United Natural Foods Inc (UNFI) 2008 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you so much for standing by, and welcome to the United Natural Foods second quarter conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded today on Thursday, the 21st of February, 2008.

I'll now turn the conference over to Ms. Julie Tu, of the Financial Relations Board. Please go ahead.

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

With us today for management is Michael Funk, President and Chief Executive Officer, and Mark Shamber, Chief Financial Officer.

We'll begin with some opening comments from management, and then we will open up the lines for questions.

As a reminder, this call is also being webcast today and can be accessed on the Internet at www.unfi.com.

Before we begin, as usual, we would like to remind everyone about the cautionary language regarding forward-looking statements contained in the press release. That same language applies to the comments made on this afternoon's conference call.

With that, I'd like to turn the call over to Michael Funk.

Please go ahead, Michael.

Thank you, Julie, and thank you, everyone, for joining our second quarter conference call. With me today on the call is Mark Shamber, our Chief Financial Officer.

Our second quarter sales were $830.7 million, a 24.2% increase from the second quarter a year ago. Exclusive of the Millbrook acquisition, our sales grew at a rate of 13.4%. The supernatural channel grew at a rate of 19.2%. Our supermarket business was at 81% growth. This includes the Millbrook business, and exclusive of the acquisition was a 9.3% growth rate. Our independents continued their strong performance and grew by 10.8%. And food service grew at 29.7%.

Despite slow economic conditions, demand for our products remains very consistent. We think consumers' continued concerns about food security and safety, health and the environment will continue to drive demand for our products and offset concerns about pricing. We have seen the same pattern of strong sales in economic downturns repeat over and over during the last 30 years.

We are anticipating increased growth opportunities in our supermarket channel as we begin to offer retailers a full selection of natural organic as well as specialty ethnic assortments. We also are anticipating offering our core natural customers more selection on the specialty side on items with acceptable ingredients. Our strategy in moving in this direction will ultimately diversify our customer base and make us a stronger competitor to gain business and accounts we have previously not serviced.

As a percentage of our total business, supernaturals, which are Whole Foods and Wild Oats, were at 33.2%, supermarkets were at 22%, independents were at 40.9% and food service was 2.1%.

With a full quarter since the acquisition of Millbrook, we were successful in our primary goal of restoring inventory levels and fulfillment rates to our customers. On the fulfillment rates, Millbrook has gone from the low 70%'s from the time the deal closed to the low 90s in January, a period of less than 90 days, and recognizing that it took us the first three weeks in November to begin to receive a steady flow of product into all of our facilities, fill retail pipelines and establish credit with new suppliers. Historic service levels in the industry for specialty foods, given the number of imports, is in the low 92% to 94% range. We have been achieving that level since mid-January and are now maintaining those levels.

We had originally forecasted being able to restore historical gross margins at Millbrook as well as reduce some initial overhead so to be neutral to our earnings within the first four to five months from the acquisition date. We now believe it will take another two quarters to establish the purchasing efficiencies and to leverage synergies with UNFI's purchasing, transportation and operation department to fully reach this goal. We believe we will make Millbrook neutral to our earnings by Q1 of our fiscal '09 year, which starts in August of 2008.

There are significant expense synergies that we expect to occur over the next 24 months, which will ultimately make this acquisition very accretive. One of these initiatives is occurring at the end of the month, in which we will be closing Millbrook's Tampa facility and integrating it into our Sarasota, Florida facility. Expense reduction from this move will begin to occur this April. Bottom line is we are allowing for an additional four to five months beyond our original forecast in getting Millbrook to be neutral to earnings.

While operating expenses increased this quarter to 16.3%, 91 basis points higher than last year, the majority of this increase was due to Millbrook's impact. Besides some nonrecurring expenses associated with the opening of our Portland, Oregon facility, our core business expenses were in line with our previous expectations. During the quarter we were able to relocate our Albert's Organics produce facility previously located in Winter Haven, Florida, into our new Sarasota, Florida facility. While both our new facilities, in Florida and the Northwest, are performing well, new facilities do not operate at full efficiency for the first six to nine months. We would therefore anticipate 14 to 16 basis points of improvement to occur as efficiencies develop in these new buildings over the next few quarters.

We also signed a lease for a new facility in Southern California, which we anticipate being operational by August 1 of 2008. This will replace our current distribution center in that area located in Fontana, California, in which we also maintain several offsite facilities there, as it's one of the most over-capacity warehouses we have. We will be able to eliminate the overhead of all the current buildings in that area and be able to lower costs through much-improved efficiencies.

The same situation applies to our new Oxford, Pennsylvania facility, which is severely over capacity and has to maintain several offsite storage facilities to handle their volume. Because of the compelling benefits to our operations, we are accelerating our relocation of this facility to begin in Q4 of this current fiscal year. This will impact our original forecast, as some of the expenses that were thought to occur in FY '09 will be moved up to Q4 of '08.

Both of our planned new relocated facilities for Q4 will be over 600,000 square feet and designed to handle increased product assortment and increased sales in those regions of the country.

For the quarter, our fulfillment rates, excluding Millbrook, were 97.65%, consistent with last quarter, and on-time deliveries were at 98.68%.

