United Natural Foods Inc (UNFI) 2009 Q3 法說會逐字稿

Good morning, thank you for standing by. Welcome to United Natural Foods third quarter 2009 conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). This conference is being recorded today, Tuesday, June 2, 2009.

I would now like to turn the conference over to our host, Scott Epstein, of Financial Relations Board.

Thank you, Operator and good morning, everyone. By now you should have all received a copy of this morning's press release. If anyone still needs a copy, please contact Joe Calabrese in our New York office at (212)827-3722, and we'll send you a copy immediately following the conference call.

With us this morning from management is Steve Spinner, President and Chief Executive Officer and Mark Shamber, Chief Financial Officer. We'll begin with opening comments from management and then open up the line for questions. As a reminder, this call is being webcast and can be accessed over the internet at www.unfi.com.

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

Thanks, Scott. Good morning everyone and thank you for joining us this morning. UNFI's third quarter was a strong one, $0.39 diluted earnings per share and a 30% increase in earnings over the prior year, demonstrate that the Company is well positioned to weather difficult economic challenges.

The Company is focused on the future and it's developing a strategy based on growing top line revenue, being operationally excellent, operating as one Company with regional preferences, and enhancing our commitment to sustainability and the environment. Of particular note during the quarter was performance in our UNFI regions, as well as Select Nutrition and Albert's Organics. At Select, we posted strong results, primarily accomplished through increased fulfillment internet sales and new line extensions.

In our Albert's Organic's business, new customer wins and further expansion of our perishables business, has contributed favorably. Both divisions are managed by passionate associates, driven to excellence in the vitamin, supplement, and organic produce channels. With sales still soft verse a year ago, we focused heavily on cost controls, productivity, and the continued integration of specialty into our core business. During the quarter, sales ex-specialty were 3.3% versus prior year. While we were optimistic that current sales trends should improve, there has not been any meaningful evidence of change.

As a result, UNFI's focus must be on building market share through added sales to existing customers and the acquisition of new national organic, natural, and specialty buyers. The latter will be accomplished through a newly created national sales organization, focusing on mass, conventional retail and alternative channels. In addition, we will expand our sales to current independent customers by adding new lines and categories, in areas such as specialty cheese, protein, produce, and food service for retail.

As the leading distributor of natural organic and specialty products in the US, we are well positioned to use our scale to further implement large categories of products, providing greater service to our customer base. It's a wonderful time for UNFI to use its national platform of refrigerated distribution centers to integrate additional lines into our current offerings. Inflation did moderate somewhat during the quarter to 6.59%, from 8.02% in Q2. However, inflation versus a year ago was up 200 basis points, reflecting a trend that inflation is falling off, yet still higher than prior year.

During the quarter, we completed our first integration of specialty from a systems and building perspective, from East Brunswick, New Jersey to York, Pennsylvania. This facility now offers UNFI customers in the Mid-Atlantic region a full assortment of natural, organic, and specialty products. With over 30,000 items, we have the most comprehensive selection available in the geography.

In addition, we began loading specialty products into our Southern California distribution center, marking our official entry of specialty distribution on the West coast. And during the next six months, we will continue to aggressively integrate and grow UNFI specialty, and have started shipping specialty to a handful of new customers. As a reminder, this will be the last quarter that we specifically break out UNFI specialty, as it will be fully integrated into our core business moving forward.

We also stay focused on managing CapEx and cash flow. For the year, CapEx was approximately $25.4 million, versus $32 million in the prior year. And the Company also generated $15.3 million in free cash. You've heard me talk a lot about inventory. During the quarter, our inventory did increase by approximately one day. This was a result of ongoing negotiations with suppliers, and program opportunities that existed during the period.

I am still very optimistic that UNFI will more efficiently manage inventory, as we implement new forecasting tools, provide our suppliers with greater transparency into buying habits, and implement greater accountability throughout the distribution process. Looking forward towards Q4 and 2010, much of the Company's CapEx spend will be on building our Texas distribution center, in addition to IT investments, and national warehouse management and procurement. Becoming one Company to our suppliers and customers will be a key strategic opportunity during the next year. Making sure to keep regional services and preferences in the field, while standardizing those business practices that offer enhanced efficiency and productivity.

