the supernatural channel that we don't think is going to slow down any time soon. And for us, it's the new store openings that drive our growth rate as opposed to the comp rates there. And the independents is the -- I think, one of the main barometers. If we can continue to see this high single digit, basically, comp growth out of the independents, then we'll feel very positive about the forecasting in the future.

I guess maybe when you look at new growth or the new doors, how much of that is just with current customers versus new customers, the type of share gains you can get from extending your reach out into the marketplace?

Well, I think the biggest opportunity there is in the supermarket channel. There's still a lot of new chains, new doors if you will. There's a lot of market share that we have opportunities with. The independent channel, there's much less of market share gains. There's much less new doors, if you will. And you know the situation with supernatural. So certainly what you're speaking of, the market share gains and new store growth exists with the supermarket channel.

And with those new facilities, have there been any preliminary discussions or talks with some potential customers in those regions, largely in that supermarket segment?

I would say in general, yes.

And then with specifically to this quarter -- and I think you brought up new customers as a margin hurdle -- is that largely Whole Foods or is there some other -- are there other customers that are thrown into that bucket? And is it more because of the transition and the ramp or is it somewhat also effect from the terms of those deals?

Sorry, I got the first half of the question. Maybe just go through it again. The 3.5 to 3.6% was primarily the new business that we had picked up with Whole Foods.

Right. No, I meant the margin pressure from this quarter --

The margin pressure, I guess I would say that I wouldn't break out what piece is Whole Foods and what piece would be other new customers we've signed. We try not to really break down the pressure by customers. But I would say that it's not -- it's not solely Whole Foods, but given that Whole Foods is our largest customer, but you could think they would be at least a proportionate share of that.

Sure. And is it the ramp, the transition for that on the cost side or is it also the terms of contract either with them or with other guys who are kind of coming on board.

I would say that less of the margin pressure is due to ramp and more due to just terms.

Okay. Thank you.

You're welcome.

Our next question will come from the line of Ajay Jain with UBS. Please go ahead.

Yeah, hi. Good morning. I was wondering if you can give a little bit more color on the customer mix. Even in taking into account the additional Whole Foods business, which looks like it accounted for 4% of your top line growth. Did the underlying growth within supernaturals improve at all in the quarter? Or was it all attributable to southern California? Because I think the trends in the last couple of quarters have been in the 10% range for supernaturals.

Well, I don't know. We reported that the category or the channel itself was 20.5% growth for the quarter. So you can probably extrapolate that. I mean, in general, the supernatural growth is going to follow their reported public sales figures, which we generally participate in the comp growth in an equal way as well as the new store growth. So certainly we saw a corresponding increase in sales from the supernatural channel as such.

Okay. Go ahead.

No, go ahead.

And as a related issue, I know that you cited lack of forward buying on your end as a negative from a margin standpoint. But was there any forward buying going on at Whole Foods as you were ramping up in the Southwest to get you that 20% growth in supernaturals? I guess I'm just wondering how representative that 20% growth is in terms of your Whole Foods business right now.

Well, the -- I guess, Ajay, the forward buying wouldn't factor into the sales growth. I mean, it would have -- if there was any forward buying opportunities that would have existed related to taking on the Whole Foods business, it would have been on the margin side. And I can tell you just from the timing of when we announced the deal and when we started shipping out of the Fontana facility, that I would suspect it would be minimal forward buying opportunities on that business simply because you're talking 2 months out that you begin buying for it. That's -- and you need certain quantities on hand by January 15th. So, you're more focussed on buying what you need for whether it's a week or month or standard sort of inventory levels than you are about trying to get the forward buys, particularly when we were trying to add the 3,000 SKUs. So I'm not sure if I'm -- I'm not sure maybe, the way you were wording the question -- I mean, the forward buys tend to help on the margin side. They wouldn't have any impact on the sales side.

Yeah, I guess I was just wondering if there was some temporary benefit as you were transitioning that business, kind of ramping the business up, if that had a beneficial impact on the top line as it relates to Whole Foods specifically.

No, basically, the retailers are generally buy on a just in time basis. We're making deliveries every day. They're not able to really buy anymore than their daily needs. There's no forward buying, per se, from the retail side.

Okay. And then lastly, can you comment at all on the extent to which the gross margin decline might have been impacted by any specific changes in the pricing guidelines with your new supply agreement with Whole Foods? Just wondering if some of the gross margin issues might be more structural in nature?