Sales from our United Natural Brands division grew approximately 31% compared to the same quarter in '07. This was primarily driven by acquisitions completed during the last 12 months. During the second half of fiscal '08 we should see sales growth for United Natural Brands accelerate to over 40%. While we are happy with the progress our branded business has made, we have not been able to achieve the sales growth required to meet the earnings that we had previously projected for this division. For our current quarter, the impact of the shortfall in sales from this division was approximately 21 basis points of operating margin. Based on our revised forecast in the second half of the year, the impact from lower than expected sales in the branded division will be approximately 20 to 22 basis points of operating margin.

We are reducing our 2008 guidance to more properly reflect the impact of Millbrook on our results, as well as reduced sales growth for our branded products division. For the back half of our current fiscal year, we forecast lower earnings per share of between $0.18 and $0.20 than what was previously given. Nearly all of the shortfall relates to the issues related to Millbrook and the branded division already mentioned.

While we are disappointed that we have not made more progress attaining profitability in the Millbrook division in the first three months since the acquisition, we are confident that we will achieve this goal by Q1 of our fiscal year '09. We are encouraged by the strength of our core business and the strength of consumer demand for our products. Our long-term goals of leveraging our leadership position in the distribution of natural and organic products and also become a leader in the specialty ethnic foods business is a strategy that our team is very excited about, and I think we will -- that we think will deliver great value to our shareholders. We continue to build capacity, invest in technology and infrastructure to allow us to capitalize on these long-term goals.

And now, for further details on our financial numbers, I'd like to turn the call over to Mark.

Mark?

Thanks, Michael, and welcome to everyone listening in on the call and the webcast.

As Michael mentioned, net sales for the second quarter of fiscal 2008 were $830.7 million, which represents growth of 24.2%, or approximately $162.1 million, over prior year second quarter net sales of $668.5 million. Excluding our acquisition of Millbrook Distribution Services, which occurred on November 2, net sales for the quarter were $758.3 million, yielding comparable sales growth of 13.4% for the second quarter. Year-to-date net sales of [$1.57 billion], yielding sales growth of $252.1 million, were 19.2% over the prior year. Excluding our Millbrook acquisition, comparable sales growth was 13.7% for the first half of fiscal 2008, with year-to-date net sales of $1.49 billion.

In mid-January, our Western Region cycled through the incremental sales volume achieved during the last 12 months, related to gaining the primary wholesale natural grocery distribution for Whole Foods' Southern Pacific Region. An 18.6% gross margin for the quarter showed a 6 basis point improvement over the prior year's second quarter gross margin. Gross margins in the second quarter benefited slightly from our Millbrook acquisition. Millbrook's full-service supermarket model should generate a higher gross margin than our core distribution business, but it also carries higher operating expenses in providing those services. Gross margin was negatively impacted in the quarter by a combination of lower than projected sales growth and acquisition activity in our branded products division. For the first six months of fiscal 2008, our gross margin is at 18.5%.

Our operating expenses for the quarter were 16.3% of net sales, compared to 15.4% for the same period last year. This represents a 91 basis point decline over the prior year, as operating expenses were negatively impacted by Millbrook's operating loss of $3.8 million, or approximately 46 basis points. Our second quarter results also include approximately $0.7 million, or nine BIPs, in costs associated with starting our -- starting up our Portland, Oregon area facility, which began shipping in December. In addition, we continued to experience inefficiencies at both our Sarasota, Florida and Portland, Oregon area facilities, both of which negatively impacted operating margins in the quarter. As we have noted in prior calls, our new facilities typically require between six to nine months of operations before they are able to achieve our optimum anticipated efficiencies.

Also the quarter included appropriately $200,000, or three BIPs, in incremental or catch-up depreciation associated with our second Auburn, California facility. During the quarter, we reversed our original decision to sell that property that had been made in the second quarter of fiscal 2007. We delisted the property and began using it again in our Western Region. As a result of that decision, we reclassified the related assets from assets held for sale back to property and equipment on our balance sheet.

During the quarter we recorded share-based compensation expense of $1.4 million, or 17 basis points, compared to expense of $1 million, or 16 basis points, in the prior year. Fuel costs for the quarter were approximately 103 basis points, an increase of three basis points over the first quarter and an improvement of 1 basis point over the prior year. However, prior year fuel costs included $673,000 in expense, or 10 basis points, related to our prior-year fuel hedge. Excluding the fuel hedge from the prior year figures, fuel expense increased by approximately 9 basis points over the second quarter of fiscal 2007.

Anticipated fuel and transportation savings from our new Florida facility were not as great as expected due to higher than planned transportation costs in getting that facility up and running. Our fuel surcharges have been adjusted to reflect the higher fuel costs of the current market, and in general we continue to feel that our fuel program allows us to offset the majority of rising fuel costs.

Our days in inventory was at 52 days for the second quarter, which represents a three-day increase compared to the prior year, when factoring Millbrook into the calculation. The higher inventory levels are due in part to the opening of our Sarasota, Florida and Portland, Oregon area facilities, and we've seen our days in inventory return to our historical levels during the first few weeks of the third quarter. DSO for the second quarter was at 21 days, favorable to our target range of 22 to 25 days, and is a two-day improvement over the prior year.

