United Natural Foods Inc (UNFI) 2009 Q2 法說會逐字稿

Welcome to the United Natural Foods second quarter 2009 conference call. (Operator Instructions) This conference is being recorded today, Tuesday, February 24, 2009.

I would now like to turn the conference over to Scott [Hickstein] from financial relations board. Please go ahead.

Thank you, Operator. Good morning, everyone. By now you should have all received a copy of this morning's press release. If anyone still needs a copy, please contact Joe Calabrese in our New York office at 212-827-3772 and we'll send you a copy immediately following this morning's conference call. With us this morning from management is Steve Spinner, President and Chief Executive Officer, and Mark Shamber, Chief Financial Officer. We will begin this morning with opening comments from management and then we will open the line for questions. As a reminder, this call is also being webcast today and can be accessed over the internet at www.unfi.com.

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

Thank you, Scott, and good morning, everybody and thanks for joining us this morning. What an interesting, exciting and challenging environment. While I feel very good about UNFI's performance in the quarter and year to date, uncertainty remains regarding many of the key drivers that affect our operations. Fuel, sales growth, product costs, and inventory are all areas that just 18 months ago were quite predictable. Despite this uncertainty, I am very pleased with our quarter earnings of $0.32 per share reflecting a 52% increase in earnings for the quarter. The sales adjusted for specialty grew 4.5%. While strong relative to the current conditions, sales have fallen off fairly dramatically since late October.

When we look into the details of our sales, there are expected changes in product movement. Out pasta, yogurt, bulk, breads, baked goods, snacks, less expensive cases has had strong growth while [Haba] pet food and bottled water fell off most significantly reflecting changes in consumer mindset towards less expensive alternatives. During the last three months, we've worked hard to look at economic conditions facing our industry and have taken steps to convert these challenges into opportunities, and this morning we'll talk about some of these steps in detail. Rest assured, we believe that given UNFI's leadership position in the natural and organic and specialty channels, there is considerable growth potential over the next several years despite the current industry malaise.

Let's talk a little bit about free cash and working capital. When I came on board, I made a commitment to improve our working capital. During the quarter we created $42.2 million in positive free cash flow and improved our liquidity by $9.5 million. This was achieved by managing capital expenditures and inventory while carefully taking action to control expenses. Historically, our Company has managed inventory quite successfully while delivering extremely high levels of service to our customers. Our intention is to hold our suppliers more accountable to service level without relying on UNFI to carry long inventory positions.

During the next year, we'll be meeting with suppliers and begin the long but mutually beneficial process of re-negotiating how we do business together. Throughout the last quarter we managed our service levels and our inventory quite effectively. From a CapEx perspective, UNFI will continue to invest in projects that deliver a reasonable rate of return for the Company and this includes construction of a Texas facility and IT projects that will unite the Company over time towards a common set of information systems and infrastructure.

UNFI Specialty distribution continues to progress. In the quarter we experienced about a penny per share of dilution compared with $0.08 per share in the prior year period. This represents a significant improvement and sends a clear signal that our integration plans are on track. With the move into our new York, PA facility complete, we are now ready for the first blending of our specialty business with UNFI Natural & Organic. This project, when complete in the fourth quarter, will put us in the enviable position of offering customers in the Mid-Atlantic region the most comprehensive product offering available. We are seeing some positive momentum with approximately $10 million to $15 million in new specialty business rolling out during the next three to six months.

We are also diligently working on expanding our customer relationships to include a broader array of products. Most importantly, UNFI is now well positioned to aggressively negotiate with new customers offering a complete natural organic specialty supplement and produce program throughout the US. Our Albert's Organics, Select Nutrition eastern and western divisions are now working extremely closely to take advantage of cross selling opportunities that exist across all of our channels of distribution. In addition, our growth to the conventional channel, including national and mass, will begin ramping up dramatically as we further integrate and expand our specialty programs across the country.

Looking forward, we'll be working diligently on expanding our SKU offering to our independent natural organic retailers. Given our scale and national distribution platform, there are categories of products that could potentially increase our growth to this very important class of customer. Also, during the next 12 to 24 months, UNFI will be standardizing business practices across all our of businesses, making UNFI more efficient and cost effective while providing greater value to all of our customers through increasing service levels, products, and systems. At the same time, having UNFI go to market as one company, easy to do business with from a customer and supplier perspective.

Our sales and service associates should and will be able to represent all categories of products, including produce, supplements, specialty, natural and organic to all of our customers. I look forward to sharing our three-year strategic view of the business during an analyst meeting that will be scheduled for York, Pennsylvania, on June 23, 2009. Mark will provide more clarity on gross margin and expenses shortly.

