United Natural Foods Inc (UNFI) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the United Natural first quarter 2011 conference call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). Today's conference is being recorded, December 8, 2010.

I would now like to turn the conference over to Scott Eckstein from the Financial Relations Board. Please go ahead.

Thank you, operator. Good morning, everyone. By now, you should have all received a copy of this morning's press release. If anyone still needs a copy, please contact Joe Calabrese in our New York Office at 212-827-3772, and we'll send you a copy immediately following this morning's conference call.

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

Before we begin, as usual, we 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, and thank you all for joining us this morning for our discussion of UNFI's first quarter 2011 results. As you know, based on this morning's release, UNFI announced sales for the first quarter of 2011 of $1.05 billion. This is the first time in the history of the Company that $1 billion in sales in a quarter have been attained. Additionally, net income rose to $17.4 million, a 12% increase over the prior year's first quarter, and diluted EPS rose to $0.39, a 7.4% increase over the prior year's first quarter.

During the quarter, several important strategies for UNFI came online. First, our new facility in Lancaster, Texas, began shipping, utilizing the Company's new supply chain and warehouse management system. Second, UNFI completed its acquisition of Whole Foods Rocky Mountain and Southwest Grocery Distribution businesses. In the Rocky Mountain market, we assumed Whole Foods' lease on its Denver area distribution center, and in Texas, we transferred the distribution from Whole Foods' center in Austin to UNFI's new Lancaster, Texas, facility. I will discuss both of these shortly. Finally, during the quarter, UNFI successfully completed a secondary offering, issuing just over 4.4 million new shares, and raising approximately $138 million in net proceeds.

During the quarter, UNFI's core distribution grew a very solid 19% over prior year. Adjusting for our recently acquired businesses, sales grew 12.3% versus prior year. Sales grew across all of UNFI's core distribution channels with the following breakdown. Independents grew 11%, supermarkets grew 31%, super natural 24%, and the foodservice channel 26%.

There continues to be very strong demand for our product offerings, as indicated by our very healthy sales growth. Embedded in our numbers are continued market share gains in the supermarket channel, as well as resumption of a robust number of new store openings. During the quarter, UNFI shipped all of its previously announced new business, which is now fully integrated.

Additionally, our data points towards continued sales growth throughout the balance of our fiscal year, based on strong consumer demand for organic products. UNFI will bring on an additional large regional retailer of organic and specialty products late in the second quarter, further supporting our continued market share gains and sales growth.

UNFI Canada is progressing quite well. We're excited to have a significant presence there, our rebranding is complete, and we're fortunate to now have a very skilled and experienced management team leading our efforts, led by our former President of the Eastern Region. The results are meeting our expectations, and we look forward to considerable new opportunity for UNFI in Canada.

We also continue to attract top distribution talent to the Company. I am pleased to announce the hiring of Craig Smith as the new President of UNFI's Eastern Region. Craig joins us after spending a 25 year career with US Foodservice, having last served as their Atlantic Region President.

Inflation, interestingly while moderate, had approximately 75 basis points during Q1 2011, has been gaining steadily since Q3 2010. Our expectation is for inflation to fall into more historic levels of approximately 1.5% to 3% over the next 24 months.

Strategically, I have been talking about UNFI's vision to increase market share, and become one operationally excellent distribution company, and during the quarter we made an important step forward. We opened our new Lancaster, Texas, facility, which is our first facility to utilize our new warehouse management system and supply chain technology. During the quarter, UNFI experienced nonrecurring budgeted start-up costs, and unanticipated expenses related to completion and the initial period of operations of the facility, totaling approximately $0.05 per diluted share.

I would like to talk a little bit about the costs that we incurred at our new facility. As you may recall, the development of this facility was meant to expand our geographical reach, and to complete our national platform of distribution. Additionally, as part of our One Company initiative, we decided to make Lancaster the first site for implementation of our new warehouse operating system. After both of those decisions had been made, we also entered into an agreement with Whole Foods to become distributor for their southwest region, and to service that business out of Lancaster.

Despite our intensive preparation for bringing the facility online, we did experience some operational challenges during the initial periods of operations at the facility. We made the decision to spend more than the budgeted, and incurred added inventory, freight and service costs, in order to maintain service levels and solidify our customer relationships. We think those decisions represent a wise investment, and while I can't tell you that I am happy about the challenges that we faced, nor the results, I am extremely pleased with how our team responded. The unanticipated expenses associated with Lancaster's initial operations meant that we didn't achieve our incentive compensation target for the quarter.

