United Natural Foods Inc (UNFI) 2007 Q4 法說會逐字稿

Welcome to the United Natural Foods fourth 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 today, August 31, 2007. I would now like to turn the conference over to Julie Tu.

Thank you, and good morning, everyone. By now you should all have received a copy of this morning's press release. If anyone still needs a copy, please call Janet Jazimin 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 will begin with some opening comments from management, and then we will open up the lines for questions. As a reminder, this call is also being Webcast today and can be accessed on the Internet at www.unfi.com.

Before we begin, as usual, we would like to remind everyone about the cautionary language regarding forward-looking statements contained in the press release. That same language applies to comments made on this morning's conference call. With that, I would like to turn the call over to Michael Funk. Please go ahead, Mike.

Thank you, Julie, and thank you all for joining our fourth-quarter conference call. Joining me as always on the call today is Mark Shamber, our Chief Financial Officer.

Net income for the quarter was $13.12 million, or $0.31 per share, up 3.5% from the previous Q4 earnings of $12.67 million and $0.30 per share. Fourth-quarter sales were $706.8 million, a 14% increase from the fourth quarter a year ago and in line with our sales guidance of 13% to 15%. The supernatural channel grew at a rate of 22%, the supermarket channel was at 17.3%, independents were at 7.1%, and foodservice grew at 27.5%. As a percentage of our total business, supernaturals were 37.1%, supermarkets were 14.8%, and independents were 43.8%; foodservice was 2.1%.

Whole Foods' percentage of our total business was 28.8%, and Wild Oats was 8.3%. Looking at it from a go-forward basis, with Whole Foods now closing on the Wild Oats sale, our business with Whole Foods would have been 37.1%. As has been announced, Whole Foods will be selling the Henry's/Sun Harvest piece of Wild Oats to Apollo very soon. This business accounted for approximately 20% of our business with Wild Oats. This would reduce the percentage of Whole Foods business with us to approximately 34.5%. We expect no issues continuing the Henry's/Sun Harvest stores under its new ownership.

We forecast sales for 2008 to be over $3 billion a year, and a growth rate in the range of 11% to 14%. We have taken into account the probability of some Wild Oats store closures during the year, while acknowledging Whole Foods has not made specific announcements on the timing or extent of any store closures. We believe that most of the consumers in the closed stores will begin shopping in other accounts that we service, making the overall impact to sales minor. We also believe by the end of FY '08, as a result of Whole Foods' management of the Wild Oats stores, we will begin to see a positive impact on the comp sales there.

Operations were steady with fulfillment rates of 97.85%, excluding manufacturer out of stocks, up slightly from last quarter. On-time deliveries were 98.48%, continuing to maintain solid service levels to our customers.

Expenses for the quarter were 15.3% of sales. While this represented an increase of 94 basis points from Q3, it was 30 basis points less than Q4 a year ago. For the full year, we saw expenses reduced 80 basis points, from 15.9% in '06 to 15.1% in '07. One major item that drove our expense number higher in Q4 was start-up costs in our Sarasota, Florida and Portland, Oregon facilities that accounted for 915,000, or 13 basis points, for the quarter. Our Florida facility is on schedule to open at the end of September, and our Portland warehouse will open before the end of the calendar year.

In addition to these two new facilities, we will be identifying new or expanded warehouses in the Mid-Atlantic, Southern California and Texas over the next 12 to 18 months. Once up and running, we look for this new square footage expansion to relieve overcapacity in several of our buildings, improving efficiencies and lowering transportation costs.

Our United Natural Brands division grew at a rate of 30% for the quarter through a combination of growth to existing brands and new acquisitions recently completed. We continue to forecast sales of our brands to be at a faster rate than the rest of our business, and we'll continue to be acquisitive in '08 to drive our branded sales to 5% of our total revenue by the end of our fiscal '08.

Gross margin for the quarter was 18.7%, 94 basis points over the previous quarter. The issues that were mentioned in Q3's call regarding significant reduction in investment or forward buying in our Western region and an unusual number of inventory adjustments were resolved, as we had predicted last quarter. Our gross margin for the year came in at 18.5%, and while we expect some fluctuations on this number from quarter to quarter, our forecast is for margins to stabilize around '07 full-year numbers.

As we look forward to 2008, our focus will be to continue to execute on our plans to increase square footage to improve efficiencies and drive transportation and fuel savings, in [selling] technology in our buildings to improve productivity and reduce costs through improvement in selection accuracy, and continue to build on our branded sales strategy. In addition to this, we are planning some initiatives to expand our sales in the supermarket and foodservice channels with increased product selection and services to further diversify our sales base.

Our 2008 earnings guidance forecast is for $1.40 to $1.45 per share, an increase of 19% to 24 over '07 earnings. We look forward to continue to expand and leverage our leadership position with the distribution of natural and organic products. We think consumers' growing concerns about food security and safety, health and the environment will continue to drive demand for our products.

We want to welcome our new President of the Albert's Organics produce division, Kurt Luttecke. Kurt was most recently the vice president of meat and seafood at Wild Oats. We look forward to Kurt making a positive impact on that division of our company.