We've revised our sales outlook for the year given trends since November 2008 between 2.5% and 4% growth. Also, CapEx will be $40 million to $45 million, a reduction of $17 million. Expense reductions primarily driven by fuel cost savings and discipline management of cost will enable the Company to manage EPS $1.28 to $1.36 per share. Our EPS range is primarily driven by potential exposure to the latest PCA peanut recall and continued sales uncertainty.

Looking back over the last quarter, I am extremely pleased and proud of the associates of UNFI. They buckled down, adjusted, changed, and delivered despite really tough challenges. We have not waivered from our view that companies can be at the forefront of the sustainability that environmental stewardship as evidenced by our previously released gold lead certification for our new Ridgefield, Washington facility. We have identified opportunities for growth, improvement, and positive change regardless of economic factors outside our immediate control. And now I'd like to turn the call over to Mark Shamber, UNFI Chief Financial Officer.

Thank you, Steve, and welcome to everyone listening in on the call as well as the webcast. Net sales for the second quarter of fiscal 2009 were $847.6 million which represents growth of 2% or approximately $17 million over prior year second quarter net sales of $831 million. Excluding our specialty division, net sales for the second quarter yielded comparable sales growth of 4-1/2%. Year-to-date net sales are $1.71 billion yielding sales growth of $144.8 million or 9.2% over the prior year. At 19.1%, gross margin for the quarter shows a 50-basis point improvement over the prior year second quarter gross margin of 18.6%. Gross margin in the second quarter benefited from a combination of the specialty division's higher gross margin and fuel surcharges that were in effect in both November and December.

As a reminder, specialty's full service model generated a higher gross margin than our natural and organic services but it also carries with it higher operating expenses in providing these services. Gross margin for the first six months of fiscal 2009 was 19.3% compared to 18-1/2% in the prior year, an improvement of 74 basis points also due to the two factors mentioned previously. Our operating expenses for the quarter were 16.1% compared to 16.3% for the same period last year. This represents a 19-basis point improvement over the prior year as operating expenses benefited from lower fuel costs and smaller operating loss within UNFI specialty of approximately half a million dollars. Our second quarter results also include approximately $2.6 million or 31 basis points in costs associated with relocating to our new facility in York, Pennsylvania, which began shipping in the second week of January as well as ongoing costs associated with our Marino Valley, California relocation.

During the quarter, we recorded share based comp expense of $1.6 million or 19 basis points compared to expense of $1.4 million or 17 basis points in the prior year. Fuel costs for the quarter were approximately 74 basis points, a decrease of 36 basis points over the first quarter of fiscal 2009 and an improvement of 29 basis points over the prior year second quarter. Our inventory days on hand was on average of 58 days for the second quarter; however, our days on hand as of the end of the second quarter was approximately 50 days, which is at the high end of our target range of 47 to 50 days.

During the quarter, we made a concerted effort to adjust our inventory levels to match the changes in sales trends as well as to work down inventory levels at our two re-located facilities in York, Pennsylvania and Marino Valley, California. DSO for the second quarter was at 20 days, favorable to our target range to 22 to 25 days and a 1-day improvement over the prior year. Capital expenditures were $17 million, or 1% of revenues for the first six months of fiscal 2009, which is below our target for the current year. We expect our CapEx to increase during the second half of fiscal 2009 as we begin the build out of a new leased facility in the Texas market during the fourth fiscal quarter.

Free cash flow for the second quarter was positive $42 million compared to the prior year second quarter which was a negative $29 million. For the first half of fiscal 2009, free cash flow was approximately a half million dollars negative. For the second half of fiscal 2009 we would expect positive free cash flow of approximately $20 million to $30 million based on current sales trends. Interest expense in the quarter of $3.2 million was approximately 6% lower sequentially and approximately 37% lower year over year. The sequential and year over year decreases were primarily driven by lower average interest rates partially offset by higher average debt levels during the quarter.

With inventory levels now back within our desired range, we would expect interest expense to be lower in the second half of fiscal 2009 barring any increases in interest rates. The Company's outstanding commitments under it's amended and restated credit facility as of the end of January were approximately $319 million with liquidity of approximately $94 million.

As discussed in our press release, we have updated our sales and earnings guidance for fiscal 2009. We are revising our projected net sales from a range of $3.63 billion to $3.7 billion to a range of $3.45 billion to a $3.5 billion which represents full-year comparable sales growth over fiscal 2008 of 4-1/2% to 6%. Our earnings per share guidance has been revised slightly to a range of $1.28 to $1.36 per diluted share. Our updated guidance reflects recent trends of slower sales growth as well as the uncertainty surrounding the impact of the recent peanut recall on sales and inventory reimbursement for the remainder of fiscal 2009. Previously, our EPS guidance has been in the range of $1.30 to $1.38 per diluted share.

