United Natural Foods Inc (UNFI) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the United Natural third 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, June 2, 2011. I would like to turn the conference over to our host Scott Eckstein with the Financial Relations Board.

Thank you operator, and good morning, everyone. By now you should have all received a copy of this morning's press release, if anyone still needs a copy please contact Joe Calabrese in our New York office at 212 827 3772, and we'll send you a copy immediately following this morning's conference call. With us this morning from management is Steven Spinner, President and Chief Executive Officer, and Mark Shamber, Chief Financial Officer.

We will begin with opening comments from management and then we will open the line for questions. As a reminder this call is also being webcast and can be accessed over the internet at www.UNFI.com. Before we begin, as usual, we would like to remind everyone about the cautionary language regarding forward-looking statements contained in the press release. That same language applies to comments made on this morning's conference call. With that I would like to turn the call over to Steven Spinner. Steve, please go ahead.

Thanks, Scott. Good morning, and thanks for joining us this morning to discuss our third quarter 2011 results. Sales for UNFI's third quarter 2011 grew over 22% to $1.2 billion. This is the first time the Company has achieved $1.2 billion in a single quarter. Sales grew consistently across all of our customer channels, highlighted by 33% growth in supermarkets, 22% growth in super natural, and 14% growth in the independent channel.

Most encouraging during the quarter was the return to better than industry growth in the independent channel which is UNFI's largest concentration of customers. During the quarter super naturals, supermarkets and independents were 36%, 22%, and 37% of our total sales respectively. Additionally, net of acquisitions, super naturals, supermarkets and independents grew 10.3%, 19.8%, and 8% respectively. UNFI continued to take market shares during the quarter, and expand its growing presentation in the specialty foods category across the US and Canada. We're confident that the organic industry is growing in the mid-single digits as the demand for these categories of products continue to significantly out pace similar categories in the conventional space.

We believe this growth is driven primarily by an increasing number of crossover consumers. In other words, those consumers who shop for both organic and conventional products. We believe that consumers who are driven to organic will over time convert more and more of their purchases to categories which UNFI distributes to retailers across North America. It appears our strategic objectives around market share growth are also working as UNFI's growth during the period and year-to-date have significantly out paced the overall growth of the industry.

Since the end of April, however, we have seen some sequential decline in overall sales growth by approximately 300 to 400 basis points. We believe this is being driven by several factors, including lapping previously announced new customer wins, the acquisition of UNFI Canada, and a moderate drop in consumer demand possibly caused by recent high fuel costs. Despite the recent sales decline over the last month, today we announced that we have raised our fiscal year 2011 net sales guidance to a range of $4.48 billion to $4.52 billion.

Net income from the period grew 20% versus the prior year driven primarily by higher sales, strong expense controls, and 33 basis points sequential improvement in UNFI's gross margin. Several factors contributed to the improvements in our gross margin, increasing fuel surcharges, continued implementation of UNFI's clear view supplier programs, and our continued migration toward our national supply chain initiative. Each had a positive impact during the quarter.

Operating margin was 3.2% for the quarter which was 20 basis points lower than prior year, but 38 basis points higher than the second quarter of 2011. As you will recall, during our second quarter call we discussed the short-term phenomenon affecting the relationship between a changing gross margin profile, on boarding costs associated with new sales growth, and the need to reduce expenses at a rate greater than the change in our overall margin profile. Additionally, operating costs at the Company's new Lancaster facility continue to out pace our other facilities as we integrate additional volume into the facility and to continue to improve operating efficiencies. The result is continued pressure on our operating margin as we manage short-term costs associated with a changing mix of customers.

We continue to expect this pressure will continue for the next three to five quarters. Notwithstanding, we believe our operating profit dollars will continue to expand at our three year objective of 10% to 19%, and operating margin at 9 to 12 basis points. Operating expenses during the third quarter were 14.9%, reflecting a 15 basis points improvement over the prior year, and 6 basis points sequentially. EPS grew to $0.48 per share diluted, an increase of 7% over the prior year, reflecting the additional share count as a result of the Company's equity offering completed in the first quarter of fiscal 2011.

Also during the third quarter UNFI's Lancaster, Texas, facility experienced significantly improved service levels and operating metrics during the period. Additionally, the facility experienced the top selection accuracy rate in the Company, a direct result of our new warehouse management system recently installed. We are also on track to implement our warehouse management system in our Richfield, Washington facility toward the end of calendar 2011. Fuel costs during the quarter continued to increase to approximately $3.75 per gallon to $4 per gallon despite some easing during the last several weeks. UNFI currently hedges approximately 30% of our fuel use through forward contracts, and continues to utilize fuel surcharges which cover an additional 60% of fuel costs leading UNFI uncovered for approximately 10% of our use.