And as a final note, we have just completed one of the country's largest installations of solar panels in our Rocklin, California facility, highlighting our commitment to environmental sustainability. The return on the investment on the California system was four years, and guarantees us a hedge against rising electrical costs for years to come.

And now for further details on the financial numbers, I would like to turn the call over to Mark Shamber. Mark?

Thank you, Michael. Welcome to everyone listening on the call and Webcast.

Net sales for the fourth quarter of fiscal 2007 were $706.8 million. This represents an increase of 87 million, or 14%, over fiscal 2006 fourth-quarter revenues of $619.8 million, and a decline of approximately 3.5% from the third quarter of fiscal 2007. For the fiscal year ended July 28, 2007, net sales increased by $320.7 million, or 13.2%, to $2.754 billion, compared to fiscal 2006 net sales of $2.434 billion.

Gross margin for the quarter was 18.7% compared to 19.2% for the fourth quarter of fiscal 2006. This represented a 54 basis point decline over the prior year, but reflects a 94 basis point improvement over the third quarter of fiscal 2007. During the quarter we were successful in executing on the margin-enhancing opportunities that we had discussed on our third-quarter earnings call, and we also benefited from a full quarter of sales of the branded product acquisitions that had occurred in the third quarter, as well as an acquisition made at the beginning of the fourth quarter.

New customer agreements entered into during fiscal 2007 and increased concentration of the supernatural channel contributed to the decline in gross margins over the prior year.

Gross margin for fiscal 2007 was 18.5%, compared to 19.1% for the prior year, which represents a decline of 64 basis points from fiscal 2006, for the reasons discussed above, as well as discussed in prior quarters.

Operating expenses for the fourth quarter were 15.3% of sales, compared to 15.6% for the same period last year, a 29 basis point improvement. During the quarter we incurred approximately $900,000, or 13 basis points, in labor and related start-up expenses associated with opening our new facilities in Sarasota, Florida and Ridgefield, Washington.

The incremental cost of fuel for the quarter had a negative impact of approximately $900,000, or 13 basis points, on operating expenses over the third quarter of fiscal 2007, as fuel represented 106 basis points of net sales in the fourth quarter, an increase of 17 basis points over the third quarter of fiscal 2007 and an improvement of 6 basis points over the prior year.

In addition, health insurance costs negatively impacted operating expenses by approximately $600,000, or 8 basis points, for the quarter after adjusting for unplanned workforce increases during the year in our Western region associated with the increased Whole Foods business. Share-based comp during the quarter was approximately $1 million, or 15 basis points.

Operating income for the quarter was 3.4% on a GAAP basis, a 25 basis point decline over the prior year's fourth-quarter operating income of 3.6%. Adjusting for the costs associated with the Sarasota and Ridgefield facilities, operating income would have been 3.5% for the fourth quarter of fiscal 2007, a 21 basis point decline over the prior-year operating income of 3.7% after adjusting the prior year by $534,000 for the loss in equipment held for sale at our former Auburn, California facility.

Our effective tax rate for the quarter and fiscal year ended July 28, 2007 was 39%, compared to 35.9% for the fourth quarter of fiscal 2006 and 37.6% for the 2006 fiscal year.

Net income for the fourth quarter increased by 3.5% to $13.1 million, compared to the $12.7 million earned in the fourth quarter ended July 29, 2006. Diluted earnings per share increased to $0.31, an increase of approximately 3% over prior-year EPS of $0.30. As I mentioned in discussing operating expenses, net income in the quarter was negatively impacted by $562,000 of labor costs and related start-up expenses associated with our new facilities, or approximately $0.01 per share. Fiscal 2007 net income increased 15.9% to $50.2 million, or $1.17 per diluted share, compared to $43.3 million, or $1.02 per diluted share, for fiscal 2006 on a GAAP basis.

Operating expenses for the full year were 15.1% of sales, compared to 15.9% for the same period last year, reflecting an improvement of 75 basis points over the prior year. For fiscal 2007, fuel costs were consistent with the prior year at 105 basis points.

Operating income was 3.39% for the year compared to 3.28% for fiscal 2006, an improvement of 11 basis points. After excluding the impact of losses related to our Auburn, California facilities, the early termination of unused leased space at our facility in Minnesota, and the start-up costs associated with Sarasota and Ridgefield, operating income for fiscal 2007 was 3.53%, compared to fiscal 2006 operating income of 3.47%, after excluding the impact of the transition agreement with a former executive and costs associated with relocating our Rocklin, California facility and opening our Greenwood, Indiana facility, for a year-over-year improvement of 6 basis points.

Cash generated from operations for the fiscal year ended July 28, 2007 was $35.5 million compared to $25.2 million in the prior year. Our inventory was at 49 days for the fourth quarter, towards the high-end of our target range of 47 to 50 days, and a two-day decline over the fourth quarter of fiscal 2006. This decline was due in part to building up inventory levels at our Sarasota facility in anticipation of a September opening.

DSO for the fourth quarter was at 21 days, favorable to our target range of 25 to 27 days, and a two-day improvement over the fourth quarter of the prior year.