Finally, we are lowering our anticipated fiscal 2009 CapEx guidance to $40 million to $45 million. Previously we expected fiscal 2009 CapEx to be in the range of $57 million to $62 million. Included in our CapEx guidance for the remainder of fiscal 2009 are some final expenditures associated with our recently opened York, Pennsylvania, facility as well as costs associated with our planned Texas facility which we expect to begin construction in the fourth quarter of fiscal 2009 with operations commencing in fiscal 2010. At this point, that concludes our prepared remarks and we'll turn the call back over to the moderator to facilitate any questions.

Thank you. (Operator Instructions) Our first question is from the John Heinbockel from Goldman Sachs.

A couple things, Steve. Can you talk about retailer destocking? How widespread a trend has that been? And you would think that at some point here we would get a restocking, you'd start to see your shipments maybe pick up a little abnormally. Have you seen that yet or do you think you'll see that?

We, we have not seen significant destocking at the retail level at this point, John.

Yes, I think, John, it might have been more from a home destocking the pantry than what we saw in the retailers. Many of them, particularly our customer base with the independence, don't have large back office areas where they can afford to store a lot of products, so there might have been a small amount of that in October, November but it didn't last very long because, again, with the frequencies of delivery and the amount of backroom space that they have, there's not that much that they can carry.

What about at Millbrook? What did you see there, same thing very little de-stocking?

Yes. Again, we have the full service model at Millbrook, the specialty division, so we're basically managing a lot of the products that are on the shelves and so, again, we're coordinating on a sales side so there's not excessive amounts that are in the back room areas.

But to your point, John, in the specialty side, and this would obviously makes sense, the decrease in sales was more dramatic on the specialty side than it was on the Natural & Organic.

Yes, I guess what I'm trying to figure out is that consumer take away or that's just your shipments because of retailers working inventory down or both?

No, we don't, we don't really think it's the retailers taking inventory down as much as it is the consumer preferences changing, so the behavior of retail has changed as it relates to --

So when you look. Okay. So when you look at, on the organic side, you talked about the 4-1/2% growth, are we sort of stable at a mid single digit growth rate in organic ex-Millbrook or we're not sure if we reached stability yet?

The problem with answering that question is that it's still fairly erratic so we still see our sales jumping around quite a bit. We're comfortable with the range that we provided for the back half of the year which is the 2% to 4% roughly. But it changes fairly significantly week to week, month to month.

All right. And then finally, how do you dimensionalize the impact of the peanut recall, felt to be that impactful broadly, but how do you think about that impact, sales, cost, and how big could it be?

I mean, the most significant part of the peanut issue for us comes out of our Hershey imports where we were buying products from PCA in our manufacturing facility. Obviously that product is recalled all the way back to 2007. We have no recourse with PCA, obviously, at this point. So we think there's going to be some kind of claim that we're going to have to eat that's not reimbursed. We don't think it's overly significant. It has the potential of being $0.02, possibly $0.03.

Have you seen, because of concerns about the safety of the product, other related products that should not have -- should not see a drop in demand, have you seen that or not really?

No. I mean, obviously this was a significant recall that affected lots and lots of products.

Right.

Obviously with peanut or peanut paste as an ingredient, but I think it's been limited to that. Yes.

Okay. Thanks.

Thank you. Our next question is from the line of Greg Badishkanian with Citigroup. Please go ahead.

Thanks. You mentioned sort of volatility over the last few months, but you haven't noticed a trend downward, it's just been volatile, right?

Yes, I'd say that's accurate, Greg.

Okay. All right. Good. Sort of the back half year sales guidance is based on kind of the average of the last few months-type of trend that you've been seeing, right?

Right. It's a balance of what we're seeing on the Natural & Organic side as well as on the specialty side with the loss business that we'll be annualizing in the trends we've seen in their customer base.

Okay. Good. So just a continuation of the current trend, most current trend. And just looking at fuel, diesel costs obviously have come down. When do you get the full benefit of those lower costs?

Well, I mean, the full benefit probably doesn't come, I mean, I guess it's a, we get the full benefit right now, but I guess if you're talking year over year it will continue to help us until we get through the fourth quarter, really to the second quarter of next year. Right now, 74 basis points you get an improvement of 36 basis points over what we had in the first quarter, but the third quarter was a similar number last year, I think it was 111 basis points and the fourth quarter was 137. So as we talked about the fuel surcharges going away with the lower full prices, we'll still stand to get a net pick up because of the lower fuel costs if they hold where they are in both the third and fourth quarter.

Okay. Good. That's very helpful. And also just kind of going back to the macroenvironment. It's tough out there, but obviously demand seems to be holding up at least okay for you guys, which is positive. And you mentioned some segments that were doing well or poorly. Any other, any other trends that we can discern from that or any -- is there just more trading down to products that are sold at, eaten at home and made at home from scratch or any other sort of trends that we can see?

