United Natural Foods Inc (UNFI) 2010 Q3 法說會逐字稿

Good day ladies and gentlemen. Thank you for standing by. Welcome to the United Natural Foods third quarter 2010 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, Wednesday the 2nd of June, 2010. I would like to turn the call over to Scott Eckstein of the Financial Relations Board. Please go ahead.

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 212-827-3772. We will 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 up the line for questions. As a reminder, this call is being webcast today 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 and thank you all for joining us. This morning UNFI announced diluted earnings per share of $0.45 for our fiscal third quarter, a 15% increase over the same period last year. As encouraging was our sales growth which was up almost 11%, versus the same three month period last year. Sales grew consistently across all of our channels, reflecting new customer wins, increases in market share, and increases in volume at existing retail locations. All previously announced new customers are on board as of the end of Q3, and transition costs of approximately $0.01 per share, were reflected in the quarter. Volume for these customers will be reflected in our sales results during Q4. I'm optimistic that the current trend reflected by these sales increases will continue resulting in revised sales guidance for the year to a new range of 6.5% to 7.5% growth, year-over-year.

During the period inflation continued to moderate to flat. This is a significant change versus 6% inflation during the prior year. Adjusting for inflation, the comparison is negative 5.7% growth in 2009, versus positive 10.7% growth this year, resulting in real growth of 16.4%. Inflation is quite difficult to predict; however, our belief based on the current trend is that inflation will migrate to more historical levels of 1% to 3% over the next year assuming that sales trends remain strong. I'm also very pleased that Whole Foods and UNFI agreed to extend our existing contract by seven years resulting in a new ten year agreement. This important announcement was made in a separate release made this morning. Both companies have very worked closely together for years and this extension solidifies the confidence and strategic nature of our relationship. Additionally, during Q3, UNFI announced the entry into a definitive agreement to acquire certain assets of the food distribution group of SunOpta Distribution Group, based in Canada. The assets will be acquired by a new entity, UNFI Canada Inc, which operate distribution centers in Vancouver, Toronto, Montreal, and Scotstown, Quebec . UNFI Canada will be the leading distributor of kosher, natural, organic and specialty products. We expect this transaction to close this month.

During the quarter our balance sheet also remained strong across receivables, inventory and leverage. Our capital expenditures during the quarter were driven primarily by construction of our new Texas facility, expected to be completed in July and continued investment in IT infrastructure and supply chain projects. Our new Texas facility will implement UNFI's new warehouse management system, marking the official start of this exciting multi-year project. We expect completion of our supply chain and WMS initiative in late calendar 2012. Gross margin during the quarter was unfavorable to prior year by 46 basis points, reflecting changes in our customer mix and moderated inflation. This was offset by continued control on expenses. During the quarter our expenses were 48 basis points less than prior year, reflecting lower fuel costs and increased productivity. Also encouraging during the quarter was a significant improvement in the sales of specialty foods, which was hit particularly hard during calendar 2009. UNFI is now marketing specialty categories across the US.

During the quarter UNFI also announced the installation of hydrogen fuels at our Sarasota, Florida distribution center, to power our material handling equipment. By converting UNFI's Sarasota lift truck fleet to hydrogen fuel cells, we expect carbon emissions to be reduced by approximately 132 metric tons annually. We consider environmental stewardship an essential component in every facet of our business. And this hydrogen fuel cell project is further proof of UNFI's leadership as an environmentally conscious organization, by advancing the use and development of alternative fuel technologies. Our third quarter results highlight a strategy that is working. Our focus on market share, operational excellence, one Company platform and sustainability, have served as a road map towards tremendous execution in the field by our more than 6,000 associates across the country. Now, I would like to turn the call over to Mark Shamber our Chief Financial Officer.

Thanks Steve. Good morning to everyone listening in on the call and the webcast. Net sales for the third quarter of 2010 were $985.7 million, which represents growth of 10.8% or approximately $96.2 million, over prior year third quarter net sales of $889.5 million. Year to date, net sales are at $2.77 billion, resulting in sales growth of $167.3 million, or 6.4% over the prior year. For the third quarter of fiscal 2010, the Company reported net income of $19.5 million, or $0.45 per diluted share, an increase of approximately $2.7 million, or 16.1% on a dollar basis over the prior year. Net income for the third quarter of fiscal 2009 was $16.8 million or $0.39 per diluted share.