Lancaster is a superb facility, and the expansion of our relationship with Whole Foods is strategically important. Finally, the implementation of a new warehouse operating system will form the basis of a more efficient national UNFI, and we plan to continue the rollout of the new system to our remaining distribution facilities over the next 18 to 24 months.

Gross margin in the period fell 33 basis points versus prior year, sequentially gross margin declined by 28 basis points. The decline in gross margin was driven primarily by the Company's shift in customer mix, expenses associated with our Lancaster facility I just mentioned, and incremental freight costs resulted from the rapid ramp-up in sales growth. In particular, UNFI consciously moved freight around the US, based on the need to keep service levels high versus utilization of the most efficient freight lane. For example, where UNFI typically acquired a group of products via rail during the quarter, the freight was moved via truck to keep the product in stock. UNFI absorbed the freight difference in this instance.

Additionally, as I have discussed in prior calls, there is a timing lag between the on-boarding of new lower margin business, and the expense efficiencies gained through added volume. Until our new warehouse management systems and national standards are implemented, over the next 18 to 24 months, we will be challenged to continue to reduce costs at a rate that exceeds the decline in gross margin due to mix shift. However, I do expect the Company to execute well against our previously discussed three year financial targets.

On the balance sheet, AR remained constant at approximately 20 days, and inventory on hand averaged 49.4 days. Overall, our balance sheet remains extremely strong and conservative, with leverage at 1.4 times EBITDA. I am still confident that UNFI is on target to achieve its previously announced diluted EPS target within the range of $1.62 to $1.71.

UNFI's largest distribution channel is the independent organic retailer, and as the country's largest distributor of organic and natural products to this strategically important group, we have worked tirelessly for the last six months towards designing a tool which will enable the independent retailer to compete more effectively with larger retailers across several different channels. The result is the introduction of our new WOWZAVILLE website, providing customers with easy to use point and click access to important retail data, shelf and product layouts by category and geography, product information, catalogs and proprietary tools only available at UNFI. I am excited about the formal introduction of our new site over the next four months. Check it out at www.wowzaville.com.

Looking at the quarter, sales continue to demonstrate growth and demand for UNFI's product and services. While the Lancaster opening was difficult, and the Company incurred added costs related to this important strategic implementation and DC opening, it was and is the right go-forward decision for UNFI. I am confident that the costs incurred were in fact one-time, and necessary to demonstrate the Company's commitment to operational excellence and service.

We will be hosting an analyst shareholder meeting at our new Lancaster facility on March 22, 2011. I look forward to demonstrating our new technology platform, and touring you through what we believe is the industry's leading distribution center.

Now I would like to turn the call over to Mark Shamber, our Chief Financial Officer.

Thanks, Steve. Net sales increased by 19% or $168.2 million to $1.05 billion for the first quarter of fiscal 2011, versus prior year first quarter net sales of $885 million. Our business with UNFI Canada, and Whole Foods Rocky Mountain and Southwest Regions Grocery Distribution positively impacted sales by $59.4 million in the quarter. Excluding these acquisitions, net sales increased by $108.8 million, or 12.3%.

Inflation continued to ease in comparison to the prior year, although it did accelerate sequentially, as inflation was 76 basis points for the first quarter compared to 2.1% in the prior year's first quarter. For the first quarter of fiscal 2011, the Company reported net income of $17.4 million, or $0.39 per diluted share, an increase of approximately 7.4% or $1.9 million over the prior year, after adjusting for the impact of the equity offering in October. Net income for the first quarter of fiscal 2010 was $15.5 million, or $0.36 per diluted share.

As Steve discussed in the first quarter, sales to the super natural channel increased by 24.2% over the prior year's first quarter, and represented 35% of sales for the quarter. Independent sales rose by 10.6% year-over-year, and independents now represent approximately 38% of sales. Our supermarket channel experienced growth of 31% over the prior year, and still represents approximately 20% of sales. Finally, foodservice grew by 25.5% over the prior year, and represents approximately 3% of sales.

Excluding the impact of our acquisitions, the super natural channel grew by 18.7%, independents increased by 5.7%, and supermarket growth was 19.1%, and foodservice sales increased by 23.2%. Gross margin for the quarter was 18.3%, which represents a 33 basis point decrease from the first quarter of fiscal 2010, which had a gross margin of 18.6%, and a 28 basis point decline from the previous quarter. Operating expenses for the first quarter represented 15.4% of sales, compared to 15.5% for the same period last year, an 8 basis point improvement.