Capital expenditures were $46.8 million for fiscal 2006, equating to approximately 1.7% of revenues for the fiscal year. As discussed in our press release, our fiscal 2008 capital expenditures guidance is $50 million to $55 million. Included in our 2008 CapEx guidance are certain costs associated with completing the Sarasota, Florida and Ridgefield, Washington facilities. We expect to begin operating out of the Sarasota, Florida facility in late September, and the Ridgefield, Washington facility should commence operations in our second fiscal quarter.

The Company's outstanding commitments under the amended and restated credit facility as of July 28, 2007 were approximately $132.1 million, with an available liquidity of $134.9 million, including cash and cash equivalents.

The press release issued this morning also announced our full-year revenue, earnings per share, and CapEx guidance for fiscal 2008. For the fiscal year ending August 2, 2008, revenues are expected to increase approximately 11% to 14% from fiscal 2007 to a range of 3.05 to $3.13 billion. Fiscal 2008 earnings per diluted share are expected to be in the range of $1.40 to $1.45 per share, an increase of 19% to 24% over fiscal 2007.

After excluding the impact of the losses related to the Company's two Auburn, California facilities, and the fees related to the early termination of unused leased space and the write-off of (inaudible) leasehold improvement to the facility in Minnesota, both reported in the second quarter of fiscal 2007, fiscal 2008 earnings per diluted share are expected to increase 16% to 20% over fiscal 2007.

Our fiscal 2008 earnings guidance includes over $3.5 million, or $0.05 per diluted share, in labor costs and related start-up expenses associated with opening the Sarasota, Florida and Ridgefield, Washington facilities during the first half of fiscal 2008, as well as the expansion, relocation or opening of two additional facilities during the latter half of fiscal 2008. Historically, the Company had broken these items out as special or non-recurring items. Going forward, they will be included within our earnings guidance. Also, for fiscal 2008, we would expect our effective tax rate to be in the range of 36.5% to 37%.

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

(OPERATOR INSTRUCTIONS). Simeon Gutman, Goldman Sachs.

I would just like to drill down a little bit further into what your guidance incorporates in terms of the Whole Foods/Oats combination. And first, as it relates to the sales, the 11% to 14% growth, what are you thinking about in terms of closed Oats stores? I know logically you can make a case for a decent amount of retention, but what kind of analysis did you do to make that assumption?

This is Michael. Obviously, Whole Foods has not been able to make any decisions or announcements on timing or extent of store closures, other than what was released yesterday relating to some stores in Colorado. We believe they are going through the analysis as we speak and will be making decisions shortly. We have used our best estimates on store closures, retention of business into other accounts, and then, to a certain extent, increase in comps towards the latter part of '08, offsetting some of that erosion. All of that is baked into our sales guidance, obviously. That is why we have a range. If there was more closures and more erosion of sales than we have predicted, you would see us hitting the lower part of our sales guidance and vice versa. But at the moment, we are, obviously, waiting for Whole Foods to complete their analysis.

So, is it fair to say that from the low to the high-end of both the sales and the earnings guidance, the largest swing factor there is more of the Whole Foods/Oats combination as opposed to the core business?

That's a fair statement, I think. Certainly, our range takes that into account. So that is a fair statement.

And then, just as far as the comp store improvement, can you just provide a little bit extra color there, or is it not something you want to share?

I think, certainly, if you asked Whole Foods, their goal would be to bring up the Wild Oats stores to the comp level of the rest of the base of Whole Foods stores, which would be a fairly significant improvement if they were to achieve that in three or four quarters. I am sure that they are going to try to achieve that as soon as possible. So, obviously, the impact on our business, not only from a top-line, but an efficiency standpoint, as we would get more sales per delivery, has a very favorable impact on us.

Separately, as for the independent channel, I guess there's a small sequential down-tick in the top-line momentum. I don't have the two-year comparison in front of me, but how did that perform as compared to your internal forecast? And is there anything notable driving that?

We don't see any major trend changes in the independents. It's been in the high single-digits growth-wise for quite a while. I think we are definitely seeing -- we have such a diverse account base in the independent channel that it's probably worth mentioning that when we break it down into larger stores that sell more perishables, more the food-based stores, those comps are higher than the overall number would indicate. And the smaller stores that maybe are more focused on the supplement business tend to be in the lower single-digits, in a sense dropping the category, the channel, down slightly. So there is a big difference in that channel. We would like to believe that our core business is in the larger-style stores, which are going to continue to grow. So overall, we think, that channel is still very healthy as consumers look for the extra customer service that they get in those accounts. And in many cases, the independents are the ones servicing the great variety of geography around the country where there is few other choices.

And then just lastly, maybe, for Mark, just on the tax rate. I know the tax rate has been around 38% for a while; this year it was a little bit higher. What's causing it to be a little bit lower next year?

It's basically due to the -- Michael mentioned earlier about the solar panel installation that we're doing in Rocklin. We received some federal tax credits for a portion of that purchase price. So that's what's driving the rate lower.

And you said 36.5 to 37.5?