Expenses during the quarter fell 35 basis points versus the prior year, and contributing factors included the lower cost of fuel and a disciplined approach to expense control, given our more modest top line revenue growth. As the Company migrates to a more national platform of operational standards, best practices, and metrics, we will continue to control expenses across the Company. Looking back over the results of the third quarter, I am most pleased with the continued resilience and passion of our 6,000 plus associates.

Economic challenges force us to reevaluate everything we do. And our people rose to the occasion and delivered exemplary results. I would like to remind you all that UNFI's Analyst Day is rapidly approaching, on June 23rd.

Our management team will share our three year vision with you, highlighting a new go to market strategy centered on market share, operational excellence, one Company platform, and sustainability. And if you have not registered, please feel free to contact Mark Shamber or Joe Calabrese with Financial Relations Board. Now I'll turn over the call to our CFO, Mark Shamber.

Thank you, Steve. Net sales for third quarter of fiscal 2009 totaled $889.5 million, which represents growth of 0.3% over prior year third quarter net sales of $887 million. Excluding sales by UNFI specialty, net sales for the quarter were $836.2 million compared $809.7 million in the prior year, resulting in growth of 3.3% for the third quarter, or $26.5 million. Year to date net sales of $2.6 billion, yielding sales growth of $147.4 million, or 6% over the prior year.

Excluding specialty, comparable sales growth was 5.9% for the first nine months of fiscal 2009, with year to date net sales of $2.44 billion. In the third quarter, sales to the super natural channel increased by 4.7%, and now represent 33.4% of sales. Independent's growth was 1.1% for quarter, and independents represent approximately 42% of sales.

Our supermarket channel experienced a decline of 9.2% over the prior year, or an increase of 5.3%, excluding specialty. And supermarkets now represent approximately 20% of sales. Food service increased by 1.3% over the prior year, and represent approximately 2.5% of sales. As Steve mentioned, with the successful integration of specialty into our York, Pennsylvania facility in mid-April, we will not be disclosing specialty results going forward, as this information is no longer separately tracked.

At 19% gross margin for the quarter showed a 27 basis point improvement over the prior year's third quarter gross margin. Gross margin in the quarter benefited from improved year-over-year gross margins at UNFI specialty and improvements in forward buying, offset by lower fuel surcharges. For the first nine months of fiscal 2009, our gross margin is 19.2%, a 58 basis point improvement over prior year to date gross margin.

Operating expenses for the quarter were 15.6% of net sales, compared to 15.9% for the same period last year, an improvement of 35 basis points over the prior year. Operating income improved by 62 basis points over the prior year, to 3.4%, compared to 2.8% in the prior year. Included in our third quarter expenses was approximately $1.2 million of nonrecurring expenses associated with our new facility relocations earlier in the year, and the integration of our specialty facility in East Brunswick, New Jersey into our York, Pennsylvania facility.

During the quarter, we recorded share base comp expense of $1.3 million or approximately 15 basis points, compared to expense of $1.1 million, or 13 basis points in the prior year. Fuel costs for the quarter were approximately 66 basis points, an improvement of eight basis points over the second quarter and improvement of 45 basis points over the prior year.

We estimate that our operating margin benefited nine to 14 basis points from lower fuel prices over the prior year, after netting out higher fuel prices and fuel surcharges. Interest expense in the quarter of $1.7 million was down approximately 46% sequentially, and was approximately 59% lower year-over-year. The sequential and year over year decreases were due to a combination of lower debt levels and lower interest rates during the quarter.

Our lower debt levels were driven by a combination of improvements in our working capital levels and increased profitability. Our effective tax rate for the quarter was 41.25%, bringing our year to date effective tax rate to approximately 40.25%. We expect that our full year tax rate will be between 40% and 40.5%, due to increased efforts by state and local tax officials to raise taxes to cover budget shortfalls.

Our days in inventory was at 52 days for the third quarter, which represents a one day increase compared to the prior year, and a six day improvement over the average for the second quarter of fiscal 2009. The higher inventory levels are due in part to certain investments in inventory to take advantage of certain forward buying opportunities offered during the quarter. DSO was just under 20 days for the third quarter, which is favorable to our target range, and is consistent with prior year's DSO.