Capital expenditures for the first six months were $21.5 million, or 1.4% of revenues, which is below our target for the current year. We expect our capital expenditures to increase during the second half of fiscal 2008 as we build out our new facility in Moreno Valley, California and identify a Mid-Atlantic facility.

Interest expense in the quarter of $5.1 million was approximately 75% higher sequentially and approximately 51% higher year over year. Both the sequential and year-over-year increases were primarily driven by the debt taken on to fund our acquisition of Millbrook. In addition, higher debt levels associated with increased working capital directed to Millbrook, higher inventory levels for the holidays and the opening of the Portland, Oregon-area facility and two branded product company acquisitions represented the balance.

During the quarter we completed an amended and restated five-year $400 million revolving credit facility. Our amended and restated credit facility replaced an existing $250 million facility that matures in November 2012. The Company's outstanding commitments under the amended and restated credit facility as of January 2008 were approximately $316 million, with liquidity of approximately $87 million.

As discussed in our press release, we have updated our sales and earnings guidance for fiscal 2008. We are reaffirming our projected net sales of $3.27 billion to $3.35 billion for 2008, which represents a 19% to 22% increase over fiscal 2007. Our earnings per share guidance has been revised downward to a range of $1.12 to $1.14 per diluted share. Our updated guidance reflects our expectation that the Millbrook acquisition will be dilutive to earnings by approximately $0.10 to $0.12 per diluted share in the second half of fiscal 2008, or $0.18 to $0.20 dilutive for all of fiscal 2008.

At this point in time we expect that Millbrook will be neutral to earnings by the first quarter of fiscal 2009. This increased dilution is expected to be due to a combination of slower than projected improvements in gross margin from both purchase discounts and forward buying opportunities and delays in our original timeline to generate identified savings from synergies between Millbrook and our distribution operations.

Previously, we had announced earnings per share guidance of $1.40 to $1.45 per diluted share for fiscal 2008. Our guidance also includes a reduction related to slower growth in our branded projects division, United Natural Brands, of 20 to 22 basis points, or approximately $0.05 per diluted share, as Michael mentioned.

Also, our revised fiscal 2008 earnings guidance includes at least $2.1 million, or approximately $0.03 per diluted share, in labor costs, duplicate rent and related startup expenses associated with relocating to the previously announced Moreno Valley, California facility during the second half of fiscal 2008, as well as the expansion and relocation to a new Mid-Atlantic facility. The majority of these expenses will be incurred in our fourth fiscal quarter. As a reminder, prior to fiscal 2008 we had broken these types of costs out as special or nonrecurring items. As previously discussed, these costs are now reflected within our earnings guidance.

Finally, we are reaffirming our anticipated fiscal 2008 capital expenditures guidance of $50 million to $55 million. Included in our CapEx guidance for the remainder of fiscal 2008 are expenditures associated with the previously announced Moreno Valley, California facility, which is expected to begin operations in the first quarter of fiscal 2009, as well as some CapEx for a relocated or expanded Mid-Atlantic facility that we would anticipate opening in the first half of fiscal 2009.

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

I thank you, sir.

(OPERATOR INSTRUCTIONS)

Our first question is coming from Ed Aaron, with RBC Capital Markets. Please go ahead.

Thanks. Good afternoon. You guys, in the quarter and with the guidance, it reflects just, I think, some challenges in a few different areas -- Millbrook, the branded business and the new facilities. And, Michael, I was hoping you could maybe just talk a little bit about how you're managing through -- managing the organization through the change brought on by the Millbrook acquisition. Just, I was surprised to some extent by the shortfall in the core business, and just wondering how much that has to do with just the organization maybe being strained somewhat by just the big change that it took on.

Well, you know, we do have a lot of things going on that we're investing in for our future growth, and I think with the branded division we've built an infrastructure that's prepared to handle a much larger business, and in many ways we just haven't been able to get the type of companies acquired that we originally were targeting. Some of the activity on the branded side has been with really small, more startup type companies that have low revenue but still require a lot of expenses to handle and integrate into that branded business. So we've built a solid infrastructure there to handle that business. It's just a little ahead of the sales growth there. So I feel real good about the future there.

With Millbrook, it's just a -- it is a large -- it's 10% of our business in terms of an acquisition. We're excited about the talent level that's at Millbrook. There's always integration challenges to tackle. I think we were just a little too optimistic on some of our initial forecasts, and now I think we've reset the guidance to reflect a very achievable and manageable level. We want to make sure with an acquisition like Millbrook is that we focus on taking care of the customers, and trying to integrate at levels that are too quick, that could potentially disrupt any customer service issues, is not what we want to do. So we're taking a little slower approach, ensuring that customers get taken care of.

So while we do have a lot of things going -- we opened two facilities in the past four months and have two more planned -- this is the challenges of a growing company. I think we've built up our infrastructure to handle it, and we will definitely be, I think, performing going forward along the lines of expectations.

The Millbrook and the outlook for breakeven by Q1 of '09, what gives you confidence in that? I mean, have you seen kind of the early start of some sort of directional improvement in the operations of that business, or is a lot of that still kind of to come?

Well, yes, I mean, we've seen some modest improvement, certainly nothing to the level that we originally forecast. But, you know, a lot of the work is in the buying and getting the synergies with our UNFI buying power, our purchasing power, our inbound freight systems and things like that that we can lower our cost of goods and improve the gross margin. Ultimately it's getting those purchasing departments integrated so that they perform at the highest level. I'm real confident of being able to do that over the next two quarters.