In the quarter sales to the super natural channel increased by 17.7%, and super naturals continue to represent approximately 36% of sales. The independent's channel sales growth nearly tripled from the previous quarter with growth of 6.9% for the quarter and independents remain steady from a mix standpoint, representing approximately 40% of sales. Our super market channel experienced growth of 12.2% over the prior year and that channel continues to represent approximately 20% of sales. Finally, food service also saw an acceleration in sales growth, with sales increasing by 19.8% over the prior year and they now represent approximately 3% of sales. At 18.5%, gross margin for the quarter showed a 46 basis point decline over the prior year's third quarter gross margin of 19%. Gross margin in the third quarter was lower primarily due to the continued shift in the growth mix of our business towards super naturals in conventional supermarkets, combined with significantly lower year-over-year inflation. Inflation in the third quarter of fiscal 2010 was approximately 0.15%. Gross margin for the first nine months of fiscal 2010 was at 18.6%, compared to 19.2% in the prior year, a decline of 61 basis points. The decline in the year-to-date gross margin is due to the two factors I just mentioned, along with some impact earlier during the fiscal year due to lower fuel surcharge revenues.

Our operating expenses for the quarter were 15.1% of net sales, compared to 15.6% for the same period last year. This represent a 48 basis point improvement over the prior year, as we continue to focus on operating improvements and expense controls as part of our operational excellence and one Company initiatives. During the quarter we incurred approximately $0.4 million or 4 basis points in non-recurring expenses associated with severance, which had been announced in January. In addition, we incurred approximately $0.5 million in ramp up costs associated with on boarding new business during the quarter that began shipping during the quarter or is scheduled to begin shipments in May. Fuel was effectively neutral to operating expenses in comparison to the prior year as fuel represented 67 basis points of distribution net sales in the quarter, compared to 66 basis points in the prior year. Sequentially our fuel costs have improved by one basis point per quarter over the last two quarters. Nationally, diesel fuel in the third quarter increased by approximately 5.5% from the second quarter to a national average of $2.95 a gallon, using the Department of Energy's weekly prices. This results in an increase of approximately 36.5%, over the prior year average for the third quarter of $2.16 a gallon. As we covered last quarter, we have managed to limit the increases in our fuel costs as a percentage of net sales in the face of rising fuel prices by initiatives such as updating or revising our existing routes to reduce the miles traveled, reducing idling times and other similar measures.

As additional note related to operating expenses -- during the quarter we recorded share based compensation expense of $2.6 million, or 26 basis points compared to expense of $1.3 million or 15 basis points in the third quarter of the prior year. Operating income was 3.4% for the third quarter of fiscal 2010, a one basis point improvement over the prior year. Excluding the severance and new business ramp up costs, operating income would have been approximately 3.5% for the quarter or ten basis points higher than the prior year. Interest expense in the quarter of $1.5 million, was approximately 4% lower sequentially, and 13% lower year-over-year. The sequential decrease was due to lower average inventory levels during the quarter, while on a year-over-year basis, the decrease was driven by a combination of lower inventory and average debt levels during the quarter.

Our inventory days on hand was at 47 days for the quarter, which is at the low end of our target range of 47 to 50 days. This represent a five day decrease from the third quarter of fiscal 2009, and is approximately a three day improvement from the second quarter. The sequential decrease was related to additional sales volume during the quarter for new business that we've added, as well as additional shipments that have begun since the end of Q2 and during Q3. DSO for the quarter was at 19 days, which is favorable to our target range and is a day improvement over the prior year's third quarter. Capital expenditures year-to-date were at $30.9 million or 1.1% of revenues, which is slightly above our target of approximately 1% for the current year as we continue with the buildout of our new Lancaster, Texas facility. Due to the gear up for new customers during the quarter, we experienced negative free cash flow in Q3. However we remain confident that our annual free cash flow objective of $30 million to $50 million will be achieved. Our leverage as of the end of the third quarter was approximately 1.7 times, based on a trailing 12 months. And, our return on equity was approximately 11% over the same time frame. Our outstanding commitments under our amended and restated credit facility as of April, 2010, were $207 million, leaving us with liquidity of approximately $201 million after factoring in approximately $10 million in cash on hand.

Finally as discussed in this morning's press release, we are raising our net sales guidance for fiscal year 2010 ending July 31st, 2010, to a range of $3.68 billion to $3.72 billion. Which represents a 6.5% to 7.5% increase in total net sales over fiscal 2009. This implies growth of 6.5% to 11.5% in our fourth fiscal quarter. Previously we had provided a net sales guidance target of $3.54 billion to $3.63 billion for fiscal 2010. In addition, we are narrowing our earnings per share guidance for fiscal 2010, to a range of $1.55 to $1.58 per diluted share. Our previous earnings per share guidance had been a range of $1.48 to $1.58 per diluted share for fiscal 2010. That concludes our prepared remarks. At this time I will turn the call over to the moderator to facilitate the q-and-a portion of the call.