CapEx was $25.4 million, or approximately 1% of net sales for the first nine months of fiscal 2009, and was $8.4 million for the third quarter. The Company's outstanding commitments under our amended and restated credit facility as of April, were approximately $267.2 million, with liquidity of over $138 million, including approximately $7 million of cash on hand. At the end of the third quarter, our leverage had improved to approximately 2.3 times on a trailing 12 month basis.

During the quarter, we generated free cash flow of approximately $15.7 million, resulting in year to date positive free cash flow of $15.3 million. And leaving us on track to reach our fiscal 2009 positive free cash flow expectation of $20 million to $30 million. As discussed in our press release, we are reaffirming our sales guidance for fiscal 2009, with projected net sales of $3.45 billion to $3.5 billion, which represents a 4.5% to 6% increase over fiscal 2008, after adjusting for the 53rd, or extra week, which occurred in the fourth quarter of fiscal 2008.

In addition, we are narrowing and raising our earnings per share guidance for fiscal 2009, to a range of $1.34 to $1.38 per diluted share. Previously we had announced earnings per share guidance of $1.28 to $1.36 per diluted share. Finally, we are revising our CapEx expectations for fiscal 2009 to a range of $30 million to $35 million. As the buildout of a new Texas facility will not commence until 2010.

Included in our CapEx guidance for the remainder of fiscal 2009 are expenditures associated with the new facility in Charlotte, North Carolina for our Albert's Organics division, which is expected to begin operations in the first quarter of fiscal 2010. Previously, our CapEx guidance had been revised to a range of $40 million to $45 million, during our second quarter earnings announcement.

That concludes our prepared commentaries. And at this time we'll turn the call back to the moderator to facilitate the question and answer session.

Thank you, sir. We'll now begin the question and answer session. (Operator Instructions). Our first question comes from John Heinbockel with Goldman Sachs. Please go ahead.

Hey, Steve, a couple of things. What are you seeing with regard to consumer takeaway as best you can measure it? Is there any sign of early improvement there? And what about retailer restocking? I know there had been a lot of de-stocking. Have we finally started to see restocking or not yet?

Good morning, John. We haven't seen any wholesale changes in either one of those questions, whether it's no real change at the consumer level, no real change from a retail or restocking perspective. We still see some volatility in the week-to-week sales. So overall, no real change or improvement that I would say would indicate that any particular trend is beginning.

Do you think sales will get worse before they get better as inflation goes from, I don't know where it's going to bottom out, but it's probably going to go lower from six. Do things get worse before they get better, or do you think an improved consumer takeaway can offset lower inflation.

We haven't seen, we wouldn't buy into things getting worse before they get better. I think things have been relatively constant for some time. Even though there's a big, volatility week to week, month to month, but over the course of several months, fairly consistent. So no, I wouldn't say that.

When you think about the profitability of core UNFI, you have a quarter here where if you strip out specialty, you're probably back to the best levels that core UNFI has had, in the mid-threes. As you look at the business, is that a business that can earn a lot higher EBIT margin than 3.5%. Or is that where you've topped out historically. Is it where you top out now or is there room to push beyond that?

That's a great question. It's just not one that I'm particularly comfortable answering right now. We obviously had a great quarter. I'm still digging in and learning the business. So it's really not something that I would be in a good position to answer at this time.

We're really focused on what the business looks like in a couple of years. And I think we'll share some of that with you at the analyst meeting. I wouldn't want to lock myself into a corner and say we could get to 4.0% or 3.75%, or any particular number at this point.

Finally, I would imagine you have, if you look at the operating companies or the locations, you've got to have some that are well north of 3.5%, and some that are quite a bit below. What's the key differentiator? Is it just strictly volume per facility that would mark the best facilities from the weaker ones?

I would say number one is scale.

Yes.

The greater the scale, the greater the ability you have to leverage the fixed costs.

We do have some big differences in the models between East and West. And that's not necessarily consistent in that the East is better than the West in all things. We certainly have the West is better than the East in some things. It's a matter of identifying what we want to look like from a national perspective.

And then migrating to that platform over the course of the next couple of years. Both regions had a very strong period. They're having a very strong year. So the answer which you may not want to hear is that there's certainly room, but it's hard for me to quantify what that room is right now. Okay, thanks.