The first quarter included $1.9 million in operating expenses associated with start-up costs for the Lancaster, Texas, facility through the last week of September, when we began shipments to customers. In addition, the quarter contained $0.6 million in severance due to former executives of the Company, and $0.2 million in impairment charges on certain intangibles of our Blue Marble Brands division, as part of a new brand management relationship. We also incurred $1.9 million in unanticipated expenses during the quarter, related to operational challenges experienced during the initial period of operations at the Lancaster facility.

Fuel had a positive impact of 1 basis point on operating expenses in comparison to the first quarter of fiscal 2010, as fuel represented 75 basis points of distribution net sales in the first quarter. Sequentially, our fuel costs increased by 8 basis points over the fourth quarter of fiscal 2010, which had fuel costs of 67 basis points. Share-based comp during the quarter was approximately $2.7 million, or 25 basis points, compared to $2.1 million, or 24 basis points in the prior year. Operating income for the quarter was 2.8%, a 25 basis point decline over the prior year's first quarter operating income of 3.1%, and a 16 basis point increase over the fourth quarter's operating income of 2.7%.

Our inventory averaged 49 days for the first quarter, within our target range of 47 to 50 days, and consistent with the prior year. At the end of the quarter, we were at roughly 51.6 days due to the normal inventory build that occurs for the holidays. Sequentially, inventory levels decreased by about a half day compared to the fourth quarter of fiscal 2010.

DSO for the first quarter was a half day higher than the fourth quarter, at 20 days, which is favorable to our target range, and a one-day increase over the first quarter of the prior year, due to our UNFI Canada division. Capital expenditures were $7.5 million, or 0.72% of net sales for the three months just ended, which is below our target spending. The Company's outstanding commitments under our amended and restated credit facility as of the end of the quarter were approximately $166.2 million, with available liquidity of $244.5 million, including cash and cash equivalents. Our leverage as of the end of the first quarter was approximately 1.4 times based on the trailing 12 months, and for the quarter we had negative free cash flow of $40.5 million, principally resulting from our investment in inventory going into the holidays.

As discussed in this morning's press release, we have confirmed our guidance for the fiscal year ending on July 30, 2011. For fiscal 2011, we expect full year revenues to increase by approximately 15.8% to 18.4% over fiscal 2010 levels, to a range of $4.35 billion to $4.45 billion. In addition, we are confirming our earnings per share guidance for fiscal 2011 in the range of $1.62 to $1.71 per diluted share, and our capital expenditures guidance of $42 million to $45 million.

At this time, I'd like to turn the call back over to the moderator to facilitate our question-and-answer session.

(Operator Instructions). Our first question is from the line of Robbie Ohmes with Banc of America, Merrill Lynch. Please go ahead.

Good morning. Actually, just two quick questions. I think the first was just the comment on how tough the next 12 to 24 months is going to be to keep the expenses coming down to offset the mix shift gross margin pressure. Can you elaborate a little more on that and how we should think about that in terms of the guidance range that you reiterated? Is it going to make it maybe tougher than you thought to get to the high-end of the guidance range and then the second question was just on specialty cheese and protein distribution. Any update on what the potential or opportunity looks like for you guys there? Thanks.

Sure. Robbie, it is Steve. Let me answer the second question first because I think that's a little bit easier. The specialty cheese and protein is going to take some time for us to fully develop it. We have made some internal hires. It is an important strategic category for us, primarily because majority of our customers buy those products, so it is just a matter of designing the right SKU mix into our internal processes and procedures so we can really be in a position to do a great job at it. We are in those categories today primarily through our Albert's Organics division, and have started to migrate into the UNFI core businesses as well, but it is just something that's going to happen over time.

In regards to your first question, I don't want to get into specifics around where we're going to come within the range. We do feel very, very comfortable with the range. You can take a look at our top line sales growth. We see that trend continuing. It is a challenge to continue to bring on lower margin business, get that business started up, and make that business as efficient as we possibly can in a very tight timeframe, so I think it is a challenge to do it.

It is not impossible to do it. It is just something that we feel that we need to make sure that we are very transparent about, that it is possible that our gross margin of rate could continue to fall, and as a Company, we're going to have to work hard to make sure those expenses drop at a similar pace.

Got it. Thanks very much.

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

Thanks. Good morning, guys.

Good morning.