No. I actually said 36.5 to 37. It will vary depending on what the ultimate cost of the installation is, as well as sort of where our operating income comes in. But that is the range that, I think, is a pretty reasonable starting point. It may be slightly outside of it one way or the other, but that is the area we think it will come in at.

Ed Aaron, RBC Capital Markets.

A couple of questions for you. I am trying to get a little bit more comfortable with the guidance. 15% to 20% EPS growth is typical, I guess, sort of a steady-state range for you guys. But considering the fact that you have about $0.05 of an impact from new facilities coming online, and then probably some -- maybe a few pennies of impact from the Whole Foods/Wild Oats combination, I'm trying to understand where you get the incremental earnings to offset that and still get into that 15% to 20% range.

We have, obviously, carefully analyzed the forecast, and believe that these are very achievable. And we have given ranges that suggest where we would fall. We would like to believe our gross margin, with the initiatives on the branded side, will continue to stabilize throughout '08 and we won't see any further deterioration on the gross margin side. Certainly, we continue to get leverage overall. On the expense side, we are going to see some savings from Florida on transportation. They will be fairly immediate. And with the two facilities, we will see some relief of overcapacity in the Northwest. We are continuing to drive efficiencies throughout the business. We have been successful at lowering our SG&A over the last several years. Our track record there, I think, is pretty good. And we still believe we have lots of opportunities to limit and reduce expenses. So overall, I would say we feel comfortable with the guidance.

Can you give us an update on the Western region? I know that it had been lagging for some time compared to the East. And there was a onetime issue last quarter. But just more bigger picture in terms of the improvements that you have been working on there.

Overall, I think, the Western region is doing very well. They have worked through many of the -- most of the Southern California issues resulting in the new business from Whole Foods SoPac. That was, again, a tremendous load and strain that was placed on them. And I think we have moved through that successfully. The West has a higher percentage of supernatural business and large-store business, which affects the overall business, both -- in many ways. And I'd say our number one issue in the West right now probably is capacity, where we have much less capacity than we do in our Eastern region overall. Our facilities in Southern California and in Seattle are over capacity right now. Denver is right at capacity. So, obviously, they are struggling with capacity issues, which we are resolving by the opening of the Portland facility. And as we just announced, we will have a new expansion in Southern California towards the end of '08. But overall, I think, the West has improved tremendously in terms of their overall productivity.

Maybe lastly on the gross margin line. You recouped the 50 basis point sort of onetime issues that you had last quarter, but then there was another 50 basis points on top of that. It didn't really seem like it would have come from mix shift within your channels of business, because Whole Foods continued to increase. Is all that incremental improvement just coming from the initiatives you have got going on in your brands business? And within that, on the brand side, can you give us, maybe, an organic growth rate of that business as you see it today, just stripping out the acquisitions you have done?

I'll answer the part on the gross margin, and then I would let Michael discuss the branded side. I think, Ed -- I wouldn't say that the branded initiative is solely responsible for some of that, but we did highlight that during the third quarter that we made some acquisitions that would be in place for the entire fourth quarter. I think that they certainly contributed. I think that there is some of a mix shift during the quarter, not necessarily significant, on the produce side. Albert's tends to contribute a bit more during the second half of the year, or going into the fourth quarter. So I think that that was attributable, a portion of the gross margin. And then, I think, we discussed that we had some of the inventory adjustments in the third quarter that were higher than expected. And probably cleaning some of those up, we maybe didn't have as many in the fourth quarter as we might have had in the past. So there's not any one single item that kind of explains that additional 50 basis points or so, or I think it's maybe like 40. But I think that all of those individually sort of contributed to close some of that.

I would remind you that there is definitely fluctuation quarter to quarter, just as a normal course of business. So I wouldn't read that the contributions from any one thing are fully responsible for the 18.7.

And as far as the comment on organic growth rates on the branded side, I would say it's probably running at approximately 10% higher than the rest of our business. I think that is certainly our target. That is going to fluctuate as we introduce new products. But I think overall that is our target and what we have been able to achieve.

Scott Mushkin, Banc of America.

Wanted to talk about potential for new business. The revenue number, 11% to 14%, I assume doesn't take into account additional business wins, perhaps in Florida, and maybe on the West Coast. I was wondering -- are you guys getting closer to that, or is that -- some of that's still just kind of in the works?

I would say overall, again, when we try and forecast our sales number a year out, we're looking at probabilities of wins in certain areas, erosion in other areas, and that overall we wouldn't be announcing or talking about any major new win until there was a contract or a deal done. But we certainly believe there's lots of opportunities for us in various areas of the country. And we baked that into our 11% to 14% guidance. We wouldn't be commenting on any specific wins, obviously, until a public announcement was ready.

Did I hear you right? You're going to -- you think you're going to keep the Henry's portion of the business? Is that what (multiple speakers)

Yes. That is what I said. We don't anticipate any issues with the new owners, Smart & Final, and believe we will continue to operate that distribution as we have.