Well, we did break out that some of the new agreements did play a role in the price -- in the margin. The inventory adjustments weren't associated with anything with the new agreements from that standpoint. So we certainly haven't gone into specifics of what the new agreements did to margin. But I'd just say that the inventory adjustments were not necessarily related to anything with any of the new agreements or impacting the margin related to the new agreements. It was internal issues not customer issues per se, other than normal customer issues.

Okay. But in terms of magnitude, were the internal issues more material than the customer issues?

I'm not going to break that out in that level of detail. There was -- as you could probably surmise, there was a reason we broke the other two out and left them general enough so as to not break that down.

Okay. Thank you very much.

You're welcome.

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

A lot of my questions have been answered, but the first one here quickly on your fuel costs. Your hedging did have a negative impact in Q3. We're now coming into summer fuel season again. And it's -- it looks like the oil prices are worse right now and diesel is creeping back up again. How should we be looking at your expense ratios for fuel kind of through the summer period here?

Well, Eric, I think the -- I think that you're going to see that our expense ratio on the fuel side changes and this is probably the first quarter related to it with some of that incremental business we picked up in SoPac, we're having much lower fuel costs as a result in that region. The trucks aren't going as far. And we're continuing, as we grow, to see sort of larger loads, which gives us some efficiency in that respect. I would say that going into the fourth quarter, the existing hedge that we have in place, as I mentioned, is still in place through the end of June. So two-thirds of the of the quarter we will be protective limited on the upside to roughly $2.90 a gallon. And it'll only be the month of July that's open from that standpoint. I guess I would say that it's a bit difficult to gauge right now. The core -- for a long period of time, the diesel prices going back to say last winter, November, December -- the diesel prices were actually tracking higher than gasoline prices. That situation has now reversed itself. And I think that the spread depending on the part of the country or if you were to go just based on the national averages, is almost up to $.30 now, where your gas prices are in excess of $3, but diesel prices are averaging $2.80. So I would say that -- I think we'll continue to see some pressure on the fuel side. We're getting some efficiencies by the larger drop sizes as well as some shorter routes in the SoPac region. But I think that once we get past say June, we'll be open to the way the market fluctuates on the diesel side.

Now when you open the Florida facilities, that should reduce fairly significantly the miles traveled, because you're going to be consolidating some of your business from the Atlantic facility. Would that be a fair assessment?

Yes. Yes. Correct.

Right. You'll see that occur in the first quarter of fiscal 2008.

The Oats business was poised to start getting some better same store sales comps in calendar 2007. Do you see that occuring?

I'm sorry, did you say Oats? Ed?

Eric, did you say Wild Oats?

Yeah, Wild Oats, correct.

I guess, what I would point to is Oats has continued to decline as a portion of our business. So while their comps may be getting better from that standpoint, from our standpoint, they're growing slower than the rest of our business. Last quarter, they were 8.8% of sales, this quarter they're 8.4. We grew at 15%. So you can make sort of a calculation that they've dropped off. A portion of that was probably due to the 7 or 8 stores they closed or they announced that they were closing in the fourth quarter of calendar 2006. But I'd say that while they may be doing better, they're still sort of growing slower than our average.

Okay. That's fair. And then finally, just the broad question, Michael. I know that you have a long-term goal, and I -- of a 4% EBIT margin. I know we all know that it's over a period of time. Is that still a fair long-term objective for an EBIT margin for United Natural?

Yeah, Eric, I don't see -- while we may be facing some short-term headwinds here, I don't think there's anything in our minds that can prevent us from getting to those targets over the longer term. The initiatives that we keep talking about all have the potential of raising our margin levels over that level. So we just certainly are -- remain optimistic that we can get there.

Okay. Thank you, guys.

Okay, Eric.

Thank you. Our next question will come from the line of Steve Chick with JP Morgan. Please go ahead.

Hi, thanks. Mark, I guess, looks like your guidance implies about $.34 cents a share in EPS for the fourth quarter. Can you get a little granular or more granular in terms of what you're anticipating the gross profit margin looks like? And is it too simple to take the 120 basis points of contraction that we saw this quarter and back out say 26 basis points for the spoilage and 26 basis points for the forward buying, and kind of -- that implies about a 70 basis point contraction for Q4. Is that what you're thinking about heading into the fourth quarter, as well?