I was hoping you could maybe just elaborate a little bit on kind of how business trended through the quarter and into the current quarter and then whether you have seen any more recent changes in trends by channel? Seems for the most part pretty stable during the quarter but wasn't sure if changed at all along the way and into the current quarter?

Yes. It is a great problem to have, but our sales sequentially have been growing. We have seen that trend through most of the first quarter, and we see that trend continuing so far through the second quarter. So very, very robust sales growth, a lot of demand for the products that we offer.

As far as by channel, it is pretty consistent across the channels. Obviously by the commentary we made this morning, most of the growth or the fastest growing category was the super market channel, and a lot of that was driven of course by new customer contracts, but we're pretty confident that we're seeing a lot of really, really strong growth across all the channels in which we trade.

Good to hear. Secondly, I was hoping you could -- we're going into the part of the year where some of the new business and specialty tends to potentially change hands and I know you obviously aren't prepared to talk in a whole lot of detail about that. To the extent you can I was hoping you could comment on like the competitive bidding environment and how you might compare that to what it was like a year ago in terms of the how competitive it is to try to get those wins.

Yes. I think that the environment is always very competitive. We certainly don't have any contracts expiring. As I mentioned in my commentary we have a large regional grocery retailer coming on board in January. They should be fully integrated by the end of January, beginning of February. We're excited about that.

There are several contracts that are up for bid. We're actively engaged in the process, so it is active. I wouldn't say that it is any different than it has been in the last couple of years.

Okay. One more and I will pass it on and I guess maybe for Mark. I know you don't like to give quarterly guidance, but I just like to ask for a little bit of direction on Q2 because it tends to be your toughest quarter just seasonally, so when you factor in kind of the seasonality of the business, the secondary offering, and then kind of the issue that effected you more of a one off basis than Lancaster last quarter, how should we think directionally about earnings in Q2 versus the $0.39 that you did in Q1?

Yes. I think the first part of your statement is very true is that Q2 is usually the most challenging of our quarters. We usually have a very strong November, very strong January, but the month of December is probably the slowest month of the year from our standpoint. I think directionally again, as you mentioned we don't give quarterly guidance.

To think directionally, we usually are relatively consistent from Q1 to Q2, this year, the equity offering comes into play where the equity offering from a dilution standpoint only impacted the last month of the quarter from a share count versus the full quarter, so the second quarter will have on a weighted average stand point, probably 48.5 million shares, somewhere in that range, between 48.5 million and 49 million, so I wouldn't be -- without commenting beyond that, I would say directionally if we're flat it is usually a good quarter for us, and if it is about $0.01 below, it is usually an average quarter for us, but you folks will have to make your decisions from there where you think the trends are taking us.

Thank you.

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

Guys, thanks for taking my question. I just wanted a point of clarification. Mark, when you talked about the sales growth acquisitions, when we looked at the super natural channel, was that number inclusive of the pickup of some of the revenues, or was that a true organic number that you broke it down to?

The 18.7 is a true organic number. It does factor in the Whole Foods new store openings that have occurred during the past year, so it is not meant to be our comp with Whole Foods, because we have never broken out when they open new stores. But it does exclude the acquisitions where we picked up additional business in both the Rocky Mountain and Southwest regions, and, Scott, there is a bit of an estimate there, because we were doing business with those regions before, so we did our best to give them a growth rate and back that out, but that 18.7 is a pretty solid number for what they did in the quarter.

Okay. Thanks for that clarification. The second thing, maybe more for Steve, when you look at the technology, I guess I want to call it challenges because the new system there is always challenges, what makes you confident as you roll this out through the other distribution centers, and then also take on a decent amount of more business, that we're not going to have the same issues as we roll through the next twelve months?

That's a great question, Scott. The thing that everybody has to keep in mind is Lancaster was a brand new facility. We had nothing running through it. As much as you can test these systems in kind of an static environment, when you bring them into production with a tremendous amount of action and a lot of data and a lot of transactions, they tend to get pressured in a way that you just can't anticipate, and that's what happened. In every other implementation that we have around the country, we have an operating system that's already running, so they will be running parallel. In this particular situation, there was no other system running parallel, so we had to get it to work.

As an example, in Texas, one of the primary problems that we ran into is this is what's called a voice enabled selection solution, so instead of selectors using manual pick labels to select product, the selectors are directed to the locations by listening to a voice and then confirming the location with a check digit back to the system. That makes for a very productive, highly accurate selection, and when in test mode, that system worked very well when we went live with production, we just could not get a lot of stability in keeping the voice system up and running, so for some time, we could not use voice.