(Operator Instructions) Our first question comes from the line of Gregory Badishkanian with Citigroup. Please go ahead.

Great quarter, guys. Just two questions. What's the tenure business in May, did you see major change one way or the other this month versus the other -- the trend that you recently saw.

Good morning Greg. We've seen what I would call a consistent improvement in our top line number. Probably since January of this year. That trend has continued through May. So I don't think there was any thing wholesale -- changed in May. I think it's been -- as opposed to year ago when we had -- you will recall we had these wild fluctuations in sales month over month, quarter over quarter. On the plus side, it's been consistently getting better since January.

That's great to hear. With one of your main competitors, the acquisition -- have you noticed any disruption, have you noticed any changes in the pricing environment or what -- has anything changed in the competitive environment since that happened.

Yes. Not noticeably. We are focused on what we've got to do. Obviously tons of business opportunities out there from a wide variety of different distributors. But specific to your question, I would say no we haven't seeing anything -- any wholesale changes, no.

Thanks.

Thank you.

Our next question comes from the line of Scott Mushkin with Jefferies & Company.

Hi, guys, thanks for taking my questions. I was wondering for you could maybe give us some insight in to the supermarket channel that accelerated significantly during the quarter. Was that driven by customers brought on board or was that noticeably improvement in what is going on in that channel.

I think it's both. We saw that channel increase from a year-over-year perspective and obviously we have also been awarded a fair amount of business in that channel as well. So I think the answer is both.

Do you think it's different Steve from the last quarter. Do you think it's gotten better in this quarter and into May. Or is it the same as it was last quarter.

I think the answer is the same as Greg's and that is that we seen consistent steady improvement across all of the channels since January. And that's true of super natural, conventional and independent.

Great. This is maybe a little bit more of a long-term question about margins, obviously you guys did a great job on expenses but gross margins came in so we are flat on the margin side. On the long-term basis where do we drive that. Last year at your investor day you said maybe ten to 15 basis points over a three year period if I'm -- on the plus side -- if I'm remembering correctly. I was trying to get an idea of -- do you still feel that way, what are the levers you need to pull to start seeing improvement in the operating margins.

Okay. Thank you for asking that question. What we have been talking about for the better part of a year or year and a half is the fact that our business is changing. And as we migrate towards more super natural, more conventional, there will be continued pressure on our gross margin. Well, at the investor conference that we did a year ago June, we talked about the introduction of our supply chain initiative. Which covers the way we manage our warehouses from selection, to loading to delivery, the way in which we manage our supply chain, the way we buy product. And, we have new technology being implemented as I discussed in my opening comments. Texas will be the first location where we go live.

At the end of the day the purpose is to make sure that we bring down our expenses at a rate that's faster than the decline in the gross margin. So we are still very comfortable with the three year objectives that we gave in June. And obviously the challenge is going to be how well we can execute against that important part of our business -- to make sure we lower expenses at a rate that's greater than the decline in the gross margin. If we do that we will continue to see increases in our EBITDA percent.

Do you have a goal -- five, ten basis points a year. Is that what your thought process is -- or do you even want to go there.

We haven't given guidance on our expenses but we have given guidance on our operating margin.

In the three year target that we put out last June in the investor presentation which may be up on the website it referenced ten to 15 basis point margin improvement a year. We didn't get that on a pure GAAP basis this quarter because of some of the start up costs and some severance and higher than average share based comp. Those are numbers we still feel comfortable with -- maybe one year we are above or below the range but over the three years we feel we should be able to average that.

You know this -- there is always a balance between increasing your earnings and increasing your EBITDA percent. I feel confident that if we execute well across the supply chain initiatives we won't have an issue making those three year targets.

That's it for me, thanks for being so detailed in answering that question, I really appreciate it.

Thank you, our next question comes from the line of Meredith Adler with Barclays Capital. Please go ahead.

Thanks for take my question and congratulations. I would like to maybe talk a little bit more following on Scott's question. When you think about this ten to 15 basis point goal, do you take in to account the one time costs of bringing on new customers -- should we be thinking about that as a normal part of your cost structure.

The guidance that we gave includes those startup costs I would say. We should be able to deliver that number over the long-term, despite the start up costs.

Okay. I would like to talk a little bit about your fourth quarter guidance for sales -- which seems light to me when you look at the fact that you're going to be closing on the SunOpta acquisition and the current trend of sales is very strong. Is there something we might be missing that would be offsetting that.