I would say that's reasonable, Steve. The one issue is that, while the forward buying may come back by the end of the fourth quarter, there's probably going to be a lag where we see that process through on gross margin. So I would certainly say on the inventory adjustment side that I would expect that that would come fully back in the fourth quarter. I would think that on the high end on the forward buying that it would get us back up to roughly 18.25. But to the extent that that doesn't start to flow through until a month, month and a half, two months into the quarter, we may not see the recovery of that 26 basis points in the fourth quarter. The other thing that will help though, to the extent that the forward buys do not occur in that time frame, is that Michael discussed the acquisitions we made on some of the branded products and we'll start to see some the benefit of that on the gross margin during the fourth quarter, as well.

Okay.

So I'd certainly say the low 18s, whether it's 70 basis points, 65, 75, that still remains to be seen.

Okay. But I guess -- so the fourth quarter guidance implies then, that EBIT margins in total will still expand year-over-year. So I guess you're -- the anticipation is that you'll have enough operating expense improvement to have overall margins, actually looks like north of 4% for the fourth quarter. Is that the way you're thinking?

I would say that there's certainly the opportunity for it. We've had issues in the past that have sort of challenged that. And I would say that fuel prices are there. I would -- one of the challenges that we would face and again is to when the forward buys come back. I wouldn't want to go out and say that we're going to exceed 4% for the fourth quarter. But certainly if everything was clicking on all cylinders, we would think this is something that we'd be able to achieve.

Okay. And secondly, just for this past quarter, can you get a little more granular on kind of your operating expense improvement that you've been seeing? I mean, down 100 basis points year-over-year and down 6 EBITs relative to last quarter was still pretty good. Where are you, particularly given that you've seen inefficiencies I think you said in California. So you're absorbing it pretty well. Where are the other cost savings coming from?

Well, in general I would say our business continues to benefit from scale. We're leveraging larger sales base over our fixed overhead. We're increasing our sales for delivery. More and more of our deliveries are larger in nature. There's significant benefits from that standpoint. We have operational efficiencies in the warehouse. Just through continuing to operate more efficient buildings, have a more efficient workforce and more productive workforce. So it's really across the board in terms of gains. It's not any one thing we would point to. But it's certainly a number of gains on both the transportation and the warehouse operation side.

Okay. And last, related to that if I could. Looks like your depreciation and amortization expense was actually down year-over-year, is that within operating expenses? And actually, why is it down?

I mean, depreciation -- I mean, yes, for the most part depreciation and amortization for us is in operating expenses. The only caveat that I would say is that a small portion related to the Hershey division on the manufacturing side does end up in the cost of sales. But it's not material. And it's really just due to some of the assets that we had placed into service in the past either now being fully amortized. Certainly one factor that comes into play is that we had sold one Auburn building. And at the end of the second quarter, the other Auburn building, which we were depreciating, we took an impairment charge and put up as held for sale. So we're no longer depreciating that building.

Oh, okay, great. That's helpful. Thanks, Mark.

You're welcome.

Our next question will come from the line of Michael Lasser with Lehman Brothers, please go ahead.

Hello?

Michael?

Oh, sorry. I sincerely apologize if any of my questions are repeat. I jumped on the call late. Number one, what was the $6.5 million in acquisition expense during the quarter or acquisition cash flow?

As Michael mentioned, we -- I guess, Michael, what part of the call did you get on? I mean --

I was 10 minutes late.

Okay, so --

If it's -- you don't have to repeat it, I can check the transcript.

It's on the prepared remarks. It's related to three acquisitions that we did during the quarter. We did one that occurred after the quarter ends. But those costs related to three acquisitions of branded product companies that occurred during the third quarter.

Okay. And number two, is it typical to put change of control clauses into the supply agreements that you sign with bigger customers?

I would say that it's not a typical item. I would say that it would be negotiated on a customer by customer basis.

And is it -- are you able to comment on whether there's one in the Wild Oats agreement?

Michael, without looking at it, the agreement, myself, I couldn't comment. I could tell you whatever's publicly available, if it's in there, that's the extent of which I'd be able to comment.