And it just took us a little while to figure out that actually what the problem was, were some firewall settings, so we had received settings from the manufacturer. We had configured the system that way, and lo and behold the firewall settings were preventing us from getting the voice to be stable. Once we fixed that, we had a very robust, very stable voice system, and obviously that is a one-time event. It just doesn't happen again. Go ahead.

I was just saying great amount of detail. Sounds like you'll have parallel systems when you move it into other places that you shouldn't have either some glitches you can work through them, is that fair?

That is correct. When we go to put the next DC live on the system, we'll have a parallel system, so if we run into any similar problems we can revert back.

Service levels now out of the Texas facility?

Service levels, for the last fairly long period of time they have been very, very good. The system has been very stable. It is producing the results that we had desired, and so we're very pleased at this point. It was tough getting here.

And then if I could, just one final one. I want to make sure I heard something right. I know you took on another retailer and I think Mark said the southeast, but I also thought you said it was national organic retailer. I wonder if you want to elaborate.

You're talking about the new retailer coming on in January/February.

That's correct, and how do you want to say how big the size?

The retailer is Giant Eagle, which has the largest market share in the western Pennsylvania/Ohio market, and it is fully integrated program of natural, organic and specialty.

Fantastic. That's a great retailer, too. Congratulations on that win.

Thanks.

Thank you.

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

Good morning.

Good morning.

On the $59.4 million from SunOpta Canada, UNFI Canada and Whole Foods new business in the Southwest and Colorado, can you give us a sense how that breaks out? I have a guess, but I would rather hear it from you all, and also if the number -- let's say the Whole Foods number is whatever, $16 million to $18 million or something, is that going to number going to go up just so we can plug the right numbers into our models?

Yes, Andy. I would rather not break them down individually for the quarter, but what I would be willing to say, I mean, we talked about what both of them were in Canadian and US dollars in the case Canada and what we thought the Whole Foods would be on an annual basis, so the Whole Foods certainly is not what we expect from a quarterly standpoint going forward. We thought it would be about $160 million annually, but we only shipped from one location for three weeks of the quarter and for the other for four and-a-half. So it is only a portion of that, but the expectation for full quarter for that would be about $40 million with the next three quarters.

Fair to say, my guess is close, less than half that, a little less than half?

Yes, I would say it was less than half.

Just want to get that.

Directionally right.

Within horseshoe range. Okay. Inflation. Normalizing back up against, it has been flattish for the last year or so, can you just give us your expectation, what you think that means for the sales and the P&L? Generally it's considered a pass through and a pretty good thing. I want to see if you concur with that or you see any --

Obviously our business is cost plus, so 1.5% to 3% inflation is pretty good, a large percentage of that would ultimately fall to the bottom line. It pushes the sales along -- not that we need any help with the sales right now because the sales are so robust, but you're right, generally speaking, modest inflation growth to 1.5% to 3% is a good thing for us. Any shocks to the system, a lot of inflation or deflation quickly are very hard to deal with, but we don't anticipate that being the case.

Okay. On the issue where you had to switch to trucking from rail, and other things, A, is that ironed out? A, are you back in stock and inventory and, B, are the suppliers in UNFI back to a more efficient means of getting product? I assume it is from the West Coast on rail cars to the rest of the country. Is that ironed out and how much did it amount to in the quarter in terms of additional costs?

That's a great question. So basically what we found ourselves in, is this very, very significant sales growth that it happened relatively quickly, and so there were two issues that we faced, okay? One was our own internal ability to keep pace with the rapid sales growth, and so we made a very conscious decision to, say, look, if we normally took it by rail, let's take it by truck to make sure we could keep the service level out.

The cost of freight that we incurred in the quarter that we couldn't pass along was approximately $1 million. It was all related to that issue of either rail to truckload or LTL to full truck. The other thing that confounded our issues is we ran into a similar problem with a lot of the suppliers where the suppliers couldn't keep pace with the sales growth, so we had a very high degree of supplier outs across a pretty broad swath of suppliers, so as much as we struggled to keep pace with the growth, so did they, so in those cases, there really wasn't much we could do other than to ex expedite the freight from the point of manufacture.