No. I think that we tend to be conservative. We tend to be a bit cautious, particularly with the fourth quarter Meredith because we've seen years in the past where -- sequentially if you look over the last three or four years, the fourth quarter may show a drop of anywhere from 1% to 3%, maybe even 5% over the third quarter. So we tend to guide cautiously on the fourth quarter in that sense. But, if the current trends were to hold up -- depending on exactly when the transactions closes -- those numbers may prove to be conservative.

Then, my final question is about the independent customers -- I think at the analyst meeting, you talked about an initiative you had related to the independents. I was wondering how that's gone -- are you still happy with it, is there anything more that you need to do to drive sales in that channel.

We are obviously extremely focused on the independent channel. It's very important to us. It's our life blood. It's where we started. We've had some very exciting things come out on to help the independent channel grow and I think we've got some more exciting things from a technology perspective that should be coming out later this year.

The independents in the third quarter turned a corner from our perspective. They were plus 6% for the quarter. And they have been running close to flat all year. We feel much better about that category and that channel today than we did certainly two or three quarters ago.

Great, thank you.

Thank you. Our next question comes from Edward Aaron with RBC Capital Markets. Please go ahead.

I wanted to clarify on the new Whole Foods or the Whole Foods extension -- did I read it accurately that there weren't really any changes to the terms of the contract. And then if that's true, can you talk about why Whole Foods incentive to get that extension done so far in advance of the expiration.

I mean, there is no basic change to the economics. I think that the relationship is extremely good. We both have a lot of confidence in each other. I think the timing was just right for both of us to say -- let's lock ourselves up for another seven years.

I think that you had a statement in your release about it that you were planning some investments over the next three years to gear up for that growth. Can you elaborate on with this contract now officially extended -- what types of projects specifically you are planning to move forward with.

I think it's more that knowing that the Whole Foods contract is out of the way and we don't have to worry about it for eight or nine years, we can remain focused on our IT infrastructure initiatives. Making sure we roll out the WMS and the supply chain project which is going to take us through the end of calendar 2012. So I think that having a new Whole Foods agreement really puts us in the comfort zone of being able to focus all of our attention on getting that project completed.

Thanks and just wanted to ask a question on the new business, you talked about this roughly $100 million in sales that was coming on line. Can you give us a sense of how much of that you saw in Q3 and then how much you might pick up incrementally in Q4 -- because I think that business was ramping up as you moved through the quarter, so presumably there is some incremental sales that you get in Q4 relative to Q3.

Directionally about 1% to 2% of our sales increase during the quarter was from new facings. Probably I would say -- Mark, you can correct me if I'm wrong -- about half the business had been rolled out through the third quarter and will have the full effect of the $100 million in our fourth quarter.

Right.

But generally speaking if you looked across our third quarter, 1% to 2% of the sales increase was from new facings or new retail locations.

Would that mean in the fourth quarter, it would be closer to 3%.

Depending upon what happens in the overall sales environment. It could potentially be 3%. But we have obviously SunOpta that we will have for part of the quarter. It's hard to say where it's going to be. Certainly comfortable saying it will be in the 2% range.

And, I think the only aspect in Q4 is that Q4 is probably the slowest of the quarters from a specialty standpoint. And a good portion of that business that we added -- maybe roughly half of it maybe a little more or a little less -- is specialty related. It's not necessarily going to translate over that if it's $100 million, $25 million of it will hit in Q4 -- but within a couple of million either way I would think.

As a last quick one are you completely through the start up costs or would you anticipate some residual costs over the next quarter or two.

We're basically through it.

Thank you. Our next question is from Andrew Wolf, BB&T Capital Markets. Please go ahead.

Good morning. On the options cost -- [Swann began to you by] $0.02, you didn't choose much leverage. What's the outlook for options costs, going forward. Is this corporate policy to increase them or was this year a catch up year.

I will take this question. What we had happen in Q3 is we had some performance shares that were granted when Steve joined the Company that basically there were performance criteria. You measure them every quarter from an accounting standpoint to see whether you are at a more likely than not that they will be achieved. During the third quarter, we went from the more likely than not scenario because we are far enough along that we can actually have a good prediction of where 4Q will play out and they are a two-year period.

It's a one time expense that hit during the quarter. If you back out -- I think the number is roughly $700,000 or $800,000. If you back that out going forward that's still the trend rate of where our comp expense would be -- our share base comp -- it's not going to be every quarter now -- you can expect the share base comp to come through in that standpoint.