Thank you, our next question comes from the line of Scott Mushkin with Jefferies and Company.

Going along the lines of what John was getting at, maybe you don't want to answer this question. I guess it's where do we go from here? Clearly, you guys are running the Company much more efficiently and diesel is helping quite a bit, the fall of in diesel costs.

And how do we start growing again? I know the core UNFI was three and change. And what do you think the medium term revenue growth rates are for the Company as we move forward? Do you have any visibility at all?

Scott, let me put it to you this way. There's two ways that we're going to grow. We're going to sell more product to existing customers. And we'll do that by adding additional SKUs, whether it's specialty, or food service, or protein or conventional produce.

There are large categories of products that the core UNFI business does not currently market to the independent segment, which is 40% plus of our total.

So the least expensive way for us to grow market share, and obviously, hopefully, a lot of that would fall to our bottom line since we're already going to those customers. We think the customers want those products, and we certainly want to be in a position to provide it to them. The second way, which will have the most meaningful impact upon our top line, is to take on new customers.

And we just set up a new national accounts group, that is calling on the big national retailers, mass and alternative channels, and we need to get some big customer wins.

The Company has not played actively in that space before. And it is now a very big target area for us. We do some business with those channels currently. We need to expand it. So if we can do those two things, and we think we can, there's a tremendous amount of room for us to grow. Not only in terms of the top line, but the bottom line as well.

So, Steve that is actually great color. I was wondering if you could go a step further. You said a lot of this will drop to the bottom line. As you bring in specialty in to a lot of these DCs, to try to capture some of these national accounts, and maybe you'll go through more of this at your analysts day, the economics there and how the DCs, how confident are you that the DC economics will not become troublesome as you try to do this.

We have gone through our first full integration from a systems and physical plant perspective. We closed our East Brunswick specialty facility and migrated it into our York facility, which you'll see. When you take a tour of the facility you'll see why it makes so much sense.

The economics of running two DCs versus one, I think are obvious. The economics of delivering more per delivery is obvious. While I don't want to quantify what specifically that means, I think common sense would lead you to, we're far better off having one center deliver as much as we possibly can on one delivery. It makes a whole lot of sense.

If I could have just one more. Obviously, Tree of Life is up for sale. What's your stance on that?

We really don't have a position on Tree today. We're kind of waiting like everybody else to take a look at it, which we will. Whether or not it makes sense for us, is certainly not something we'd be willing to comment on at some point.

But you will obviously take a look?

Of course.

Okay. Thanks and really good quarter given the environment. Congratulations.

Thanks, Scott.

Thank you, our next question comes from Ed Aaron with RBC Capital Markets. Please go ahead.

Good morning and let me add my congratulations as well. Steve, you mentioned in your prepared remarks something about a handful of new customers in the specialty business. Can you elaborate?

Sure. Most of the new business we've taken on in specialty are expansion of existing relationships. We've been the supplier of record on the natural organic side, and now we've added the specialty as well.

Which to me says, again the thought process of acquiring a specialty business was the right one. Our customers want it. They'd rather buy all the products from one supplier as opposed to two. And we see that in the base hits we've gotten in winning some of these specialty accounts.

The specialty sales numbers wouldn't suggest much of a pickup from that yet. Have you just not, is that entirely on the come or have you gotten some of those new distribution benefits already, and it's just been overwhelmed by kind of a weak economy?

No. These new relationships are happening slowly. We've just started shipping some of them. So you wouldn't see them in our third quarter results.

On the non-food side, which is also part of our specialty business, that business has been hurt a little bit more from an economic perspective, than the specialty, organic, and natural. So while we've had customer loss, we've had a really hard time just given the fact that the entire non-foods business is down so significantly year-over-year.

That makes sense. Thanks. And on the Tree of Life deal, I guess acquiring the business is one option. But another option would be to just try and go wrestle some business away from Tree while they're in the transition process. And presumably, maybe you've had discussions with customers. I know you can't comment on anything too specifically. Broadly speaking, can you comment on any opportunities along those lines?

We're not going to go there. We're going to have to wait and see. And obviously, we're watching it very closely.