We think that we are caught up, our service level has been pretty consistent over the last four or five weeks, a very high service level. We think the supplier community has caught up. I will tell you that one of the things that I think affected the suppliers negatively is if you go back a year-and-a-half or so when sales were really struggling, a lot of the suppliers who would typically stay out of the mass channel went into the mass channel because they had to, to capture some sales growth, and that made it even more difficult for those suppliers to keep pace with the demand when they were faced with filling the demands of the mass customer as well as filling the demands of their more historic customer, which is UNFI and the independent retail customer.

I feel that we're in good shape today. We have most of those hurdles were passed. We have the freight under control, the suppliers have rebounded, I think that they made good head way in keeping pace with the new demand, so we're in a much better place today than we were several months ago.

And, Steve, I want to also revisit what I think Robbie asked you about on guidance on your commentary on on-boarding mass market and other players who might have lower gross margin structures. If you take out the $3.8 million one-time costs in Texas and $1 million dollars here in freight, stuff happens at distribution, but if you just normalize some of this out, the $600,000 in severance, there was a lot of margin expansion this quarter. Even if you sort of pro forma it for a full load of the new Whole Foods business, as far as I can tell, there was a lot of margin expansion on the operating line, so I guess I am trying to understand what would be different going forward from this quarter, if I have normalized it correctly.

That's a tough one for me to comment on, Andy. Obviously I believe that we have got a lot of really good things happening. We had some tough things that hit us in the quarter related to all of the things that we have already discussed, but I certainly wouldn't be comfortable going out beyond the guidance we have already provided. I know that doesn't give you what you are looking for.

It is all right. How would you define -- you said it will be challenging. I mean, distribution is always challenging and stuff occurs like happened this quarter, and I am sure you weren't -- you didn't want $2 million of unexpected costs, but are you really trying to signal us there is going to be some operating margin contraction or are you just trying to let the Street know that that's the nature of distribution and --

I think it is the latter. I am not trying to signal anything. I think it is just the nature of distribution. It is a pennies business. We feel we have pretty tight controls and are making the right decisions, but you can't always hit a home run. I think that's the situation we found ourselves in this quarter. I am not signaling anything.

Sure. I guess the last question is what kind of, if it was about a $2 million of planned costs, at Lancaster for the first rollout of the warehouse systems, what kind of costs would it be -- are you expecting going forward for as you roll it out? I am sure it must be less than that per distribution center, but there are going to be some duplicative costs there.

I mean, it would be. Keep in mind this was a brand new center that wasn't operating, and we don't have that. We will not have that experience again. So the future conversions and by the way the next conversion is not going to happen I think most likely until late third quarter, early fourth quarter, most likely fourth quarter, and that's going to be a conversion of an existing facility, smaller facility from the current system to the supply chain technology, so I would say directionally we wouldn't experience the same kind of costs that we experienced with Lancaster.

Thank you.

Thank you. Our next question comes from the line of Jason Whitmer with Cleveland research. Please go ahead.

This is [Stephen Gregory from Mandalay Research]. Can you provide color on your e-commerce vision going forward and do you have any plans to eventually start selling goods and services on your website or help your channel partners sell their goods and services on their sites as well?

Sure. We don't have any plans to sell directly to the consumer. I mean, that would be competitive with our current customer base, so there are no plans to do that. Obviously, a lot of our transactions today are web-enabled so they're happening over the internet, and that's all as a function of our own customers placing orders directly through the internet or having the internet carry the traffic. We do -- we are converting rapidly to the web for a lot of the added value service that is we provide to the customers. I talked a little about that in my commentary regarding to Wowzaville, which takes a lot of the tools that we have historically been able to provide and puts them into an easy to access format, but just want to make sure we're clear that we have no intention of going direct-to-consumer.

And how are you guys utilizing Facebook, Twitter, some of the social media to gain a bigger market presence and expand your customer base?

We do utilize Facebook and some of the social media. Tough on comment on the value that it provides us. I am just not that close to it. We certainly do embrace all of that technology. Again, it is a little bit tougher for distribution company, because we're not facing the retailer, the consumer day-to-day. We're more a B-to-B type provider.

And final question going forward for 2011 what would you say your top challenge is and how you plan to overcome that challenge?

I wouldn't say that there is any one challenge in particular, outside of the challenges that we would face day-to-day as distribution company, and we're going to continue to become operationally excellent off of our One Company platform, and that is our key strategy for moving the Company forward. It is our key strategy to continue to take down the expenses at a rate that exceeds the potential decline in our operating margin, and so I think that is probably going to be the biggest challenge as we move forward through the rest of the year and into the next two years.