And then, as far as acquisitions go, obviously, you guys have made some in the past. What is your appetite? I know you have also said specialty wasn't an area, necessarily, you were going to focus in on, although I think maybe perhaps you have changed your mind that way. So maybe we can just talk about what you are thinking as far as acquisitions go.

We continue to look for opportunities. And certainly on the branded side, we have stated we want to be acquisitive on the smaller emerging brands. And we are definitely going to continue to be active there. And I would say on the distribution side, we'll again be opportunistic where we think something may fit into our overall distribution that can add to our business, particularly in the supermarket and the foodservice side. We are very focused on building business in those areas.

Scott Van Winkle, Canaccord Adams.

A couple of questions. First, I guess, for Mark. The timing of the expenses for Sarasota and Portland, and the two facilities you mentioned for next year in -- can you give us an indication of how that is going to flow through throughout the year now that you are including it in your guidance and it won't be excluded from EPS?

Sure. I think that the timing for the Florida facility is probably going to see that in the first quarter. It should be limited to that. We are getting the facility up and running as of the end of September. So I think that you'll only see that in the first quarter. I think you'll see a little bit more in the first quarter related to the Ridgefield facility going into the second quarter, and most of their expenses will be in the second quarter. And then the other two facilities, I think, you'll see it more in the fourth quarter, with maybe a little bit in the third.

So if I look at the number that we discussed in the prepared remarks, I would say that probably 55%, 65% of that is going to be in the first two quarters, and probably the other 35%, 40% is going to be in the fourth quarter with -- end of third quarter, beginning of the fourth quarter. So a 60/40 split between the first half and the second half of the year.

And the timing of getting your initial benefits on fuel from the Sarasota facility?

The benefits will be immediate. We'll have some costs that will be associated with it where it will be neutral -- neutral, maybe slightly dilutive, slightly accretive once we start shipping out of the facility. But day one once we start shipping, we'll start to see that. I think that as we manage to grow that business or pick up any incremental business, that's when that facility starts to become accretive to us, beyond sort of the current state that we had when we were dealing out of Atlanta and the terminal facility in White Springs.

The capital expenditure forecast, 50 to (technical difficulty), what percentage of that was maintenance? I apologize if you said it; I missed it.

I didn't. But I would say that probably -- at this point it's probably about 20% -- wait, sorry -- 10% of that number -- I'm doing the math in my head; you'd think I could do that. About 20% of that number. So in the range of about 10 to 13 million.

Lastly, on the numbers, supplements. What percentage of sales are they today versus a year ago? And what is the impact, if you can measure it, on top-line growth and on gross margin? You may not have that, but at least the trend as they're growing or declining as a percentage of sales?

I think the last number I saw was -- it was about 8% of our business, nutritional supplements. It may have gotten slightly below that in the last several quarters, but it's certainly our slowest-growing category, mid-single-digits typically. The last part of your question was contribution on margin? What else was it?

I assume the margin is higher, but you mentioned the growth rate being lower.

We'd don't really view the gross margin as being higher. It's really more of, I think, a function of -- it's favorable to our overall transportation costs; it helps add dollars without adding space in (inaudible). We look at it as basically the same operating margin.

Another one on that. Michael, you mentioned, obviously, the smaller natural food shops growing at a slower rate than the larger-format stores in your independent channel. That probably had a lot to do with the smaller supplement stores. But do you find that supplements are growing at a lower rate, even in the larger-format store as well?

I wouldn't really be able to comment on that, Scott. It's something I would have to double-check. I think for us it is, but I don't know. Retailers buy a lot of the supplements from direct vendors and other vendors. Sometimes you don't have full visibility on that.

You just went through your planning. You set your guidance for next year. I am wondering if you're targeting any improvements in return on equity and invested capital; it looked like both were down a little bit this year versus last -- certainly a function of the capital expenditures this year. Michael, are you focusing (technical difficulty) that return on equity target as well?

Certainly we would like to. Mark, do you want to comment on that?

I think certainly we are. I think that in some respects it's a little bit lower this year, because we didn't -- we put a lot of money into building out both Ridgefield and -- well, mostly in Ridgefield, less so in Sarasota, and didn't get any sort of return in the current year on that. So I think that getting those facilities open in the first half of fiscal '08, and sort of getting a return in that respect, you should see some improvement in those numbers. And to the extent that the other two facilities that we discussed are both up and running in fiscal '08, we may see even a little bit better kick from those if they slide into FY '09 for any reason. I still think that '08 will be better just by virtue of Ridgefield and Sarasota being open.

Last question, Mark, if I could. You talked about the gross margin versus last year, and operating expenses improving over last year. You gave some reasons behind it. I'm wondering how much of that might be mix towards [Whole Foods] or your supernatural customers, where you have lower gross margin, but also lower operating expenses.

I think that's certainly the case. That was one of the reasons, sort of, on the gross margin that I wanted to focus on the increased concentration of the supernatural channel, is that we do have lower gross margins in the supernatural channel, but we do benefit by lower operating expenses. So that's certainly -- you see that the Whole Foods and Wild Oats business, or now the Whole Foods business, is a larger percentage of sales than it was in the prior year. That is certainly one of the drivers for that mix shift, or that shift from gross margin to operating expenses decline.