I think we're constantly trying to take business from all of our competitors. I don't know that we'd be singling Tree out, compared to anyone else we're competing with.

Sure. And then lastly, Mark, may be one for you on fuel. We've had a bit of an uptick in fuel prices in recent weeks. Take that uptick for what it is and look at the fourth quarter, how much do you think that might shave off earnings sequentially Q3 to Q4.

It depends on where the prices go or if they continue the upward trend. If you were to go back and look at the fourth quarter of the prior year, ex the surcharges, we were at 111 basis points in the third quarter of fiscal 2008. I believe we reached the high water mark in the fourth quarter of 2008, where we were at 137 basis points.

So, I think that I need prices to probably rise above $75 to $80 a barrel, maybe a little bit higher, in order to have year-over-year fuel be, or sequentially quarter to quarter, have year-over-year fuel be not as much of a benefit as we got this quarter. So I don't think we're there yet because of the way prices ramped up so much in the fourth quarter of last year. But based on a quick calc, I'd say it's higher than $80 a barrel before the fourth quarter would see a decline in the benefit.

Thank you, our next question comes from [Diedrich Bash] with Canaccord Adams.

Thank you. Just wondering, a little bit more color on what's been done in the last six months to improve operating expenses, other than the lower fuel costs and some of the head count reductions that you've had.

There are a number of things that have gone on. One thing, that is a softer number but certainly is reflective of it is that, we're not spending as much time from a training standpoint with personnel in the warehouse.

Where we've got an assembled work force. We're not losing people at the clip that we were losing people, and our best people are not out training new hires. And that's one area where we've seen, on both the selecting and the receiving side, we've seen our rates per hour increase by virtue of putting those trainers back into the work force, selecting, and having more experienced personnel where the turn has decreased from what we were seeing last year at this time.

Beyond that, I think that some of the steps that we've taken from a standpoint of becoming, we've done re-routing projects where we tried to become more efficient with the roots that we're having our folks take using road net, and such technology. And we continue to roll out, whether it's carousels or other technologies in the new warehouses that we're opening, that allow us to get better pick rates in the repack area.

Without a carousel, without pick to light, you're in the range of say 200 units an hour, you may be able to get 25% or more improvement with a carousel.

Specifically what we did, is when we saw that the top line revenue was falling off, we did an internal re-forecast, and we held ourselves accountable to the same earnings targets on much lower revenue numbers. And that forced us to have a much tighter discipline around expense control and productivity. Because we had such a smaller top line number.

Okay, thanks. That's helpful. And if you look at your inventory turnover, which has made some steady improvement this year, do you have a long term target or an estimate of how high that can go?

Well, I think under the current model, our target has been 47 to 50 days from an inventory standpoint, which gets you a turn of between seven and eight.

Some of the new programs that we're trying to roll out with our suppliers, that should be a win-win for both of us, that should allow us to take that down further. I don't know that I'm willing to commit to that number yet. We might be more willing to share at the analysts day, or once we've got that a little bit further developed.

We've done a lot of work around a new program called Clear View, which is designed to give our suppliers a tremendous amount transparency into our current inventory by DC, by region, provide them a lot of information about seasonal purchase trends. So that we can work much closer with these key suppliers to drive down our inventory and improve the service level. And we're in the very early stages of that. That's something we'll spend some time talking about at the end of June.

Last question if I may. At Expo West, I saw a new private label brand called Field Day. I was just wondering what the strategy was in rolling that out and how much traction has that gotten from independents?

The basic premise for Field Day is an everyday low price private label brand. It is rolling out to stores as we speak. It's a little premature to comment on how well it's going.

It's something that our independents have been asking us for for some time. Which is just an every day low price private label brand, so that they can compete more effectively with some of the other bigger retailers.

Okay. Thank you.

Thank you. Our next question comes from Meredith Adler with Barclays Capital. Please go ahead.

I was wondering if you could talk about the gross margin, which looked very good this quarter and what the drivers are, and what you see happening in the next couple of quarters.

Sure, one of the areas where we put a lot of focus after making the acquisition on the specialty side, was improving their gross margins. And I think that we're seeing some of the fruits of those labors starting to pay off. And that's the biggest driver from a year-over-year standpoint.