Thanks. That helps clarify. This one may not be as easy to clarify but I wanted to ask about the gross margin contraction. In relation to the disinflation in the business going from 6% to nothing. And I don't know if you can quantify specifically -- but can you tell us a little bit about how much margin you lose or year ago margin you gained -- looking in the MD&A or your explanation last year, there were holding gains or forward buy gains -- so I assume with that going away that's part of what is swinging some of the gross margin is just the lack of inflation the ability to buy in front of that.

We don't quantify the net effect but you are 100% on Andy. When you are in a period of no inflation, you certainly lose out on all of your ability to forward buy. So that had certainly had an impact in the quarter.

It's not something we've really ever attempted to quantify Andy because it's very hard to truly factor in what portion of the forward buy you retain versus what portion of it you pass on to customers during the promo periods and what portion of it you lose to spoilage and damages and such. We don't publicly come up with a number, we don't put it in the filings -- because it's not something that we could definitively work our way back to. But, we do know it's an influence, If I had to guess I would be willing to say it's probably from a quarter to a third of the margin erosion -- but again I couldn't give you a number or a calc that would tie back to that.

The other interesting thing that happens is when you are in a period of no growth, products tend to be more heavily discounted. When you are in a period of ramping up growth which is what we seen since January, the discounting starts to slowly fade away because the manufacturers don't need to fund movement of their product through the channel. So between the significant decline in the manufacturer's discounting and the lack of inflation which basically eliminates forward buy, those two things do have a significant impact on our gross margin.

Got it. Thanks. That's really helpful, appreciate that. Then on mix you mentioned the customers segments are all up. Can you talk more within categories -- private label items versus brand movements -- some of the higher end categories -- at least I would include a lot of the specialty goods and also health and beauty care if you are seeing the trading up there that one would expect in this part of the recovery.

I think you are spot on Andy. When you look across all the categories, most of the categories are growing. The categories that were hurt the most a year ago were specialty, HABA, personal care, pet food. Those categories have all started to come back nicely. To one extent or another. I don't think there is one category that's jumped out as having much more significant sales growth than others. I think it's more we've seen a steady growth across all of the product categories that we sell. With specialty and personal care coming back at a much faster clip than some of the others.

Thank you. That's it for me, thanks.

Our next question comes from the line of Scott Van Winkle of Canaccord. Please go ahead.

Couple of questions -- first, on the inventory, the turns and days, is there any channel shift impact on the efficiency of your inventory moving towards mass and super natural as a higher percentage. Is that one of the reasons we see inventory turns picking up?

I think there could be a component of it, Scott, where some of the -- for conversation discussion here -- you've got some of these supermarkets that have a much smaller set on average than what the independents do -- you are working off an improved product list that maybe only 2,000 to 2,500 SKUs -- and if those are fast movers at one supermarket they are probably fast movers at another. You might have 1,000 to 1,500 SKUs that every supermarket is carrying, and there's only a little bit of diversity for the balance. So I think that that's certainly an element of it. But the other piece is that generally just as we do more volume and even on some of the slower moving products as we are doing more volume, we are working our way through that inventory on a more frequent basis, you are able to not stock as much because your minimum order sizes -- you are basically moving through them faster than you were before.

The only thing I would add is that about a year ago we put in some fairly rigid metrics that look at inventory days and several other factors. So that certainly played a role as well.

Mark if you could remind us, as we look at last year's fourth quarter, can you adjust for that extra week in the year before just so we can -- I should have this but I don't -- see what it looked like the fourth quarter comparison looked like relative to the trend coming into that quarter.

So I'm sorry, Scott, so the fourth quarter what we looked like in the fourth quarter of last year --

What was the year-over-year comparison excluding the extra week in the prior year.

I'm going to need a minute to go back to that. I want to say it was maybe around 2%, I think that if memory serves me correctly. I don't have it right in front of me, but if memory serves me correctly, we bottomed out from an overall growth standpoint in Q3 where we were at 0.3% when we were factoring in speciality. And, I think in Q4 it went right around to about 2%, when you adjusted for the extra week.

But if you give me a minute, maybe after the next question gets asked, I can answer that question. I just need pull the data. I don't have it sitting in front of me.

Thank you very much.

Thanks, Scott.

Our next question comes the line of Eric Larson with Soleil Securities. Please go ahead.

First question is administrative -- when you complete the acquisition of SunOpta how are you going to talk about those sales -- will it be a separate item disclosure or will you put it in independent sales. How do you plan on talking about those revenues?