Driving expenses out will take a little bit longer, and certainly, as I mentioned, this first move in Florida, integrating those facilities, getting out of their Tampa facility, is a real positive step forward. We've identified where the expenses are. It's just, like I said, it's taking a little bit longer to flush them out of the system. But I think Q1 '09 is a real good date for us to commit to the being neutral.

Okay. Now, just, Mark, maybe one for you real quick. Can you give us the growth that you reported? I just don't recall the number last quarter for the branded business?

You know, I -- just specifically for the branded business?

Yes, just 31% growth actually didn't strike me as being some unusually low number, but 20 basis points in margin for a business that's that small as a percentage of your total business just seemed like a pretty big hit, so I was just trying to understand if -- I just couldn't remember if last year you -- last quarter you had some huge growth number and now it's slowed to dramatically (multiple speakers).

No, I think that there was certainly a pickup in the growth number for brands. But, as you may recall, I mean, we were, prior to having closed the Millbrook acquisition, we were looking to grow that brand from, say, 3.3%, 3.4% of the business to 5% of the business, with an expectation that the core business was growing at 11% to 14%. In order for them to achieve 50% growth when the core business was growing at 11% to 14%, they really needed to have some high growth. So the expectations were there that with some of the acquisitions that we had done as well as organic growth that the figures would've been higher than where they ended up being. And I think one of the things, just to clarify, or it might help from the standpoint, is that, you know, as Michael said, it's on the operating margin, and we did build out some of that infrastructure in anticipation of sales volume that we haven't achieved yet.

Okay. Thank you.

All right. Thank you. Our next question is coming from Scott Van Winkle, with Cannacord Adams. Please go ahead.

Hi. Thanks. You know, looking at Millbrook a little further, Mark, correct me if I'm wrong, but the financing costs alone on a quarterly basis for Millbrook are only about $0.03 to $0.04. So what was Millbrook, was it losing significant amounts of money when you bought it? I was thinking it was closer to breakeven.

Well, I think I can clarify one thing, that the financing is probably running us about a couple cents a quarter. And, you know, prior to the acquisition, Scott, they had run into liquidity issues. I would tell you that there was certainly a dramatic decline leading up to the acquisition that led to service levels dropping down to the 70s. So earlier in calendar 2007, yes, they were probably closer to breakeven. But when we acquired them we knew that they were losing money at a relatively healthy clip, and we thought that the increased service levels and the working capital could address a great deal of that, but in trying to ensure that the customers were fully serviced, there were some incremental costs that we needed to incur in order to make sure that we maintained that business, because there had been a little bit of an extended period with lower service levels.

So it seemed like originally you thought you'd take some business back from better fulfillment levels, and now you're working hard to make sure you don't lose any incremental?

I would say that's a fair statement. I mean, I think that from a standpoint of the incremental, I think that we've gotten -- as Michael said, we got the service levels back into the low 90s, which is sort of consistent with what the specialty distributors did, by mid-January. So I think that from a standpoint of the existing customer base, we've gotten back to a level that Millbrook had been before they ran into the liquidity issues, and now we'll start looking at growing that business.

Okay. And how significant a business is the Albert's facility that was in Winter Haven that moved to Sarasota? It's a small operation, I assume.

Yes, it was a smaller -- all the produce facilities that Albert's has are generally much smaller than the UNFI broadline, 20,000 to 35,000 square feet type of size.

So the impact from that is probably fairly insignificant once you get through the initial cost?

Yes, I mean, we didn't break it out. There was some nice savings there. But on the big picture it's not real material.

Okay. And regarding the growth you posted in the independent channel, which continues to improve over the last few quarters, is there anything significant driving improvement? Is it just same store sales, or more customers, or easier comparisons? I realize the comparisons are a little easier now on a year-over-year basis. Is there anything different happening in the independent channel?

Well, you know, it's a question we're constantly asking about. The independent channel, as you know, I think is the best barometer of the overall health of the business and the overall sales demand of the business, and seeing it strengthen really is a result of comp growth in those stores. There's much less new store activity generally happening in that channel. It's more of a function of comp growth. So, again, it's back to what I said earlier. It seems like sometimes when the economy goes south a little bit we see the strengthening of the sales, and it's particularly notable in the independent channel.

Okay. And back on that, follow-up on the branded side to Ed's question, is there any particular -- I think there -- I can't remember exactly how many acquisitions that were made that were relatively small -- one particular acquisition that is causing a little bit of pain, or it's just a function of you developed an infrastructure and you're delivering lower sales?

Yes, I think that's what -- there's no one -- all of our acquisitions that we've made on the branded side are actually doing well and within expectations. There's nothing that's blown up on us. It's what you said, basically, is we built up the infrastructure. We've got a lot of expenses to handle, a much bigger business. And we forecast much more growth than we've been able to achieve for this year. I think we're going to see that growth materialize as we get into '09 and beyond. But for now we're just a little short on our forecast.

And the losses in that business, at least hitting the (inaudible) P&L, are those losses mostly coming from SG&A, or is there some issue in there in the gross margin on those branded products, as well?