With a full service model, we do get higher gross margin that's off set with higher operating expenses. The margins when we took over the business last year, were much lower than they had historically been, due to the challenges the business was facing leading up to the acquisition.

We've made improvements in that area and seen some offset in the last couple of quarters, by virtue of the elimination of the fuel surcharges. As I look at gross margin going out for the next two to three quarters, I think it could continue to fluctuate in the range of 19% to 19.2%. That's a relatively wide enough range that I would be comfortable committing to.

And then my next question would be about, are you seeing any kind of pushback as you go out there and talk about this, the new combined model? Is there anything or is it just the lead time that it takes to get people to think about changing suppliers?

It's 100% lead time. It just takes a long time.

And are there any meaningful competitors?

On the specialty space?

With the combined model.

You're talking about natural, organic, and specialty? There are some regional players that are relatively good competition.

The thing that makes us differentiated it is that we are primarily a natural & organic supplier first, then a specialty distributor second. That gives us a breadth of line in the natural organic space, that at least from my perspective with some small exception around the country, is unequaled. Some of the other competitors that do offer natural, organic, and specialty, are primarily specialty distributors first, and carry a very limited supply of natural & organic. So it puts us in a really unique position.

My final question would be back to the topic of expense control. How quickly do you think that you can put these best practices in place. And also the timing on Clear View.

Clear View will take several years to fully integrate. It's a matter sitting down with each one of your major suppliers and converting to a new business model. And for some suppliers, it may never make sense. But it will certainly take us the better part of at least two years to get through the ones that will move the needle.

On expense control, we're going to be rolling out a national procurement and warehouse management system, starting in the early half of calendar 2010. So these things are all going to happen over time. I don't expect to see any significant needle moving initiative happening in any one particular period. I think what we want is consistent improvement over the next couple of years.

Great. Thank you very much.

Thank you. Our next question comes from Greg Badishkanian with Citigroup.

Great quarter, guys. Two questions. First, just as it relates to food inflation, as that moderates, do you think you'll see impact to margins? And also, your inflation seems to be a little higher than the conventional food industry. Would you say that the natural food industry inflation is lagging the overall conventional food inflation?

I'm not sure about lagging. But the timing of what was hitting last year led to a lot of the manufacturers putting through price change right around this time of year, anywhere from March to May. And with the commodity prices still increasing the way they were, there was a second round of price increases that happened. And a lot of them chose to do it over six months rather than three.

We saw another big uptick in the September to November time frame. What we're still seeing is we've now annualized a good part of the first round of those price changes that hit last year. We still probably have another six months or so before we'll cycle through that next big wave of price changes that have gone through.

I know by listening to some of our suppliers, that there may be locked into commodity pricing contracts that don't expire until June or July. They're just now catching up from what happened when they entered into the agreements from last year. From a standpoint of the impact on margin as inflation moderates, I think that what we've seen so far is that we're still continuing to see a normal level of price increases go through.

It's just not at that hyper level that we saw last year. And so I don't think that we'll have as much of a forward buy opportunity with price increases, but I don't think it's going to hurt the margin. It just won't help them as much as it did.

Just to give you added perspective, in 2007 inflation ran 2.1% to 2.3%. And then started ramping up in early fiscal year 2008, from 3% in the second quarter of 2008 all the way up to a high of 8.7% in the first quarter of fiscal 2009.

Good. That's helpful. And with respect to a lot of the cost cutting, particularly with labor, sounds like you got a nice improvement to margins. And it sounds like that's pretty sustainable. And how sustainable is that over the next few quarters? And also, is there more room to cut out some costs?

You know, I think that for the time being, we're comfortable with our current rate of expenses. Certainly, as we look to invest in some of these new alternative SKUs, in different types of customers, it could potentially change, that expense ratio. But certainly for the short term, we're relatively comfortable that we're in a good range.

The other thing that kind of comes into play is that as unemployment levels level off or start to decline, we are in a scenario where we do have relatively high turnover, just by virtue of the nature of our business. We stand the risk that people will go back to a historical approach where we have a higher turnover in the warehouses and on certain shifts.

Right now, as Steve said, we're comfortable with where we are, but there certainly are opportunities where turnover increases and we're going back and pulling our best people off to do training, that we lose some of the efficiencies at that point. But, I don't think that's anything that we feel is imminent.