No. I mean, it's, it's all fairly common sense. For those of you that follow the restaurant industry, you know what's happening there. People are eating out less more and eating at home morning and people that are eating at home more are buying less expensive products. And we've seen that pretty consistently during the last quarter. So I think you can kind of back into which product categories are going to be impacted positively or negatively.

Good. All right. Thank you very much.

Sure.

Thank you. Our next question is from the line of Ed Aaron with RBC Capital Markets. Please go ahead.

Thanks good morning, guys. Nice job on the quarter.

Thanks. Good morning Ed.

In thinking about kind of sales environment going forward. I'm trying to better understand the price elasticity of the products that you sell because there's still a fair amount of inflation in the system that's probably going to roll off over the next few quarters and if you're look at you're trends right now, volumes are obviously down a bit from where they were a year ago, and just as that inflation rolls off, I'm just kind of wondering what kind of volume re-acceleration that we might see that you're total sales growth won't need to decelerate further. Can you give us kind of any color in terms of what you've observed maybe in the categories where you've seen relatively high inflation as far as the actual price elasticity of those products?

Yes. I mean, the inflation, interestingly, if you look at inflation in this quarter versus the last two, hasn't come off all that significantly. Certainly it would be our believe that we are going to see some deflation over the next four quarters. You would hope that you were going to see some. But I don't think we could really talk to demand by product category or its influence on our overall sales just because there's so much volatility still in our sales in general.

But all else being equal, if you have that deflationary environment, would you expect your top line growth to slow down as that inflation rolls off or is it just kind of too early to say?

Yes. I think it's too early to say.

Yes, I would agree. I mean, we, I think we saw probably from a year over year comparison standpoint inflation hit the high mark in November and start to slow down in December, January, but it hasn't moved, as Steve mentioned, enough yet for us to be able to comment for us to comment on what that might do to sales trends.

I can tell you the biggest single category deflating is organic produce.

Right. Okay. That's helpful. Thanks and I was hoping you could talk a little bit, maybe elaborate a little bit on that $10 million to $15 million of new specialty business that's apparently coming on line. Is that an annualized number or is that how much you expect to get this fiscal year?

No, that's an annualized number and, for the most part, it's expanding existing relationships into this specialty space.

Okay. And in terms of actually bringing on new accounts, is there any maybe progress report on along those lines?

We've got a couple of customers that we're working very closely with. These things take a long time to build a relationship. We're optimistic, but I can't give you a time line.

Fair enough. Last question is on the gross margin 50-basis point improvement, you talked about the positive impact of specialty there, but from a mixed perspective I would think that specialty would have actually hurt you this quarter because you owned that business a year ago and the specialty division was down in the quarter and so the mix of specialty actually went down, so why is that a positive contributor to the year over year gross margin change?

Well, as much in fiscal '08 we did get some benefit from the gross margin on specialty. In the second quarter, Ed, that was the first quarter that we had ownership of the division, and so if you recall probably going go back to the conference call notes from that quarter, there were a lot of comments about extra steps that we took in order to get product on hand, extra costs that we incurred given that they had such high out of stock levels right after the acquisition. So I'd say that we've made improvements to the point where we're now back to normal service levels, and we're back to the contribution on the margin side that we would have expected from the division all along, which is significantly stronger than it was in the first quarter that we owned them, so that, despite the fact that they're providing smaller percentage on a sales basis, f of our overall sales, they're providing a stronger gross margin in this quarter versus what they did in the second quarter of last year.

Okay. That makes sense, one last housekeeping item if I could. You typically giving us the sales growth breakdown by channel. I didn't hear that, if you have that if you wouldn't mind giving it.

Sure. So for the quarter, second quarter super natural were 3.2%. Supermarkets were negative 5.4, if you exclude specialty they were 6.4% and independents were 3.3%.

Great thank you.

Your welcome.

Thank you. Our next question is from the line of Scott Mushkin with Jefferies. Please go ahead.

Hi, guys. This is actually (inaudible) filling in for Scott here. This is really just following off the last couple of questions. I mean, what has been -- I was going to ask basically the same question I'll just ask to a little differently. What's been the response from customers, especially new business, as you go with this combined platform? That was kind of the idea back when you bought Millbrook, what's been the response?

It's been extremely positive. The beauty of UNFI Natural & Organic and specialty is the product offering, so for retailers that want to have a significant offering in terms of breadth of line, new items, we carry far more Natural & Organic SKUs than any of our competition. So that gives us a real added value option. Specialty obviously makes it easier for them to make the decision because they buy Natural & Organic and specialty together. But these retailers have existing contracts. It takes time to build a relationship. We didn't want to go to these customers until we were 100% sure that we had an offering with a very high level of service and a high degree of confidence that our program could be better than the program they already had. And we're in that position now. So, very confident. In answer to your question, lots of good interest. It's just going to take some time, but I really don't have any doubt that we will ultimately prove that the acquisition of Millbrook was a very strategic one and one that was the right decision for the Company.