We will carve those revenues out depending on channel they fall to. And, then as we have historically done if they move the needle on a particular channel we will talk about it. If you go back to the Millbrook acquisition with the specialty it was almost all conventional supermarkets -- and so for a time frame what we referenced was -- let's say in a quarter, it would say that supermarkets were 73% growth, when you excluded the acquisition they were at 12% growth. So we will do that on overall basis but we'd also do that by the channels to the extent they influence the channels growth numbers.

But, I think Eric, you were asking if we were going to report the sales of UNFI Canada as a separate line item?

It's hard for us to see what the customer base is up there. I don't know if you really have a customer base that could be put into super naturals or -- obviously you do have conventionals, you can probably split that up. I was just curious how you would actually talk about that.

I don't think we've actually worked that through yet. There is super natural up there. There is independent and there is conventional. I don't think we've gotten to the point of determining how we are going to handle disclosure, of whether we will give a Canadian sales number or not.

I'm trying to figure out how we look at it from a modeling point of view as well.

I think the channel, they have pretty much all the same channels Eric, maybe we move forward to some did differentiation of the sub channels within there -- their supermarkets maybe don't match up the same way ours do is what they classify it. We honestly haven't gotten that far yet from a disclosure standpoint.

My next question -- Mark, I don't have the -- it's related back to the inventory side of this again. You mentioned in your prepared comments that interest expense was down partially due to a little bit lower debt level but also due to lower average inventories. I don't have the May inventory figure from a year ago, but your inventories look like from a quarter over quarter basis -- this fiscal year have been actually trending up. So --

What I was trying to get to there, Eric -- I may not have worded it well enough -- I was trying to reference that during the quarter, inventory levels were lower during the different months of the quarter compared to where we finished the quarter. The reason for that is that towards the end of April, beginning of May, as we referenced earlier to one of the other questions, we started building inventory to start shipping to that other $50 million of business or so we that we started ramping up with. And so the inventory was at a higher level than it might otherwise have been at the end of the third quarter because we had just started shipping that customer.

That's whey meant by average inventory levels during the quarter. If you were to look at month by month from January to April, April was higher than where February and March were.

Okay. That was -- that helps clarify that. Then final question, maybe Steve can comment on this, but during the Whole Foods earnings release, they talked about a desire to, over the next several years, start to reaccelerate their square footage growth. We will start seeing it more in lease obligations and things like that with Whole Foods.

Are you seeing renewed or talk of renewed square footage growth at the independent level as well? Any color on that would be helpful.

I don't have any commentary on that.

I would tell you that if I go back Eric and I think back even to the period probably four years ago at this point, four to five years ago when all the channels were growing really in the mid teens -- I think that at that point even then, the independents were maybe adding new doors at less than 10%. So I would expect that if the trends continue there maybe new doors they open but it would be well below the rate that say a Whole Foods would be doing.

Okay. All right. Thank you.

Just to the operator before we the take the next question. In answer to the question that Scott Van Winkle asked -- when you adjust for the extra week is fiscal '08, the fourth quarter fiscal '09 growth is 0.8%.

Our next question comes from the line of Robert Cummins with Wellington Shields & Co. Please go ahead.

I wanted to follow up on the Canadian acquisition as to what the opportunities might be up there. I think you alluded to the fact that they serve similar channels to those that you deal with but just curious -- they seem to be a coast to coast company. I'm wondering if there are regions of Canada they don't cover that might be opportunity of expansion for you. Does Whole Foods operate stores in Canada? And how do the profit margins of that company compare with your own. Is there an opportunity to make it more profitable?

Let me address the first part of the question which has to do with coverage -- the beauty of SunOpta is their footprint -- their national footprint. They -- from 5 DCs cover just about all of the population. While they are not in every city they cover the majority of the population. In Canada, there's the -- we call it the one-tenth rule which applies -- that is that things in Canada tend to be about one-tenth size of what they are in the US. If you want to buy roughly a $4 billion company then there is roughly a $400 million opportunity for UNFI, in Canada. SunOpta is approximately CAD180-some-odd million. You can do the math and so we think there is great opportunity for us to more than double the size of that business in Canada over the next decade. Bob, did you have a question.

Go ahead. That's great. I thought there might be opportunities like that.

There definitely are. SunOpta has some very strong distribution centers in Toronto and Vancouver. They have a great organic distribution center in Scotstown, Quebec. And we also are acquiring an organic produce business in -- based in Vancouver -- called Pro Organics which is going to fold up underneath our Alberts division. As far as the margins, I don't think we disclosed the operating margins at SunOpta, but we did talk about the fact that they were historically higher than where we were at currently.