Okay. And then, Michael, in your experience, how sticky is -- are the sales in the mass market channel? There's been a significant movement to offering more natural and organic foods from the mainstream retailers. Question is, if trends change and consumer demand changes, how quickly some of those retailers might look to pull those products. And have you seen instances like that in the past? Well, Michael, I'd say, I've been in this for 30 years and certainly we've seen the supermarkets get into offering natural products a couple of times and get out of it a couple of times. It seems, though in the last 10 years, the business has stuck for good. It's one of the fastest growing areas for supermarket sales, the chains are devoting more and more shelf space to these items and they're seeing the benefits of drawing in consumers that are looking for these products. So I think the key item for supermarkets is that they are able to maintain a fresh product selection. We know it's a dynamic industry and product demands change and preferences change. There's a lot of emphasis on new products that needs to be taken into account. And what we usually find is that supermarkets whose sales aren't at the level they should be have dated sets, so that they need to constantly be freshened up, which is why we can help people with expertise on the category management side. But in general, I don't see supermarkets going away from natural products. It's definitely, for the last 10 years, it's just continued to gain at -- everywhere we see products being placed.

Have you contemplating -- contemplated putting in supply agreements with -- in place with some of the more mass market retailers?

Yeah, we have various agreements with all of our customers. Supernatural, supermarkets, as well as some independent. So we certainly have agreements along those lines.

And the, could you talk a bit about -- and I apologize if this is a repeat, but your appetite for further acquisitions. How aggressive are you going to be and what would be the timing there?

Well, we've made public our acquisitive nature for the emerging branded items. We expected to continue to acquire generally the smaller emerging brands, so that we can build sales in our United Natural Brands division. That's certainly an area of focus that we would -- you should expect to see us continue to make acquisitions and we're always opportunistic looking for opportunities that might broaden and diversify our sales base. And we're keeping our opportunities open. So, obviously we wouldn't be able to talk about anything until it was happening.

But we could, perhaps, see one day more specialty food type products from your offering?

That's one of the areas we're certainly looking at. There's a lot of growth in ethnic and gourmet items and certainly things we've looked at in the past, broadening our offerings in those areas.

Okay. Thank you for taking my questions and your patience.

You're welcome.

Thanks, Michael.

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

Hey, guys. Just wanted to clarify a couple questions back. It sounded like it was -- you guys were endorsing that Oat sales have picked up quite a bit. And I think the statement was made that they had and, of course, their last quarter their sales were actually pretty low -- comp store sales. I just wanted to get clarity on that issue.

Well, I think, Scott, what Mark was saying was basically pointing out their percentage of sales from our total revenue standpoint. They have dropped when you look at our quarter-over-quarter sales numbers that we reported. That basically indicates as a total chain, their sales are not growing as fast of the rest of our business. We don't comment on any of our stores' comp sales or that type of thing. And certainly with Oats, we would expect to benefit from their new store openings as well as whatever comps -- comp gains that they were throwing off. But in their case, they have -- they did close some stores, I don't know two or three quarters ago, and we were probably comping over that. So that certainly has some impact. But we're not making any statements about their specific comp sales.

Okay. Just wanted to clarify. So you're not seeing necessarily a speed-up in Oats business with you. That was kind of the implication.

No, if they were growing as a fast as we were, Scott, we would -- they would still roughly be 8.8% of our sales. So the fact that they dropped to about 8.4% would say they're growing slower than us.

Right. Move on here a little bit. Margins, we kind of hit this a little bit. What I'm trying to understand is there's clearly a shift, even though independents did well in the quarter, but away from the independent channel to supernaturals and supermarkets. What kind of drag does that 1% switch -- what kind of drag does that put on gross margins? And I guess, conversely, what kind of benefit does it give you to the SG&A? Have you guys been able to quantify that? How serious of a problem is it?

I mean, I think what we've always said is that, first of all, we want to try and get people focussed on operating margin. That certainly as we take on some larger business that has larger delivery loads, larger order size, there's going to be tradeoffs from gross margin to -- that gets offset by operating efficiency. So part of what we're seeing is some tradeoffs there. Margin to expense reduction. And we need to make sure we have a diversified sales base so that we can complement those efficiencies with other business that adds to our operating margin, as well. But there's not -- there's not a formula that we can give you right now that suggests how that translates.

Okay. Two more quick ones, I know we're going on a long time here. The percentage of your -- of the United Brands sold to supermarket and supernatural channel, do you have that?

We haven't disclosed that. I would say, in general, our branded products are -- have a higher percentage of sales in our independent channel, followed by supermarkets and then, third would be supernatural placements.