And just a quick follow-up. Systems, you talked about it a little bit. How is the integration with the joint platform? Do you feel good about the infrastructure in place?

Yes, I mean we're at the beginning stages of determining you know which platform we need to be on. Which portions, whether it's (inaudible) management systems, transportation systems, supply chain management, we're looking at all of those things now. Without a doubt, we need to have a one company facing. Whether it's in any of the areas that I just mentioned or all of the above, that's exactly what we're trying to figure out as we speak. But there's a lot of opportunity throughout the country as we look at a one-company platform and, again, it's just going it take us a little time to figure out what's the best method to move forward is and, again, I think we'll be in a position to share a lot of that with you in June.

Okay. Great thanks.

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

Good morning. Thanks. Congratulations on the strong quarter.

Thanks.

A couple questions following on the supply chain. First, a near-term question. As you're bringing down inventories, could you give us a sense or could you give us what your service levels, did they remain intact or was there some spottiness?

Yes. I mean, on average when you look at our service level week to week over the period of a quarter, our service levels were right where they needed to be. We always run through one period where we have one DC or another that has a little blip but, on average, service levels were right where they needed to be. I should make sure that everybody knows that our inventory today is higher than it was, for example, a year ago. And so the Company has managed at inventory levels lower than what they are today and we expect to get back to those levels. The challenge and the opportunity is for us to work a lot closer with our suppliers to help us get that manufacturing out of stock level down. On the UNFI side, some of the systems that we're talking about implementing will help us do a better job on our own internal service level. I think we can do both of those things at the same time.

Okay. That's sort of a prelude in to my next question. I know you want to give the details or more details in June at the conference, but just generally in terms of systems and working with vendors to rationalize supply chain, are they co-dependent or is there work that can be done with the vendors before you have a unified purchasing system internally?

That's a great question, Andy, and the question is yes, we've started to do that. The idea is to give our suppliers more transparency into our product movement by SKU by DC so that they have some consistency in is how they produce the product. Right now they don't have in transparency, which is one of the reasons why the supply out of stocks tend to be as high as they are. And we can certainly begin the process of providing that transparency before we get to a national platform with a national supply chain model. So, yes, those things are happening. It's going to happen over time, but those discussions have already begun.

Great. And lastly, my version of the sales question is this, some of the retailers who have reported already and some of the vendors as well kind of described, and the government numbers looked the same, that for the business, food retailing and merchandising really December looks like it was the trough, at least as of now. Things got really kind of brutal into December with if not a recovery at least a stabilization, which means that maybe some out of stocks had to be reordered from the retailers if they were managing inventories too tightly. So if you look at the business from month to month like November, December, January, with December being the worst and sort of a quasi either stabilization to recovery in the last couple periods, couple months, does that kind of comport with how you view what's United Natural's business or are you going to continue to think it's too volatile to to discern that kind of a trend?

No Andy, I don't think we can really answer that question with a lot of certainty because of how our weeks matched up with the 53rd week from last year. So, for instance, I would say that yes our December was a low point from a comp standpoint, but our fiscal December this year had both the Christmas and the new year holiday in it, so there were two days when we weren't shipping that we normally would have been versus prior year where there was only one, so it's made a week to week comparison for our weeks very difficult, but if you go strictly on calendar days, I don't think that we saw a lot of change between the months. I think that we saw the at the deceleration take place in late October, early November and then it was, again, relatively consistent month by month from there, although we have, again, as we've mentioned, we've had weeks before we've had strong growth and then we've had weak growth so there's been a lot of volatility, but I don't think I can necessarily say with complete comfort that we could sort of back up that statement or the answer your question confirming the way everyone else has reported.

Okay. Thanks. Look forward to seeing how things go.

Our next question is from the line of Gary Giblen with Goldsmith & Harris. Please go ahead.

Hi. Good morning. In your fourth quarter conference call you mentioned that as gas prices come down that you kind of have to pass that on fairly quickly to the customer base, but my question is, is there opportunity for gross margin expansion from lower gas prices where the -- where you're pass-through lags or something like that?

Gary, there was an aspect of that and we try to eliminate that both on the upside and the downside going forward, so historically we had been working with a trailing indicator of a quarter or 13 weeks from a standpoint of fuel surcharge with prices decelerating the way they did in the back half of calendar 2008. We went to a trailing four weeks on the surcharge that brought down the fuel surcharge much more quickly in our east and west regions to the point where they did not have it in place in January. Similarly, we would be much faster to react once fuel prices go back up again at some point in the future. So I mean, I think that at this point we recovered the way we had the lag set in place was to allow us in times of declining prices to recapture some of the expense that we had lost in time of rising prices and I think that's come and gone in the second quarter and that at this point going forward we'll be pretty timely in reacting to rising and declining fuel prices.