Greg Badishkanian, Citigroup.

Just a quick question on inflation in the overall category. Have you noticed any increase in inflation on organic natural food? And if so, maybe, any particular categories?

We look at that sort of every quarter. We do update it, sort of, from a weight average from mix shift. I can say that for fourth quarter '07 versus fourth quarter '06, it was probably about 2.25% from an inflation standpoint. The categories that tend to have more have been some of the perishables, some of the yogurts and, obviously, the milks, or the dairy, I should say. But it goes across the board. Sometimes it's just a particular SKU versus the entire category that experiences that. But I would say that [it fits in] with what we have had for a range historically, at least at this point.

And I would add to that, Greg, definitely, with the pressure on commodity prices -- particularly soy and corn, obviously, all of the animal feed, animal products, from dairy, meat, eggs, etcetera, are all -- the inflation is definitely more significant than we have seen in some time. We just have an overall response to the inflation question for ourselves as a wholesaler. We pass on all increases as we receive them. We are never taking any erosion in our margin resulting in inflation. So, where it may squeeze retailers a little bit, and in some cases manufacturers, for our piece, things are passed through immediately. So it's not really an impact unless there was some significant top-line erosion, which we don't believe is the case.

With respect to passing on price increases, etcetera, fuel had an impact this quarter, and plans to -- maybe additional surcharges in the future to sort of help out margins to offset that?

We look at our fuel costs -- as we have sort of said on previous calls, we look at our fuel costs on a quarterly basis. So we would have done that as of the end of the fourth quarter. We decided, based on where we currently are, that there was no change in the fuel surcharge. And I would say that we'll look at it again as of the end of the first quarter, and reevaluate (technical difficulty). There are some instances where customers have specific arrangements that may be different timing-wise to any sort of surcharge or adjustment in their pricing related to that.

Andrew Wolf, BB&T.

I missed the beginning of the call, so I apologize if this is somewhat redundant. On the gross margin, the recouping in that, first of all, have you specifically talked about what you expect next year numerically? Michael, I think, you alluded to qualitatively this notion of stabilization. Could you elaborate on it, either through numbers in the guidance? Or if that is not the way you want to go, what could -- using, let's say, this -- what you put out this quarter as kind of the baseline number, what could make it better or worse, and how are you looking at it?

What we stated earlier was that our full-year number came in at 18.5, and we look basically for '08 to stabilize around that number with some fluctuation quarter to quarter. But basically, that was the target we stated.

But that sort of implies that last quarter's onetime issues, if you adjusted that out, that there's still a little bit of sort of at least year-over-year erosion on an adjusted basis. Is that because of mix? Or is that -- what's that play there? Is it you just sort of straight-line what you would expect at mix today, and if it were to be better than that, maybe your private brand initiatives would goose it a bit?

I think if we looked at our margin being consistent from '07 to '08, it would be a combination of some erosion due to mix and consolidation of customers, as well as being offset by branded initiatives to a place where it would stabilize. Just a combination of the two.

On that mix thing, let's just say Whole Foods is growing faster than the rest, and everyone knows they have a better gross margin. All in, on the operating income ratio line, Mark was alluding to it's much more efficient. Is that generally -- let's say there's some negative mix on the gross margin that's kind of [secular] because of the way the business is -- may or may not be offset by brands, but let's just say kind of on a neutral brand basis, if the brands are okay but not really goosing that number too much, is delivering to Whole Foods so much more efficient that this trend is -- your expense ratio goes down commensurate such that we shouldn't look for the EBIT percentage to decline commensurate with gross margins?

Basically, Andy, I think, the number-one driver of our expenses is dollars per delivery. And certainly with our largest deliveries, we get tremendous efficiencies, which offset to a great degree the lower gross margins. So at the end of the day, operating margins can be very similar. And I think where the capacity issues are dealt with and the efficiencies are there, again, overall operating margins can be very similar.

I don't know if you've got this calculated, but it would be interesting if you do. The Whole Foods -- do you have a pro forma what Whole Foods is to you in '08, excluding, obviously, Smart & Final is going to be owning a lot of the Oats -- a fair chunk of the Oats business. And you talked about you're not quite sure what they're going to close. Pro forma, obviously, it's not just a simplistic 40%, 42%; you can't add them up because they're not going to own -- at the end of the day, certainly at the end of the year, it's going to be a lot lower than that. Can you give us a sense of what your pro forma Whole Foods pro forma for the acquisition and then divestitures and closures -- what it looks like in '08?

I guess the answer is that I could, but I'd still be concerned that folks will be backing in as to what the numbers are going to be for the Wild Oats stores, and what's going over to Smart & Final. So I think I would decline to do that at this point until there is some announcements.

I think that you can certainly make a fair assessment, as we have discussed, that we think that the supernatural channel will continue to grow at 20%. So, from the perspective that Whole Foods and Wild Oats now are under the Whole Foods label, take the split of what Whole Foods was and say that grows at 20%, what number do you use for Wild Oats, and what do you think that Whole Foods can achieve from growth on those stores that they retain? There's a number of different estimates. I would decline to do it at this point simply because I think that it would back into where we're estimating for sales. And I don't want to get pinned down on that right now until Whole Foods has made their announcements about what they are going to do.