Great. One final quick one. I know you guys didn't mention Texas at all, but -- and there was some mention that CapEx spending, some of it could be delayed into '08. Any preliminary look at CapEx spending in '08? I mean, it seems like it could be materially higher than the $40 to $45 million. Or is that not right?

We've signalled in the past that we didn't see any major spike in '08. But obviously we're going through our '08 budgets and forecasts right now. We'll be prepared to talk about it. Certainly Texas is still on our radar. But we -- we'll be able to talk about that more comprehensively on the next quarter's call. But off the top, I wouldn't think we would see a huge difference in the CapEx number.

And anything that you saw, Scott, that might indicate that would certainly just be a timing issue from '07 to '08.

Okay.

Where, if there was -- there's $5 to $10 million that I don't end up spending in '07 just due to timing of getting facilities constructed or retrofitted. That's really where you might see a big jump from '07 to '08 where we just shifted costs from one year to the next.

Maybe since maybe I'm taking up the rear, I'll do one more question here, if that's all right, on Oats. Have you guys, I know there's been some speculation on what it might cost you next year. Is there any way that this thing becomes neutral to you guys? Or is it just kind of no matter what happens at this stage it's going to cost you a few pennies next year?

Well, it's really difficult to say until we know more specifics about the actual transaction. We would like to believe that whatever happens it's not material to our forecast. But until we really have more visibility on the actual transaction, it's hard to say. But on the surface we don't see anything material impacting us.

Perfect. Thanks, guys. Thanks very much.

Thanks, Scott.

Thank you, our next question comes from Gary Giblen with Golden, Smith and Harris. Please go ahead.

Yeah, hi. Just to clarify some of your previous remarks, the gross margin impact resulting from changes in customer contracts, is any of that from the Whole Foods contracts post the Wild Oats deal? Or was that new contracts that were in place prior to that? Different ones?

The Oats deal hasn't closed yet, so there would be nothing related to Whole Foods acquiring Wild Oats.

Okay. And is it fair to say, though, that among those contracts that are changing that Whole Foods is one of them? Or is that not -- are there other ones?

I would say it would be fair to say that Whole Foods is one of the contracts that changed given that we signed that in the first quarter of fiscal '07.

Okay. Why would it take until now to be apparent in the reported financials? Was it always there but just offset by --

In the reported financials, we're comparing year-over-year. So I would say that, as we've said, a portion of the difference year-over-year is related to new contracts. So it -- the comparisons that we're making in gross margin are comparing against the prior fiscal year.

Okay.

So it was not -- the new contract was not -- the new contract with Whole Foods and certain of other new contracts that have been signed in the last 12 months were not in place for the third quarter of fiscal 2006.

Okay. I understand that. And just a different question in terms of building a -- the Florida facility. So that's a -- that goes into the market that is the primary facility of your primary competitors. So is there a particularly good opportunity to win new customers, in that case?

Every time we locate a facility closer to our customers, it gives us advantages in servicing that customer. So like anywhere else in the country where we open up, we would look at it as bringing us opportunities on the sales side.

Okay. But I mean is your customer penetration particularly light in the Southeast because it's been a region that has been the primary region of the competitors -- of the main competitor?

Well, I would say -- I wouldn't categorize it any way other than to say we believe there's lots of opportunities in the southeastern market.

Okay. Well, good luck with Florida and everything. Thank you.

Thanks, and we probably have time for one last question.

Thank you, sir. And that final question will come from the line of David Smith with Cypress Capital Group. Please go ahead.

Thank you. I just wanted to see if you could comment on the buy back program in place and if there was any indications that you would increase that at any point?

I would say that, based on our current needs, I would say that we're probably -- would not be putting any additional funds towards the buyback. There's opportunities that we have on the acquisition front and building out our infrastructure that we feel would be a better utilization of our capital.

Thank you.

You're welcome.

Thank you, and Management, if you would like to make any closing comments at this time. Please feel free to make those at this time.

Well, thank you once again for joining us on our third quarter conference call. We appreciate your support and interest in United Natural Foods. And we look forward to visiting with you again in the next quarter when we'll review our '08 forecasts and guidance. Thank you.

Thank you, Management. Ladies and gentlemen, we do thank you for your participation on today's program. If you would like to listen to a replay of today's conference call, please dial 1-800-405-2236 or 303-590-3000. You'll be asked to enter an access code of 11089970, followed by the pound sign. We thank you for your participation. At this time we will conclude. You may now disconnect and please have a pleasant day.