On that line of thought, if that happens, that means the economy is recovering at a nice pace, and people are going to buy more natural, organic foods, so that's a good thing overall I guess. So that's a good problem to have. Thanks a lot, guys, and great quarter.

Thank you, our next question comes from the line of Chris Krueger of Northland Securities. Please go ahead.

Good morning, guys, nice quarter.

Thanks, Chris.

I recently toured an Albert's Organics facility. I was wondering on that fresh produce category, I believe it's been more volatile than that center of the store stuff. It fell off in October. Can you kind of give us an idea of where the trends have been since then?

On the organic produce, we've had massive product deflation. So I think it's been, we've had 1.5% inflation in the quarter. But we've seen, there were periods where produce, organic produce, was deflating.

I think for the full year we saw a deflation of over 1% in FY 2009.

Okay. Would you say that actual consumer demand has shown improvements month to month?

Yes, I think the division, and Steve mentioned in his comments, the division put up strong results for the year. Even with the challenges that they've faced with deflation of certain products and categories, the demand has still been out there. Through a combination of growing the business and taking market share, they've posted strong numbers through the first nine months.

Other thing to keep in mind on Albert's is that while organic produce represents the lion's share of what we distribute, we do also a big job in perishable protein and dairy.

Next question. I'm not sure if you're providing this any more. I don't believe you stated how accretive or dilutive the specialty division was in the quarter to EPS.

As I mentioned, with the integration into the York facility, we're not breaking it out any more. And there's really not a clear cut way to break that out for the quarter. I think it would be fair to say that it was minimally dilutive.

There was a portion of the nonrecurring, were costs associated with moving the product and such from the East Brunswick facility to York. It's not something that I have the ability to break out. We've chose not to do that going forward.

Thank you. That's all I've got.

Your next question comes from Andrew Wolf of BB&T Capital Markets. Your line is open. Okay. We'll go on to the next question. The next question comes from Robert [Gosh] with Mack Capital. Please go ahead.

One of the strategies is to increase SKU count to help the organic part of the business, and you mentioned the independent channel as the major channel opportunity there. And I think you said earlier that that channel increased on the organic side 1.1%. So I was just curious whether or not again are things forth coming because things were relatively slow going. It was the slowest channel I believe for organic. So if that's where the opportunity is in terms of SKU expansion, what am I missing here?

That is where the opportunity on SKU expansion is. And we have not yet rolled out the new SKUs into that category. That'll be happening over the next six months.

Thank you. And these SKUs, would you describe them as center or more periphery. I know it's not in the supermarket channel.

It's gourmet specialty cheeses. It's some conventional produce.

It's some protein which initially would be pre-sliced, antibiotic free meats and cheeses. Food service items for those independents that have food service prep kitchens. So that we can sell all natural, no preservatives, no high fructose corn syrup food service products to those independents who have food prep areas.

From the sounds of it, its more on the periphery of the store type of items.

Yes.

Okay. The other thing, you took down your CapEx guidance for the year. You brought up your earnings guidance for the year. Yet the free cash flow guidance is the same? Is that right?

Yes, that's fair. What we've basically done is the inventory levels, we've been presented with a number of opportunities to make investment buys with inventory by some of our suppliers. We've left the free cash flow guidance the same to give us the flexibility that if those opportunities present themselves again in the fourth quarter, that we can take advantage of those.

I think I've just left some flexibility there. To the extent that we don't hit our days on hand target because of those investments.

So it's more inventory than working capital.

That's correct.

And just on the other expense, what exactly is in there and why the variance?

You know, I mean, it's a whole bunch of things. I mean, it's only $64,000. So from prior year quarter, about $130,000 year to date. You said other expense, right?

Maybe I had the wrong line item. And, I don't have the P&L in front of me. We can skip that I guess. If it's that much, I'm not really interested. Good quarter. And thank you very much for taking my questions.

Thanks, Robert.

Thank you. Ladies and gentlemen, (Operator Instructions). Our next question is Gary Giblen Goldsmith & Harris. Please go ahead.

Good morning. Could you elaborate on, how did the 12 basis points of gross margin benefit from lower fuel costs. Was that the timing differences between fuel price changes and the surcharge adjustments that you made?