Well, I guess, I mean, maybe just to clarify, it's not losses as much as below expectations from where we thought they would be coming in.

Oh, so the 20 BIPs is just relative to your expectations, not a loss that's hitting the P&L.

Right.

Correct.

Okay. Okay. And relative to your expectations, so you were assuming just higher revenue, higher operating dollars? It's -- the revision relative to your prior expectations, Mark, is it just sales level, or is it the expenses -- or I guess I'm just trying to figure out, is it a function of the infrastructure side is just a lot of SG&A that's not being absorbed by the sales dollars and that's simply it?

I mean, I guess that -- yes, that's probably the simplest way to look at it, that if the sales were there, the incremental margin would more than cover the infrastructure that we've built up. Without the sales there it's covering less of that operating expense base.

Great. Thanks.

All right. Thank you. Greg Badishkanian, with Citigroup, please go ahead with your question.

Great. Thanks. Just as a follow-on to the branded business, I'm assuming that acquisition prices in the industry have come down. Are you looking at more targets to maybe take in? And also baked in your guidance how much acquisition growth are you assuming for the year?

Well, for the rest of '08?

Yes.

Actually, for the rest of '08 I think we'll be -- we'll only be forecasting I'd say minor acquisition activity and be looking more for organic comp growth on the existing brands. To your question about where our targets are, I think, again, we see the -- our sweet spot is in being able to identify emerging companies, emerging brands, that we can acquire in the early stages and grow those companies rapidly by being ahead of the curve, identifying a trend that -- before it hits mainstream, so to speak. We're trying to stay away from larger acquisitions at this point, in which the more mature companies that generally command a higher multiple. We're trying to, again, target the -- a lower multiple type of acquisition from a more emerging company.

Right. Well, that makes sense, particularly where you stand, where you see all the products and you provide a distribution. And so looking at internal growth, 13.4%, pretty similar to, I believe it was about 13 million in the first quarter. Is there anything in the core business that you're seeing? Has it deteriorated very substantially in February, or is there something there that's -- that you're baking into the guidance?

Well, no, the only -- what we see is sales that are still very consistent. [We're lapping] that Whole Foods [SoPac] business that Mark mentioned in January, so you're seeing a slightly lower sales growth for the back half. But if you X out that SoPac business, it's a very consistent run rate. I haven't seen any changes in demand in the current month.

Okay. That's encouraging. So, and what type of organic sales growth would you say if you X out the Pacific area for the Whole Foods business? What type of organic growth rate would say?

Well, I think we're seeing 10 to 12, in that range.

Good. Good. All right. Thank you.

All right. Thank you. Our next question is coming from the line of Andrew Wolf, with BB&T Capital Markets. Please go ahead.

Thank you. The $0.08 dilution, that I assume had some extra expenses? I think you were talking around this, but what I'm really trying to get to is just to get the business in stock and things like that I've got to assume there's some extra expenses. So is it fair to say that the current run rate loss in that business, including financing, which I think is what's in the [$0.08 is], the current run rate is less than that, so maybe at least the $0.10 to $0.12 that you're predicting for the last half of the year, at least there's some progress already made there?

Yes, that's correct, Andy. I mean, there -- we have seen some progress in the month of January compared to where the months of November and December came in, and so we've -- as looking at first quarter of fiscal '09 we expect to see some modest improvements each month as we move forward.

Okay. And are the greater savings -- I mean, to get to this business, to turn about -- I guess for it to be neutral, to turn about on a swing of about $5 million in operating profit per quarter, it sounds like, or somewhere -- 4.5 to 5, is most of that money in the purchasing side, or is it more in the expense side, in terms of what you've identified?

No, Andy, I'd say it's split between the two. There's, I think, big opportunities in both. I think the ones that are achievable earlier are the purchasing or buying synergies, and I think we expect to achieve those earlier. The expense ones are equally as great, but probably taking more time and spread out over the next 12 to 18 months as we develop other expense reductions. So, but overall they're -- the purchasing as well as the, I guess, the operational side, they're equal opportunities.

But I framed it in terms of getting to it to be neutral. So if it's 12 to 18 months on the expense side, you won't get to neutral in time. You're just talking -- were you answering it more towards the whole opportunity of the business, even beyond getting it to neutral?

Yes. Yes. Yes, so I was answering it in the whole opportunity. So to your question about for the next two quarters, there'll be, I would say, a large part will be on the buying side.

Yes, I mean, Andy, it's probably -- overall it's probably a 50/50 split. And we'd like to think that there's some opportunity to maybe shift that more towards the purchasing and the buying side, so maybe to turn 60/40 or something. But for the rest of fiscal '08 --

And is there a structural reason or a personnel reason that you haven't yet achieved the buying synergies, or anywhere near what you're expecting? I mean, is the buying group right? Is -- what do you think? Is there some kind of impediment or is it just sort of focus, or is it a systems type of thing? What -- why do you think it's --?

Well, part of it, Andy, is that we did have -- when the acquisition came in and they were cash starved, for lack of a better way of putting it, there were -- there was a lot of inventory that was in there that reflected no forward buys, where they were getting it that day or that month, or they're buying it in the minimum order quantities that they need but paying full price for it and not taking any discounts. And so there is an aspect of specialty foods that they turn a bit slower than our business does. And so in some respects we're still selling out some of that product that was bought at a higher cost.