Okay. Thanks. And then just my second question is you mentioned in your prepared remarks, Steve, that you are going to have a lot of presumably head to head vendor discussions, so my question is does the guidance presented in the press release assume any improved margins or lower cost of goods from that or could that be incremental upside?

Yes. There is no incremental gross margin assumed in our numbers as a result of those discussions. It's really too early for us at this point to have a good enough understanding of how that all plays out. I certainly view it as upside for both the supplier and for UNFI.

I mean, is that the primary focus of those discussions. I mean, of course, you're discussing a lot of things, but is a lot of it how to do the math on lower food prices, for instance on the produce side or even the package side?

Yes. I mean, Gary, I think it's all the above. I mean we, as a company, for a lot of our suppliers are their single largest customer and we need to do a better job being more transparent with them so that we can provide them with more consistency as I said earlier around the way they produce product. Our view has to be of the entire supply chain, how it's produced, where it's stored, how we move the product around the country to our DCs and how we ultimately get it to our customer. And those are things that will, I think, highlight some very big opportunities for us to lower costs of goods, reduce the inventory, perhaps increase our gross margin, and do the same thing for our supplier.

Yes. Okay. I understand. Good luck with those discussions and with the year ahead.

Thanks, Gary.

Thanks.

Thank you. Our next question is from the line of Meredith Adler with Barclays Capital. Please go ahead.

Thanks. Maybe I'll just follow on first on the question that Gary just asked. It's fair to say that what you think about saving money and improving the gross margin your really talking about a win-win of lowering the supply chain costs and sharing that. It's not about doing an arm twist on anybody to get better pricing per case.

That's 100% accurate.

Okay. I was wondering if we could also go back to the discussion about inflation. I have heard retailers say that prices tend to be sticky on the upside and sticky on the downside and costs are going up and then they're going down and so that you probably on the downside pick up a little bit more gross profit pennies. Do you think that's right, especially you've got organic produce being deflationary right now?

I'm not sure I understand the question.

Your costs are going down, is your cost going down faster than what it's costing you're customers to buy from you?

I don't think so. I don't think so. Organic produce, keep in mind our inventory position on organic produce is very small. We turn it very quickly, so there's no real lag between the time that we buy it and the time that we sell it. The lag obviously is much longer on more shelf stable grocery typical Natural & Organic products. So I'm not sure I see that, yet.

Okay. And your not seeing particular declines in those packaged goods yet right?

Not yet.

And aisle then I'll like another question is kind of two parts about combining Specialty and Natural & Organic. You talk about getting one sales force is going to sell everything. How challenging is it to educate the sales force about the other products and is it easier for one sales force to pick up on the other piece than another. I mean, is there, is that going to be a lot of work?

Yes I mean, it's really a combination of both. I mean, from our perspective, what we want to have is one point of contact for the customer. So if the customer wants to buy Natural & Organic Specialty Albert's Select Nutrition, they have one point of contact and not multiple. Now that doesn't mean that that one salesperson will have to have all the knowledge around all those product categories because they can't, it's impossible. But it does mean that they would be the point of contact making sure that we brought in the right resources to make sure that the customer was educated and understood what they were going to be potentially getting from us. So it's a combination of one point of contact supported by lots of field support specialists.

Great. That makes sense. And have you ever quantified the benefit from having a distribution center like York which will send shipments out of both kind of products to those customers that buy both. They must be a pretty big, say, revenue per employee kind of savings there.

Common sense would say yes, it should be. We have not quantified that. Also, keep in mind that in some cases what we want to have happen is the sales associate who's responsible for the customer manages all the products going into that customer regardless of where they come from. In some cases it may be more efficient to ship the supplements from Select Nutrition via UPS. It may be more efficient to sell them organic produce from an Albert's facility that may be closer. So there's not one black and white answer. It's a matter of looking at the entire supply chain, but from a sales perspective and a customer perspective, it's one company.

Okay. That makes sense. My final question is, because you provide a full service model on the specialty side, which I know part of that means that the ordering is done by your own delivery folks, is there any risk that they're not moving quickly enough to flow the orders for those kind of products? There's kind of an incentive for them to continue to ship until they run out of room.

Yes. No, I don't, I don't, I don't think that that's the case because the retailers is certainly going to hold us accountable for their inventory.

Okay. Great. Thank you very much.

Thank you. Our next question is from the line of Chris Krueger with Northland Securities, please go ahead.

Good morning, guys.

Good morning Chris.

Hi. One quick question. There's been a lot of talk about the impact of private label products, and I think last week Whole Foods indicated some progress there as well. What's your overview of the impact of private label on your business?