Thank you very much.

Thank you. Our next question comes from the line of Chris Krueger with Northland Securities. Please go ahead. It appears Mr. Krueger stepped away from the phone. Our next question comes from the line of Karen Short with BMO Capital Markets. Please go ahead.

Thanks for taking my question. I just had two quick follow-ups and a bigger question. First of all, your revenue guidance that you originally had given, that always included Giant Eagle, didn't it?

Revenue guidance?

Yes.

When you gave -- the full year revenue guidance --

We just said it was awarded right as -- yes, it was already impacted into our guidance.

And the transition expenses that you called out for the Lancaster, did that include the $1 million in rail costs or not?

It did not. Those costs were not limited or solely associated with Lancaster. That was across our entire distribution network.

Okay. And then any thoughts on timing of rolling out two additional retailers to be supplied out of Lancaster? How is that looking?

Well, the Lancaster facility is built to accommodate many, many different customers within that facility. It is certainly not a single customer location.

Right. You didn't actually start with Whole Foods as kind of the test case, I guess, so I am wondering --

There was a phased approach for all the different customers, and so I would say that there was a set of customers that we got, given that we're opening at the end of September, there was a set of customers that we knew we could move in prior to the holiday season and the balance of the business always planned for post because November and December was not the time to transition, so I would say that we're still in line with our timeframe for converting that -- converting the business is not already done, just indicates that we're still in that timeframe.

Fair amount of the business has already been converted. The balance will convert in January and February.

Got it. Okay. And then just I guess bigger picture, obviously gaining share in the supermarket channel is one of your priorities, but I guess I am just wondering thinking about your relationship with Whole Foods, I guess I would think they would consider some of the retailers that you're going after as their competitors, so I guess how do you balance those two just philosophically, curious?

I am not sure that we perceive that as an issue for us. We are in fact a distributor whose mission is to sell a wide range of customers across many different channels. We're certainly not a captive distributor to any one customer or group of customers.

Okay. Thanks for taking my questions.

Thank you.

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

Thanks for taking my question. Steve, could you just give us a little bit more flavor on the timing? You had to get your operating systems in place for Lancaster which is now up and running before you could more aggressively go after conventional grocery store contracts and sales, and obviously you announced the Giant Eagle one this morning. You have got I think you said another conversion coming in Q3. Is it really fiscal 2012 when you feel that you can become more aggressive in taking on those sales knowing that you would then have the potential of getting those operating expenses to where you need, to preserve your operating margins, what's the timing on that?

I think that we are aggressive with sales all the time. It is really irrelevant where we are in the implementation of the new system. The new system just gives us a tremendous amount of flexibility to improve our accuracy, primarily through the voice enablement and, number two, and probably most importantly, is the technology gives us the ability to procure and manage categories of SKUs as one company across all of our DCs, and that's just going to take two years to implement so we can, for example buy all of our organic snacks from one facility for the entire country.

Today we just don't have that ability. So this technology is what gives us the platform to do it. As importantly, we have got a national operations group that's implementing national standards so that we manage and evaluate our DCs in the same way. We're pretty far down the path there. So the two are not linked at all, bringing customers on board versus systems conversions.

Okay. And then finally, just a little bit more flavor related to that same issue, given that you are taking on a lot more customers, et cetera, and you actually ran into some supplier disruptions this quarter, what did you learn on that? Is there a way to head off potential supplier issues going forward as you put on more of the conventional business?

I think that the supplier issues is that they were caught with the same issue that we were and we just didn't anticipate the amount of sales growth organic industry growth that we saw because if you go back a year, so you're comping over a period where there was what margin --

We were 2.4% the first quarter last year.

2.4% growth and all of a sudden we're 12% growth, so I think the suppliers were faced with the same issue that we were, that we just thought a little bit too late and therefore were a little bit slower to respond. One of the things that I think is very helpful to our supplier community for those who have embraced it is, we did roll out a program called ClearView which gives the suppliers transparency into our inventory and inventory history by DC, so that they can more adequately plan their manufacturing, and I think that has helped some of the suppliers keep pace with the demand, so on the one hand clear view will help, and on the other hand I think getting used to an environment with 10%-plus growth will get us there.

Okay. And then just one final question on this. Talk about the industry organic growth for a second. Your independent channel which I have always sort of used as the barometer for sort of overall industry growth, Whole Foods obviously has been growing quite a bit faster than that, but your organic growth for the last two quarters has been about 6% in the independents. Are you suggesting that your actual category growth is actually better than let's say 6%, is it close to that double-digit range right now?