You know, that certainly was a large portion of this reason -- of this particular quarter, where we would've thought that we could've turned that inventory or that we would have had less of that inventory on hand by the end of the quarter so that we saw some of the pickups in margin where we're taking advantage of purchase discounts now or making forward buys. But it didn't materialize as quickly as we would've anticipated.

Yes, and, Andy, maybe another way to look at it is, we had the focus on this first three months on getting the customer service levels up and the inventory levels up, as we've mentioned. So there was a lot of energy put into that that we can now take to focus on synergies and getting the efficiencies in there to start driving out cost. So I think that's a good way to look at it.

Okay. And one last thing. Just on the buying, I mean, now that you've probably talked to the management in the buying or the category managers or whatever they're called in that business, are your original assumptions about the kind of purchase discounts for buying and the like that you might've -- before you owned the business you had to make assumptions about, are they there, or is the business just a structurally somewhat different than you had expected in terms of the available amount of purchasing synergies that you originally identified? I mean, are they -- is that pretty much the same number, or is there -- or were you sort of negatively surprised as to what's available over time?

No, I think it's as we had thought prior to close on the deal, that there are significant amounts of opportunities on the buy side, and in particular the transportation side. You know, a lot of the specialty vendors are very small. They're small LTL shipments, unlike our core business where we're shipping in railcar and full truck. A lot of the shipments in the specialty business are small LTL loads with much higher inbound freight costs, for example. So the -- the opportunities are huge there by combining and consolidating all of our shipments to lower the freight costs, so -- as well as just being able to buy. But, I mean, 15% of Millbrook's product mix overlaps UNFI's. And there's significant cost reductions that we can get on those items.

Okay. And just the last question, I guess, Michael, you know, independent from the financials, which obviously I'm sure -- you sound as disappointed as everyone else -- just operationally, is Millbrook working well enough operationally that if a big customer that you don't currently serve wanted to use the business, the integrated business now, do you think that's something that operationally you all could achieve? Is there any issue on the operational side?

No, not at all. In fact, we're out, as we alluded to, we're definitely offering our customers both programs. We're soliciting new business. And we're confident of our ability to service any new customers on the specialty side as well as obviously the natural side.

That's good to hear. Thank you.

All right. Thank you. Simeon Gutman, with Goldman Sachs, please go ahead with your question.

Yes, just another follow-up on the branded business. To clarify, it sounds like it's sourced at the top line and it's a fixed cost leveraging issue. I'm just curious three months ago how that changed so much. Is it the first half issue that you were seeing, or is this consistent throughout the year? And what's causing it specifically? Is it not the right products? Maybe the forecast was too aggressive? Is it the environment?

Well, I think the forecast being too aggressive is probably number one. I think, again, number two, the being able to identify acquisitions and close on them that are in our -- that meet our criteria. It's hard to build forecasts around an acquisition expectation. While there are a number of companies out there that we're interested in that meet our criteria, it's not always something you can set a timetable on on when you can get them closed. So I think initially it's really just an aggressive forecast that we were unable to achieve, but through the availability of acquisitions.

And you may have mentioned it earlier, but that implies, then, the organic growth -- or maybe not -- the organic growth from existing branded business is okay. It was just more contingent upon finding other companies out there to tuck into your portfolio.

Yes, I'd say that's mainly true. I mean, there's -- we are definitely focused on both sides of the ledger. We want to build our growth with the existing brands and the organic growth of the products that we already have, as well as tucking in the acquisitions. But the big growth spike and the reason we built out the infrastructure for that division was the anticipation we were going to have some higher acquisition activity than actually materialized at this point. As I said, I do think those things will materialize as we get into '09 more and more.

And is there any particular categories where your branded portfolio you would say is weaker than others?

Is weaker? No, I mean, we're not specific in terms of any category. We're -- we have frozen lines. We have grocery lines. I'd say we're opportunistic in that generally we're looking for growth items on emerging products. I'd say the only area that we're not really active in is in the nutritional supplements or the health and beauty care categories.

Okay. And then, second, as to the macro, and I'm not sure you've looked at this, but in the last downturn, five, six years ago, whatever you could characterize that as, have you looked at the composition of sales from the independent customer, and realizing that they were smaller and the industry was growing much faster, was there any evidence of trade-down, anything that you can see either hurting that sector broadly or from within?

No. I mean, I don't have specific numbers to throw at you, but I know, again, thinking about my career and the 30 years where we've had probably four or five good downturns, every time there seemed to be that event, the growth in independents ticked up in a surprising way. While so many people anticipated some kind of a slowing of sales in those markets, we seem to tick up. So while, again, I don't know how to necessarily explain it -- a lot of people have different theories about it -- but it seems to have held up consistently over the years we've been in business.

Okay. And then, last, the transition with Whole Foods and Oats, just an update on it. I imagine it's running pretty seamlessly, but curious what your thoughts are.

Well, for us I would say there's no major issues. I mean, they're obviously having product assortment decisions. They're taking some of the products, the Whole Foods label and other products, into some of the Oats stores and eliminating some of the other items. So our distribution centers are taking the assortment demands and changing those out. But overall I think they've been very -- the Whole Foods team has been very good to work with through this transition, and very cooperative in assisting us and working through the transition as efficiently as possible.