I think on the supermarket side it certainly hurt us a little bit over the years because in a lot of cases we were shipping a national brand and some of the larger retail customers converted to private label and brought it into their own captive distribution centers. Whether that trend is going to reverse, we haven't seen that yet.

Okay. On the Specialty or Millbrook, can you refresh my memory exactly what happened a year ago versus this year? You probably went over it on the call a year ago, but I know doing my math sales are down a double digit rate year over year. Was there something unique in that period that makes that a not really apples to apples comparison or how should I look at that?

Well in the prior year Chris that was the first quarter after we'd taken over the business and we spent a great portion of that quarter getting service levels back up to where they needed to be, and what ended up happening is because of the time frame leading up to the acquisition where service levels had been below what was acceptable, many of the customers had gone down the path of securing alternative sources for their distribution, and so after that first quarter of ownership, we did lose some customers and so it's not an apples to apples comparison because we have, we're work off of a smaller base and we haven't sort of annualized all of the loss sales as of yet. That won't occur until maybe the end of the third quarter and maybe a little bit into the fourth quarter. We lost some of that business in the second and third quarter of last year.

Okay. And obviously the profitability of the division, it looks much better than it did a year ago. I know you guys had previously guided for it to be dilutive by $0.06 this year and it looks like it was diluted by a penny in the quarter which was a penny better than I looked for. Would you still stick with that $0.06 language or do you think it is potentially break even even in the third quarter?

I think that we probably stick with it. Is there always the potential that it could be, sure. I think that the run rate when you allocate the interest to it as well, which is how we get to those dilution numbers, they still get the allocated interest where they need to generate a certain amount of operating profitability to actually be accretive with the interest as well. So I think I'd stick with the fourth quarter.

And also keep in mind that the Specialty side of the business has been hit a little bit harder than the Natural & Organic.

Okay. That's all I've got. Thanks.

Thank you. Our next question is from the line of (inaudible) with Canaccord Adams. Please go ahead.

Hi. It's Scott Van Winkle. A couple quickies for you, Mark. First, you mentioned the fuel surcharges ending in January in the east and west. Was there kind of an average number for that January quarter you could throw out?

An average, I'm sorry Scott, an average number of?

The fuel surcharge for the quarter. That went to 0 essentially in January. I'm just wondering what the comparison will look like sequentially when we look at the April quarter relative to the January quarter.

We've always given the numbers excluding the surcharge, so that, there would be no change from a comparison standpoint, so you'd still be comparing against the 74 basis points we've always done, because it's a miss match on the income statement with the surcharge up and revenues and the expenses for the fuel and operating expenses we've always given it X the surcharge so you'll be comparing against the 74 basis points when we report Q3.

Okay. And your comments earlier about interest costs being lower in the back half, I don't know if I missed the more detail, did, what's driving it? Obviously you're paying down debt, have you locked in lower rates and how significant is the benefit you got maybe from lower interest rates coming into January?

Well, we haven't locked in rates yet with where the markets are and where interest rates swaps are, there's been very, probably only a 10 basis movement in the last three months or so, but rates, if you were to go back a year ago, I don't know the number off the top but I'll say that the second quarter last year interest rates were probably between 5% and 6% whereas for this quarter it was probably a little more than 2 plus percent on the revolver, so where we stand right now is that our borrowing costs against our revolver right now are probably 1-1/4% to 1-1/2% and we have the term loan that's probably at 5.7. So we're certainly probably, it will decrease as the back half goes along but we're probably 200 to 300 basis points more favorable on a borrowing rate in this year versus the prior year and then you throw on top of that that we are paying down debt. Our debt levels are down, virtual of timing as when we sort of start collecting the cash and reduce the payments going out the door but since the end of the quarter our debt levels are down $35 million so our borrowing against the revolver are down at 262 right now as pose ed to 297 at the end of Q2.

Okay. Thank you.

Your welcome.

(Operator Instructions) And our next question is from the line of [Laura Olson] with Credit Suisse, please go ahead.

Hi, just as a little segue from the last question. Do you expect revolver drawings to continue to decline or are levels there going to remain a little bit elevated for the foreseeable future, and then I just have a question on your competitive landscape?

I would say that the revolver, I would expect it in the third quarter the revolver will pay down, I mean, I can't say exactly depending on the timing of the some of the CapEx as to whether it will go further as what it's already done for the first three, four weeks in the quarter, but then I would expect the borrowings to increase slightly in the fourth quarter when we start to build out the Texas facility because there will be some payments that need to be made at that point in time. I would expect it to be lower Q3 significantly then perhaps a slight jump in Q4.

Okay. Thanks. In terms of what's going on with some competitive issues, do you think there's going to be more consolidation or are you seeing some weakness where some of the smaller players may be forced to exit the market all together and what is your strategy in general in terms of growth or maintaining you're scale?