What was the number net of acquisitions?

It was 12.3 for the quarter net of acquisitions. I would say it is probably high single digits because if you are looking at the channels and you back out some of the additional business that we have taken on, Eric, Whole Foods, you have seen the numbers they put up, even if you back out new store openings. They have still been very strong from a comp growth standpoint, and I think that the conventional supermarkets may be a bit ahead of the independents when you strip out all the new business we have won there, so it is probably not given the way the industry is sort of shifted right now, it is probably, the overall industry comp is probably upper single digits versus mid-single digits, which is where the independents have been, where historically they have been a good barometer of the industry.

Keep in mind looking at independent growth a year ago they were flat, you know, and today they're in upper single digits, so that's a very big difference.

Yes, absolutely. I totally agree. It is very strong growth. It is hard for us to kind of, like you say, you have new stores in your 12.3 organic and it is just very helpful to get that clarification on industry growth. Thank you.

You're welcome.

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

Thanks for taking my question. Steve, based on your prepared comments, I just wanted to clarify that you don't expect to incur any additional start up costs in Lancaster over the rest of the year, that the integration process is 100% complete, is that correct?

That's correct.

And Ajay, the only thing I would add to that, we talked about when we have a new facility up and running it takes its six to nine months to get to the operating margin that the rest of the business is at, so while there won't be any more start up costs, we will still -- that particular facility will still be dilutive to the overall margin until it gets up to the ramp like everyone else is because you have a brand new workforce that their pick rates improve over time, they become more efficient over time, so no start up costs, but we aren't yet operating at our average DC operating margin yet.

Understood. Mark, could you confirm again what portion of the $3.8 million was unplanned and how much of that was inventory-related as well?

It was about a 50/50 split, and then we -- Ajay we weren't going to break down the different components of the other $1.9 million. It is not something we historically have done. There is so many different components I could put them in multiple buckets if I chose.

And switching gears a little bit, sounds like you were pleased with how things are going in Canada. Can you comment at all on the margin performance of the Canadian business since the acquisition closed in June? I know it has been less than six months, but directionally, can you confirm whether the margins have taken a step back at all or have they actually improved --

The only thing I would tell you is that like I said in the commentary, the business has performed well against what where we thought the business would, and that is a pretty positive statement.

Okay. And just finally, as far as the integration for SunOpta and the Colorado facility that you took over from Whole Foods, have there been any unexpected integration costs based on what you experienced so far, or is everything pretty much on track, based on what you're expecting?

Canada, there were no integration costs because we didn't have any facilities up there, so the answer is there was no surprises.

There was a portion of the severance that related to some individuals in Canada, but we had expectations that there could be the need for some changes.

I think directionally the same is true for Denver.

And, Mark, can you confirm your D&A guidance for this year?

We didn't give D&A guidance. There is nothing to confirm. We were, I think it was $8.4 million for the first quarter. We're now depreciating the supply chain system that we had sort of been working on for the last 15 months, and that's now being amortized, but we don't give depreciation and amortization guidance, Ajay.

Thank you very much.

You're welcome.

Thank you. (Operator Instructions). Our next question is from the line of Gary Giblen with [RL Lavery]. Please go ahead.

Good morning.

Good morning, Gary.

Thank you. The strong growth in the specialty, sorry, food service, would you attribute that, let's say half to underlying industry conditions, improving and half your own market share gains or how would you handicap --

I think it is -- you hit it on the head. It is both. I think that industry had a rough time of it for the past year-and-a-half, and it is improving, and we have also had a fair amount of success in expanding existing relationships and taking on some additional new ones. We're very active in that space as a redistributor, more than we are in actually trying to take on direct delivery customers. We just think that's a better model.

Great. That's what I wanted to clarify. Thank you.

Thank you. I show no further questions in the queue at this time. I would like to turn the conference back to management for closing remarks.

Thank you once again for your continued support of UNFI and for joining us this morning. Please remember to mark your calendars for our March 22, 2011, analyst day in Lancaster, Texas, and check out our new website at Wowzaville.com website. I hope you all have a terrific holiday. Thanks again.

Ladies and gentlemen, this concludes the United Natural first quarter 2011 conference call. If you would like to listen to a replay of today's conference, please dial 800-406-7325 or 303-590-3030 and enter the access code 4386401. Thank you for your participation. You may now disconnect.