Lastly, your cash flow from operations was a good number this year, and despite the fact that the inventories were up quite a lot as a use of cash. Can you speak to what you're looking for in '08? It strikes me if the inventories growth comes in a little debt, you could be pretty close to self-funding on your CapEx by next year. Is that in the realm of possibility?

I think it's in the realm of possibility. I think that it may -- I can tell you that for this year, just as an example, that 53 million that we're showing for inventories, that includes a little more than $7 million related to the Sarasota facility where we are building inventory; we start building inventory anticipating the opening. So, that's probably -- it's part of the reason why our days in inventory declined.

I would hesitate to say definitively that that will be the case for fiscal '08, simply because I can't predict the timing of when the other facilities that we're talking about in the latter half of the year, when they will occur, and whether or not they are going to be relocations versus a new facility. If they are going to be a new facility, we're probably going to have, again -- have that utilization of the working capital to basically get the inventory in that facility. And it will take us sort of a quarter to work our way through it. If it turns out being an expansion or relocation, then we're probably not going to utilize the same amount of inventory. So, yes; I think in that case it probably could be self-funding for the CapEx.

Ajay Jain, UBS.

My first question is for Mark. I think there was a swap agreement on fuel costs that just expired in June. And I'm just wondering to what degree you're hedged on fuel right now. If you can also comment on how you see the year-over-year comparisons for diesel in the current quarter.

Sure. To the first question, it ended at the end of June. We are no longer hedged on any portion of the fuel. As we discussed on previous quarters' calls, we had gone into it and had some success the first year that we did it. The second, this past year when we had done some more hedging, the correlation between diesel and #2 heating oil, which is what you hedge against, was not to the same level that it had historically been. So that hedge worked out relatively unfavorable for us. And the correlation does not seem to have gotten significantly better. So we feel that we are better off not being hedged at this point.

And from a standpoint of where the fuel prices were, I would say for the quarter as a whole, it probably was up about 15% to 20%. I would say that the latter part of the quarter was relatively flat, maybe 2% to 3%. But it was more of the first part of the quarter where there was a significant increase over prior year.

So at this point, the variability on fuel, is it just a function of the spot prices in the open market and the extent to which you can pass along any increase through the surcharge program?

For the most part. We have full-service leases, so our pricing comes from the trucking companies. So it's not per se open market. But for all intents and purposes, that would be true.

In terms of the '08 guidance, given that you have the two new DCs opening up, and obviously you've got to incur depreciation for those facilities, can you confirm what you're looking for in terms of D&A for this year?

I can tell you that it's again a function of when the facilities in the latter half of the year kick into it. But I would say that you are probably looking for maybe roughly a 10% to 15% increase in depreciation and amortization.

Forgive me if you already mentioned this, Mark, but what is the outlook for options expense this year?

I actually didn't give it intentionally, only because from where we were last December versus where we were this December on the stock price, I could say that it will be up year-over-year up from what we ended up having for share-based comp. So this past year ended up being $4 million. I could say that it's probably between $4.5 million and $5 million. But it really is dependent on where the stock price is when we do our grant in December. I gave a range last year. The stock price wasn't at the level that I anticipated when I did it, and I kind of took the guidance down. So I can feel comfortable saying that it's probably up $0.5 million to $1 million over fiscal '07. But I would be more willing to give that as of 2Q than to do it now.

Lastly, can you give anymore specificity on the preopening and also the operating expenses in the next few quarters, just for the Sarasota and Ridgefield DCs? You spoke a little bit earlier about the timing and the 60/40 split. I'm just wondering if you can quantify things a little further in terms of the actual P&L impact.

I guess what I would say is we said that there's about $3.5 million. So if you took it from 60/40, you could say that that would be, say, $0.03 in the first half of the year and $0.02 in the latter half of the year. I can't predict definitively, simply because the timing of when Ridgefield is up and running could shift. So if we're ready to open Ridgefield at the beginning of December, then I'm probably going to have more costs in Q1 proportionally out of that $0.03 than I would in Q2. If Ridgefield is not ready to start shipping until the end of December or somewhere into January, their costs aren't going to -- we don't start hiring the folks until a month or so, a month to two months before we need them. So I could say definitively that the facility will open at the beginning of December, I would say probably two-thirds Q1, one-third Q2. If it shifts at all, then it's probably a 50/50 split of that first half of the year. The second half of the year, I really can't give any more specifics, other than it will be in that part of the year, simply because I don't know at this point that the dates are going to be firm as to when we're ready to open the new facilities or expand the facilities.

But regardless of how back end-loaded Ridgefield might be, $0.05 incrementally, that's the overall impact for the full year? Is that --?

Yes. The impact for the full year between the four facilities we estimate to be $0.05.

Eric Larson, Piper Jaffray.