Okay. What about Whole Foods. Do they operate in Canada?

They do. They have some facilities in the Pacific Northwest, in the Vancouver area. They also have some stores in Toronto and we will be servicing some -- not all of the Whole Food stores -- through UNFI Canada.

Thanks for the information.

Okay, Bob.

Next question is from Colin Guheen with Cowen and Company. Please go ahead.

Congratulations on extending the Whole Foods agreement. I just have a follow up around that. As they are sharpening their pencil on square footage expansion over the next couple of years and given your long-term relationship -- at what point are you anticipating having to add some warehouse capacity to match up with their long-term square footage growth plans.

I think that with the addition of our Texas facility which will be completed this summer we'll be fully built out and don't anticipate any new buildings over the next three to four years.

And, beyond that, the jury is still out, I take it?

I think the jury is still out. You need a lot of volume in a geography to put up a new DC. It's hard to say from where we sit today where that might be. We know that by putting up Texas we defer a lot of volume from existing DCs into that new building, which gives us a fair amount of room for growth. Until you have a high density of delivery locations, it's far more economical to travel the miles from existing DCs than it is to build out a new one.

You still have about -- if I remember -- 30% free capacity I think overall.

Yes I would say that's still a accurate figure.

Great. Congratulations on a good quarter.

Thanks Colin.

Thank you. Our next question comes prom the line of Chris Krueger with Northland Capital Markets. Please go ahead.

Good morning. Couple of quick ones here. With the acquisition of the Canadian assets, I believe on the last call you said you expected to it be dilutive to the fourth quarter by about $0.02. Can we assume that your updated guidance range includes that dilutive effect? What I'm trying to get at is if we excluded that dilutive effect would the high end of the range gone up by about $0.02?

I will tell you that it includes the dilutive effect. I'm not necessarily sure I would raise the high end. It does reflect the dilutive affect.

On the acquisition activity, do you anticipate further acquisitions in the coming quarters, are do you think you will absorb this one and work it through the system before making --

I would say wholeheartedly, no, there will be no additional acquisitions in the next quarter.

We've got to close this and get working on an integration on that before we'd look at any other acquisitions. But historically the Company has been acquisitive so in the future I wouldn't rule out additional acquisitions.

One of the things that made this acquisition particularly attractive is there is not a lot of integration that's required. It's a five distribution center -- distribution entity -- we don't have a presence in Canada today this will give us presence as the number one supplier of like products in Canada. So other than some potential synergies over the long-term, with getting some of the things we've learned in the United States up to Canada and getting the things that the Canadians have learned into the United States, we are basically going to run that business as is.

We'll switch from whatever corporate functions SunOpta had performed, UNFI will perform those. But, everything else we plan to leave untouched.

Thank you. (Operator Instructions) Our next question is from Michael Krestell with M Partners.

Wondering you talked on previous calls and some of the meetings about looking at getting into the protein side of the business. Wondering if any further plans are being made there -- and what you're taking a look at in the near-term.

Sure. We have we done quite a bit of work on the protein side. Our protein sales have actually geared up very nicely primarily through our Alberts division. And we've got a fair amount of work taking place on the UNFI side as it relates to the right market, the right products -- and it's going to take time to do it right as you might imagine. There is a lot of temperature control, quality assurance, that's required in the distribution process itself before we can jump in it from UNFI DCs. But we are showing nice improvement across the protein category, primarily in our Alberts division.

Lastly, an update on the IT rollout and some of the integration that's happening along there. I'm wondering what happened during the quarter, what we could be looking at over the next quarter.

We are still primarily in the integration phase. That's nothing more than -- this is a bolt on that we've acquired and we are in the process of integrating the software package into our current legacy systems. And the first rollout will be at our Texas facility during mid-summer. Once we have the integration completed into our legacy systems, then it will be a matter of a couple of dedicated teams going distribution center by distribution center to get that product rolled out.

That's it for me, thank you.

Thank you. Our next question comes from the line of Gary Giblen with Quint, Miller & Co. Please go ahead.

Good morning. The operating margin of the typical super natural business equal to the average UNFI corporate in that the higher volume per store translates to operating expense efficiencies that offset the lower gross margin.

Gary, we talked about historically that, certainly we would not refer to the super naturals individually given that Whole Foods is the only customer in the channel. What we've talked about historically is that obviously super naturals have the lowest gross margin but they also have the lowest operating expenses. And conversely independents have the highest gross margin and have the highest associated operating expenses. And when you get to operating margins, that spread is much closer between the different channels. But we don't break out for individual channel or individual customer so that's not a question we've historically answered nor would we answer on this call.