Okay, and then one last one for Mark, if I could, the Mid-Atlantic and Moreno Valley both were anticipated but they weren't included ahead of the guidance that you issued back in November.

They were -- well, there was some aspect of Moreno Valley that was in there, but we're accelerating the work that we're going to be doing both there and in York. So are you asking from a CapEx standpoint or the additional expense standpoint?

More from the expense, just the way the budget and the guidance kind of laid out.

Yes, I mean, there's probably at least an additional penny or $700,000 or so of expense that will occur now in the fourth quarter than what we had originally planned, because we're pushing to get both of those facilities open a bit sooner than what we had originally put in there.

Okay. Thanks.

All right. Thank you. Our next question is coming from Ajay Jain, with UBS. Please go ahead.

Hi, and thanks for taking my question. I have one main question, and maybe I'll address this to Michael. I mean, your stock is down about $6 right now in after-hours trading, and based on my account this is at least the fourth time you've lowered your near-term outlook over the past year or so. So just in the context of all the operational challenges you've been dealing with for more than a year now, and the more recent integration issues at Millbrook, are there are any governance issues that you think need to be addressed within your organization? I mean, do you have the right team to make all the necessary adjustments to get the efficiencies from Millbrook in the near term and kind of get back on track to your goal of 4% operating margin longer term?

Well, I think we're in an environment of a lot of change, and we need to constantly adapt and get the right personnel and the right resources to deal with the challenges that we've had. We've had, I think like every business, ups and downs in the past, and we've been able to navigate through them in a high-growth environment. I think there's always going to be challenges when you're trying to invest in the future for a growth business. So if you're asking me do we need to have other resources or other staff, that's a constantly evolving thing. I would say, yes, we're adding people to our executive team that bring us, I think, additional talents that we haven't had before.

On the branded side that's one good example of where, again, building an infrastructure for a business that we didn't necessarily have all the expertise for. We're retaining some new talent for the specialty business as well as retaining the talent through the acquisition to help us grow that specialty foods business. So we're taking on a lot of initiatives, but I think the team we have is experienced, and we've gone through ups and downs before, and we see our future as being a very strong one.

Okay. Thank you for that. And then can we just review what the current outlook is for interest expense and D&A for the full year? I think, Mark, just as a related question, your tax rate was also higher than what I think you've communicated previously. So if you can also just indicate what your tax -- what the tax rate you're assuming is right now for the back half of the year.

Sure. I mean, the tax rate, Ajay, with the acquisition of Millbrook, the way it fell out in certain of the states has increased some of our exposure where we now have nexus where we did not before. So the tax rate, we're accruing now, and we did a catch-up in the second quarter to put us at approximately 37.2% for the year. From a standpoint of interest expense, it obviously will depend on where rates go from here, but based on the current debt levels and the timing of when we're going to have the CapEx occur in the third and fourth quarter, you're probably talking in a range of between $4.2 million to $4.5 million, maybe a little bit lower, depending on if there are additional rate cuts. But I would say that based on where rates are currently that would be my estimate.

Okay. And as it relates to D&A?

You know, the D&A, I think we have the figure for the second quarter that was probably 5.3. I mean, it probably drifts up by virtue of when the new facility opened in Portland. It probably is closer to a run rate of 5.5 or so for the third and fourth quarter.

Okay. Thank you very much.

Thank you. Our next question is from the line of Scott Mushkin, with Banc of America Securities. Please go ahead.

Yes, hey, guys, a couple of things. A little bit of housecleaning, just trying to understand the reduction in earnings, just the buckets here. So we got about $0.20 from Millbrook, a certain percentage from the branded, but it also sounds like you got some expenses from the opening of facilities that are a little bit more than you thought, too, so I was hoping you could quantify that. I know, Mark, you said $0.01, but it sounds like there's some ongoing additional expenses or higher than expected expenses in some of the stuff you're already doing, and I was wondering if you could kind of clarify that a little bit.

Well, you know, Scott, there were some delays, only a couple of -- a week or two or so with respect to the Portland facility, but there was a delay of a month in opening up Sarasota. So we're about a month behind from a standpoint of where we get our synergies once the new facilities get up and running, sort of under that whole six to nine month time frame.

So if I had to hazard a guess, it's probably -- if you look at it from the standpoint that Michael is saying we expect 14 to 16 BIPs of improvement as those facilities become more consistent, you're probably talking in that case that it's maybe anywhere from $0.015 to $0.02 each quarter right now, where it's just incremental expense as they get -- as they are selecting their transportation and so on and so forth, become consistent with what our other facilities that have been open for a year or more are doing.

But it is in that respect a soft number. I can't say definitively that it's this person selecting slower or this person selecting faster, but if we look at the facilities that we've opened in the past, if you were to go back to, say, the Rockland facility and the Greenwood facility, which both opened in the first quarter of fiscal '06 were the two most recent before this, usually in the six months or nine months after they open, we start to see measurable improvement in the operating expenses. So, I mean, we're sort of indicating that that's a piece of it, but I couldn't give you a hard and fast number because it just doesn't exist.

Would it be safe to say that you had $0.20 from Millbrook, maybe the rest -- the other piece is 50/50 between branded and some higher expenses from opening facilities --?