I think I'm presuming that you're taking the middle of the range that I said. Basically what that is, if you go back to when we put the fuel surcharges in place, basically what we've said historically is that the fuel surcharges are not a 100% pass through of higher fuel costs.

We recover with the fuel surcharges 70% to 80% of the increase in the fuel. When fuel prices decrease and we move away from a surcharge, or get to a scenario where we're not having a surcharge. We're getting a benefit of 20% to 30%.

If you took the 45 basis points that fuel is lower year-over-year, so with 66 basis points this year in the third quarter, versus 111 in the third quarter of last year, that would get you 45 basis points and really the nine to 14 is 20 %to 30% on that. It's not an exact science. That's why we estimate it that way.

Okay. And going forward the way to think of that is that if fuel goes up, you can pass it on pretty much immediately. And if fuel goes down, you take out surcharges and other, in other words what's the effect of fuel going forward? Is your practice the same as it has been?

The practice has not changed. The only difference that we talked about I believe on the second quarter earnings call, is that we moved the surcharge to a rolling four week average to allow us to pass through price increases sooner, as well as to reduce fuel surcharges sooner when prices go down, rather that be going with the quarter lag.

Going forward, it would be the same approach as when we had fuel surcharges the last couple of years. But it would be done based on a four week rolling average. It would shorten the lag when prices go up, and it would shorten the time for us to recover the benefit when prices decline.

Okay. And then finally, to what extent is the type of ownership of stake in whole foods changing any of their dealings with United Natural?

We can't really comment on that. We have a contract with them and to our knowledge, there have been no changes in the relationship. We continue to work with them under the terms of the contract. And we have a very healthy and strong relationship with Whole Foods.

Any items arise that may be gray areas of the contract or outside the definition of the contract?

Well, I mean that happens with every customer. There's nothing that would be of anything worth mentioning from a discussion standpoint.

Okay, great. Thanks. See you in York.

Thanks, Gary.

Thank you our next question comes from Michael Krestell with M Partners. Please go ahead.

Good morning.

Good morning, Michael.

Just a quick question on an expense item. Is the cost for putting the national sales organization that's focusing on mass, is that all in Q2, or should we be looking at expenses for managing that forward.

It's all in Q3.

And the last question is around the supplier base. As we move through, a little bit slower times, are you seeing any impact on the supplier base. The same number of suppliers that you had and what is the relative health?

We spent some time looking at that and we have not seen any wholesale changes in our supplier base. So for the most part, they're hanging in there.

Okay. That's great. Thank you.

Thank you, our next question is a follow-up question from the line of Scott Mushkin with Jefferies and Company.

This is a little bit of a housekeeping item, but I figured I'd ask it anyway. D&A, Mark was up quite a bit in the quarter, even though CapEx spending is coming down. I was wondering what was driving that, have you guys changed the way you're looking at that.

I think there are a couple of items relatively small that with some cleanup that had gone through on some investments that we made. The biggest piece is that when we exit facilities such as East Brunswick and/or when we relocated from New Oxford to York, you've got to raise the depreciation for those buildings or not those buildings but the assets in those buildings, if you choose not to use them or carry them over.

That's really the driver. I wouldn't expect it would be as high in Q4. But it certainly will be, we'll see a higher run rate than what we had in Q2 because of York coming on line for a full quarter. I think that most of what you saw in Q3 was just some of the assets being accelerated as we exited different buildings.

That's perfect. It was just housekeeping, but it saves a phone call later. Thanks.

Thank you, and I'm showing no further questions at this time. I'll turn it back to management for any closing remarks.

I'd like to thank you all for joining us this morning. I'm encouraged by the results of our third quarter and hopeful that current economic conditions will improve. We will continue to stay vigilant as we standardize our businesses, control expenses, and implement new programs to further increase our market share.

I look forward to seeing you all on June 23rd in York, Pennsylvania. And have a great day.

Ladies and gentlemen, this concludes United Natural Foods third quarter 2009 conference call. If you'd like to listen to a replay of today's conference, please dial 1(800)406-7325 or (303)590-3030, access code 408-3344. AT&T would like to thank you for your participation. You may now disconnect.