I wasn't sure I was ever going to get on. I queued in so long ago I thought maybe it wasn't working. A couple of questions on the fourth-quarter revenues. My perception here is that your new contract from Whole Foods in the Southwest is about -- I think we kind of rounded it to about $100 million annually of incremental revenue. If you take out the -- I just said take out 25 million in the quarter, I get to about a 10% growth rate year-over-year from existing business outside of the new Whole Foods contract. Is that the proper way to look at the fourth quarter?

That is not too far off. We would say it is a little higher than 10, and that the (technical difficulty) SoCal business is more like a little over 3.5% of the growth. But you are not too far off.

Michael, the revenues on the street for the quarter were quite a bit higher than what you reported. And the one thing I did notice is independents look like they're kind of back to what their normalized growth rate is, around 7%. And they had been running quite a bit higher. Is that also a fair observation? Are we starting to see going back to a more normalized growth rate in independents? Or is it sort of a one kind of quarter blip? How are the independents doing today versus, let's say, six months ago?

I don't think there has been a huge shift at all. I think there is a normal amount of fluctuation quarter to quarter that's based on a variety of factors. We basically have noticed in the past two years Q4 coming in a little softer then we might have normally predicted. I certainly don't know if that is some kind of seasonality trend that is beginning or not. But I wouldn't read too much into one quarter's numbers. They weren't that far off. Certainly, there's factors out there that impact these things. We would still expect independent numbers to be high single-digits going into '08.

Steve Chick, JPMorgan.

I guess just to clarify the comments on the potential Wild Oats impact, should we think about it -- if it's 8.3% of your business now, and let's say 20% goes with Smart & Final, is that remaining 6%, kind of day one, is that the now under different terms or under the new Whole Foods contract terms? Is that factored into your guidance going into '08?

Obviously, into '08, we assume at some point we'll consolidate contracts. We haven't sat down and negotiated that as of yet. There's different issues that need to be resolved. And I think we're going to wait and see what the Whole Foods decisions are on various stores, etcetera. But certainly at some point in '08, we would anticipate that. And that is baked into our guidance.

That's helpful. Second thing, if I could. Mark, the CapEx guidance for the year into '08, it looks like ex-maintenance it's about incremental growth spend, I guess you could say, of $40 million or so. And with the uptick in CapEx for the fourth quarter of the $26 million in spend, I had kind of thought that the spend of, like, a Sarasota, and maybe even a little bit of Ridgefield, was already spent. Can you reconcile between the two?

I can say that a good portion of Sarasota is in the fiscal '07, as well as I would say the majority of Ridgefield -- I would say there's still probably -- if I had to estimate, it's probably up to $5 million or so that could still be going into fiscal '08 for Ridgefield. But we have got the two facilities in the latter half of the year that whether, again, it is an expansion, a relocation or a new facility. So you could make the presumption that one of them may be a lease and one might be a purchase. Or there could be two leases. I guess what I would say is that there is a good amount that is in there for the CapEx for the new facilities in the latter half of the year. There are also some IT initiatives that we have got that we have talked about with the pick-to-light and the pick-to-voice that we are rolling out through other facilities across the country that maybe closes some of that gap, and isn't sort of maintenance related.

But it sounds like maybe you are being a little conservative in terms of your spend. I don't know if you are kind of taking here's the highest level it could be, and let's throw it out there and kind of see the timing of it and --

I guess I would disagree with that only from the standpoint, if you look at where we said '07 would come in, we talked that it would be 40 to 45. And dependent on when some things shifted, I think that '08 is the same thing. If both facilities get open, there's probably right at the high end of that range. If only one of the facilities gets opened, we're probably at the lower end of the range and have some carryover into fiscal '09. That is where the 50 to 55 comes in.

I think that if we look at what we spent, we have talked about that Sarasota was a leased facility and we only required far lower levels from a CapEx standpoint than typically when we go into a leased facility. I think that the guidance that we have got out there for the two facilities in the latter half of the year, we certainly feel that we're not at the high-end, and we are probably right in the middle of where things will play out.

Gary Giblen, Goldsmith & Harris.

Will the Henry's business that you retain be at levels similar to the Wild Oats contract that has existed, or will it be a whole new ballgame?

We are not forecasting any changes in that business in any way right now.

Are you seeing any material weakness in the Florida and California stores that you serve, which is the case for the general retail community, seeing weakness in those states?

Gee, no. We would look at those two markets as some of our strongest markets, with the demand for our products being as high or higher than in other regions. So, no; I would say that doesn't apply in our business.

I guess they're good natural food states.

That's right.

Ladies and gentlemen, that concludes the question-and-answer session. Please go ahead, management, with any closing remarks.

Thanks, everyone, for your support of United Natural Foods. If you would like more information, feel free to go to our Web site at www.unfi.com. And I wish everyone a safe and healthy holiday weekend. Thank you.

Ladies and gentlemen, this concludes the United Natural Foods fourth quarter 2007 conference call. If you would like to listen to a replay of today's conference call, please dial 303-590-3000, or 800-405-2236. The passcode is 11095745#. ACT would like to thank you for your participation. You may now disconnect, and have a pleasant day.