No, I would attribute more to the branded, I mean, particularly if you look at this past quarter and where we're going in the third and fourth quarter. I mean, the facilities, as I said, are probably only delaying us a month or two in total. So, I mean, there's probably an aspect for this quarter on top of the preopening expenses, but I would say that it's maybe 70/30 brand versus the operating expenses of the rest of the business.

Okay. Two more, going back to Millbrook and just kind of picking at some stuff that you guys said, I mean, it seems like the revenues are coming in kind of what you thought. And then I guess I'm curious, because like some of the -- the overlap of brands, I mean, the overlap of purchasing and everything, generally those things are easier to get done in the sense you kind of see, "Oh, we're buying the same thing. Let's consolidate it, go back to the vendor," boom, it's done. So I guess the question is your service levels got down pretty low. Some clients were pretty [probably] upset. So some of this, and the fact that it just all of a sudden ends as we get to the first quarter '09, is some of this just attributed to you having to go to these customers and saying, "Hey, we want to keep you. We're going to make it better for you to stay with us"?

Well, the way I'd answer that, Scott, is that rather than having, let's say, a purchasing efficiency that takes some time to implement, the goal was get the product to the retailer, get it on the shelf at whatever cost. So they continued to buy in maybe some inefficient or less efficient manner. It cost us more money. But we got the product to the store. And that was the primary focus, even though we didn't really be able to generate any synergy. So now that we've got that occurred, we can begin to pick up the low-hanging fruit of taking the longer term consolidations between the two companies.

So do you think, Michael, that there is any revenue risk related to Millbrook in the sense that the service levels before invited other people to service those customers and contract come up for bid and whatnot, I mean, how would you gauge the revenue risk at Millbrook at this stage?

Well, you know, there's definitely customers that were very upset with Millbrook, as you can tell, with those kind of service levels. I think we stabilized the situation. Contracts will come up for bid in that business. Generally their customers are bidding on a contract basis every couple of years. And you win contracts and you lose contracts. We've -- I would anticipate we'll have some sales erosion, but we're also seeing new sales being generated, as well. So we're leaving our sales forecasts alone. As Mark had stated earlier, we still believe that we're going to see Millbrook's top line at about what we expected prior to the acquisition.

A final question, and I guess for Mark, can you go over the debt again? I think I tuned out. How much cash you're going to need, what your facility is, and do you think you need to expand it, and kind of just give us a little bit of a picture of the cash use this year and kind of where you think you're going to stand from a debt perspective?

Sure. I mean, so just to recap it, as of the -- we put in place a new $400 million credit facility. That was in November. Of that facility, the purchase price for Millbrook probably was about $80 million. We put a fair amount of working capital in there as well as -- and specifically for Millbrook, as well as the working capital to build up inventory at Portland and for the holidays, and then on top of that we did a couple of other acquisitions on the branded side. So it left us, at the end of the quarter, between cash on hand and availability under the credit facility, at about $87 million. That's most likely the high water mark for the year. If you look at past quarters, usually at the end of the second quarter our debt level's at the highest and we generate more operating cash flow in the second half of the year.

And so I would say that debt levels should come down in the third quarter and into the fourth quarter. Historically they would come down a bit more in the fourth quarter. Because of the CapEx that we have on tap they're probably not going to come down as much. So from a standpoint of where we currently are, Scott, I feel very comfortable that we have sufficient liquidity to be able to execute on our strategy. And we feel that the working capital that we've put into the business on the Millbrook side, other than anything that may come from further growth of that business, we feel that we've stabilized it and that the needs going forward are minimal from that end.

Great. That's it for me. Thanks, guys.

All right. Thank you. We have time for one more question. That's a follow-up from Scott Van Winkle. Please go ahead.

I'm sorry about that. Just an easy one, Mark. Did you say it's $4.2 million a quarter in interest?

I said anywhere from $4.2 million to $4.4 million or $4.5 million, Scott, based on the current rates.

Okay. Okay. And that's just down sequentially from what we saw in this current quarter.

Right. I mean, but, you know, with this past quarter, after, actually, the end of our quarter was that one and a quarter drop that the Fed did in the -- on the 75 basis points followed by the 50 basis points. And for a large part of the quarter, when the lending supply got tight, LIBOR was actually at a much higher premium to, say, the prime rate -- to the Fed rate calculation than it normally was. So interest rate was a little -- interest rates were a bit higher in the quarter than we might've otherwise expected.

And just to clarify, you're not changing the Millbrook revenue guidance, so $75 million a quarter, roughly, about?

Yes, I would say that that's still accurate for the rest of the year.

Thank you.

All right. Thank you. And with that, that concludes our question-and-answer session. Management, please continue with any closing comments.

Well, again, thank you for your support and interest in United Natural Foods. We'll look forward to getting with everyone next quarter and continuing to drive shareholder value. Thank you.

All right. Thank you. Ladies and gentlemen, this does conclude the United Natural Foods second quarter conference call. If you would like to listen to a reply of today's conference in its entirety, you can do so by dialing 1-800-405-2236 or 303-590-3000. Enter the access code 11107899. Those numbers again, 800-405-2236 or 303-590-3000. Input the access code 11107899. (Inaudible) would like to thank you very much for your participation. You may now disconnect. Have a very pleasant rest of your day.