Yes, I mean, I haven't seen a dramatic change in the competitive landscape yet. I mean, I can only speak to what we're doing. We're out there aggressively expanding our business relationships with existing customers by adding more SKUs and services. The biggest potential upside for us is as we acquire some regional and national combined Natural & Organic and Specialty contracts, and we think there's a lot of opportunity for us to do that.

Great. Thanks.

Thank you. Our next question is from the line of Robert Goch with (inaudible) Capital, please go ahead.

Hi. Good morning.

Morning.

On the gross margin improvement, just for clarification, it looks -- has your mix of Organics and Specialty, has that SKU'd toward more organic year over year?

Yes, with the decline in sales in Specialty year over year, it has shifted more toward Natural & Organic. Although as I mentioned I think it was answering the question for, I want to say it was Chris or Ed, that it was more of the benefit from the gross margin side came from the fuel surcharge as well as the improvement in the Specialty division even though it was off of a lower sales base.

How much was Specialty down in the quarter?

Well I mean, I don't have that number right off the top, I mean, it was 2% was our overall growth and it was 4-1/2% excluding Specialty, so you can back into it from there.

Sorry what percent age is specialty in the quarter?

I said I don't have the number off the top. I said that you can back into it from our overall growth of 2%, and it was 4-1/2% at Specialty will let you get to what Specialty was for the quarter compared to last year.

Okay. Do you expect the year over year gross margin to, I mean, how big was that bump in the second quarter on just from the service issues you encountered the quarter following the acquisition, and could we expect a similar magnitude going forward?

I mean, I'm not going to sort of compare an improvement from the gross margin year over year from that side. I guess what I would say is that if you look at the gross margin in the back half of the year with fuel prices where they are, then I would expect gross margin to be anywhere from 19 to 19.2, so roughly 10 basis point either way from where we are now and that will lead to, in some cases, a benefit year over year and I this I in the fourth quarter a probably a little bit of a detriment because we had such higher fuel surcharges last year with rising prices.

Right. And then lastly, I think you went over this already. What's your back half CapEx guidance and free cash flow?

Yes, I mean, I gave, I expected free cash flow for the year, for the back half to be $20 million to $30 million which would, say in the back half of the year free cash flow of $20 million to $30 million which would give full year 19-1/2 to 29-1/2 because we were about a half million negative and then CapEx for the back half of the year, we were at $17 million through the first six months, so if you deduct that from the $40 million to $45 million, you get $23 million to $28 million in CapEx in the back half.

Thank you very much.

Thank you our next question is a follow-up from the line of Ed Aaron with RBC Capital Markets. Please go ahead.

Thank you. Just a couple follow-up questions. First, it sounds like the Texas DC is getting pushed out more into 2010. Is there some savings from an EPS basis this year relative to year, you're previous plan? There's usually some start-up costs involved. Will some of that flow into 2010 as well? And then, secondly, I think in your prepared remarks you talked about some potential for increased distribution within the independent channel which was kind of interesting only because I think you guys are pretty well distributed there as well already. I was hoping you could maybe he elaborate on that a little bit.

I'll answer the second question first. There are categories of products that UNFI does not particularly today doesn't carry and those are product categories that are currently moving down the path to become significant suppliers in and these are all products that are independent channel currently buys, they just don't buy it from us. As it relates to the Texas question, I'll let Mark answer that one.

Yes. I mean, depending on how far we get into Texas in the fourth quarter, Ed, will determine how much we might have from a non-recurring standpoint, but certainty with it sliding back some of that will come out of fiscal '09 and slide into fiscal 2010 because we won't necessarily, for sake of discussion, start hiring people yet. We may not be in a position where we are training drivers and/or selectors, receivers so there certainly be some non-recurring that will slide from the fourth quarter of '09 where it was likely going to land into first quarter maybe even the second quarter fiscal '10. It was probably, our expectations were that we'd have roughly $0.02 I think of non-recurring was the way I laid it out at the beginning of year in the fourth quarter so it could be as little, it could obviously be as little as zero depending on when we start, and it would probably be no more than a penny at this point.

Thank you.

Thank you and I show no further questions. I would like to turn the call back to management for any closing remarks.

Thanks. I thank you all for joining us this morning. Once again, we are pleased with our results this quarter despite a tough environment. Yet there are lots of positive things happening here at UNFI and we look forward to sharing them with you during our analyst and shareholder tour of York, PA on June 23, so please hold the date and thank you very much for joining us this morning. Have a great day.

Ladies and gentlemen, this concludes the United Natural Foods second quarter 2009 conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-405-2236 or 303-590-3000 followed by the access code of 11126389 and the pound sign. We would like to thank you for your participation. You may now disconnect.