I guess what I'm trying to get at though is should we think of the people -- investors are focusing on the gross margin impact of the channel mix with supermarkets and super natural -- but do you -- is it the better way to look at it just as a operating margin fairly neutral thing.

I think you need to look at the ratio between gross margin and operating expenses.

Yes.

That will obviously give you a good indicator as to whether or not we are doing a good job. Knowing that gross margins have come down are we lowering the expenses at a rate that's greater than the gross margin decline.

We do try to steer people Gary to the operating margin versus focusing on the gross margin because of the efficiencies that we get. That's why we tend to -- when we did the investor presentation and when we did the three year targets at the analysts day we focused on the margin expansion, there was no reference to gross margin or operating expenses because they do tend to offset each other -- if one goes down the other one should concieveably go down by more than that.

If you look at the third quarter in particular we did have a ramp up in what we would consider our lower gross margin business. And if you would adjust for some of the one timers in the quarter we had a ten basis point improvement in operating margin percent.

I think that's impressive. But people are focusing on gross margin, but okay. Then the -- because we know that Whole Foods same store sales are accelerating and you noted that even in the independent channel -- really in all your channels and supermarkets in particular sales seem to be on a positive the trajectory -- does that in itself -- does that degree of sales improvement significantly leverage the operating margin even despite direct cost saves. In other words I know --

I would say the answer to that is yes Gary, and to Steve's earlier point whether -- if you were to back out the one time impact of the share based comp or the one time impact of the severance and start up costs, we would have seen the operating margin expansion of ten to 15 basis points that we put out there as the target. I understands that there may be some folks that still focus on gross margin and on this call and in investor meetings, we continue to try to guide them and steer them to the operating margin because over time we expect the gross margin to go down, but we expect the operating expenses to go down more than the gross margin which will yield us expansion of the operating margin.

Gary you are spot on in that directionally, if we can sell more to existing customers and existing stops that becomes considerably more efficient for us. Because it just gives us the ability to level our fixed costs against a wider berth of existing delivery locations.

That's what I wanted to clarify. So its not cost cutting. You don't have to cost cut forever. It's the natural volume efficiencies and pick densities. That's very helpful. Thanks so much.

Operator we probably have time for one last question or one last person for questions.

Our last question comes from the line of Ajay Jain with Hapoalim Securities. Please go ahead.

Thank you. I just had two quick questions. Maybe I will just address them to Mark. Assuming that the SunOpta transaction closes in early June, I want to confirm that the revenue in P&L impact will be fully effective in Q4 -- is that correct.

When you say fully effective, we are going to close -- even closing now in early June we are already missing a month of the quarter. so you will get only about two-thirds -- than two-thirds of the benefit -- you wouldn't get a full quarter's benefit.

Okay, and then can you also comment on the outlook for interest expense -- between the increased borrowing on the revolver to fund the acquisition and then you've also got some variability in LIBOR rates is that something you can speak to at all. Can you give any specificity on interest expense in Q4.

Beyond referencing that the purchase price -- we haven't closed the transaction yet but the purchase price is CAD68 million, LIBOR is currently between 25 and 30 basis points, our spread is 75 basis points, so our all in rate based on where it is now is roughly 1%.

On annual basis even if you took the CAD68 million, and said it was US, you are talking $175,000 to $200,000 for the fourth quarter. If it was a full quarter -- given that it's not -- it's probably $125,000 to $150,000 impact on interest expense in the fourth quarter. That's probably as much clarity as I can give you. It's reflected in the guidance we have given. The impact is probably in that range. $125,000 to $150,000 on interest expense.

That's very helpful. Steve in your prepared comments you mentioned the integration costs for the new specialty customers and then the severance costs as well, can you provide that again?

It's about a $0.01.

It was roughly $400,000 or $0.4 million related to the severance and about $0.5 million related to the start up costs in Q3.

Okay. Thank you very much.

Thank you.

Management, please proceed.

Thanks. Okay. Our results in the quarter reflect continued improve in the economy, supported by a strategy that is bearing real and meaningful improvements across our businesses. New customer wins and renewed agreements along with UNFI Canada support our long-term commitment to growth. I want to thank you all for joining us this morning and have a great day.

Ladies and gentlemen this concludes the United Natural Foods third quarter 2010 conference call. If you would like to listen to a replay of the today's conference, please dial 303-590-3030 or 800-406-7325, with the access code 4304040. ACT would like to thank you for your participation. You may now disconnect