Due to the increased high cost of fuel during the quarter, UNFI's additional costs relating to fuel were approximately $450,000 and $1.4 million year-to-date. Also during the quarter UNFI began to see improvement in service levels, selection and delivery accuracy, warehouse productivity and transportation efficiencies, as a direct result of our national efforts to standardize processes and metrics. Warehouse throughput or efficiency of the total cases shipped by DC improved sequentially, and our miles per gallon improved as a direct result of managing truck idle times and the efficiency of our routes.

Of particular note is the continued success we are having in our newly acquired Canadian business. Our people are performing in an exemplary manner, our market share is growing, and our operational excellence metrics are improving, all of which driving strong improvement in our operating results. Here in the US several UNFI divisions continue to demonstrate very strong improvements versus prior year. Albert's Organics, the leading US distributor of organics perishables and produce, Blue Marble brands, UNFI's own stable of growing consumer brands, and Woodstock farms, UNFI's organic nut, trail mix and dry fruit manufacturing and packaging business are delivering terrific results versus the prior year.

Inflation during the quarter accelerated sequentially 60 basis points to 1.47%, which was up 132 basis points versus the prior year. As we have comment in prior quarters, we believe inflation will continue to rise to approximately to 1.5% to 3% over the next twelve to eighteen months. UNFI's balance sheet remains strong with leverage at 1.4 times, AR days expanded by approximately one day, primarily driven by a shift in customer mix, and inventory days dropped four days to 50. Capital expenditures were 0.7% of revenue, well below our 1% of revenue target.

Looking ahead to our fiscal 2011 results, as I mentioned earlier, we are updating our sales guidance to a range of $4.48 billion to $4.52 billion which represents a 19.2% to 20.3% increase in total net sales over 2010 reflecting the strong demand for UNFI's products, and the continued growth of the industry. In addition, we are narrowing our EPS guidance for fiscal 2011 to a range of $1.67 to $1.69 per diluted share, and we have previously updated our EPS to $1.65 to $1.71 per diluted share. Now I would like to turn the call over to our Chief Financial Officer, Mark Shamber.

Thanks, Steve. Good morning, everyone. Net sales for the third quarter of fiscal 2011 were $1.2 billion as Steve mentioned which represents growth of 22.1%, or approximately $218.3 million over the prior year third quarter net sales of $985.7 million. Our acquisitions positively impacted net sales by $95.9 million in the quarter. Excluding the acquisitions, net sales increased by $122.4 million or 12.4%.

Year-to-date net sales of $3.37 billion yielding sales growth of $602.7 million or 21.8% over the prior year. Excluding the acquisitions our year-to-date growth is 13%. For the third quarter of fiscal 2011 the Company reported net income of $23.4 million or $0.48 per diluted share, an increase of approximately 19.9% or $3.9 million over the prior year. Net income for the third quarter of fiscal 2010 was $19.5 million or $0.45 per diluted share. Earnings per share increased by 6.9% over the prior year.

The secondary offering in Q1 of fiscal 2011 was the primary driver behind the higher weighted average shares outstanding resulting in the difference between EPS growth and net income growth. And while Steve covered our sales mix for the third quarter, I wanted to also provide a year-to-date breakdown. On the year-to-date basis super naturals represented 36% of sales, independents represent 37% of sales, supermarkets represent 22% of sales, and food service represents approximately 3% of sales.

At 18.2% gross margin for the quarter showed a 36 basis points decline over the prior year third quarter gross margin of 18.5%, and a 33 basis points improvement sequentially. Primary drivers of our lower gross margin year-over-year with the continued shift in the growth mix of business towards super naturals and conventional supermarkets, the addition of new non-service conventional supermarket customers with base pricing lower than our average gross margin, and higher inbound freight costs which were partially offset by higher fuel surcharge revenues.

The improvement of gross margin compared to the second fiscal quarter was driven by the higher fuel surcharge revenues I just mentioned, along with lower inventory adjustments and write-offs. Gross margin for the first three quarters of fiscal 2011 was 18.1% compared to 18.6% in the prior year, a decline of 47 basis points due to the various factors I just covered.

Our operating expenses for the quarter were 14.9% of net sales compared to 15.1% for the same period last year. This represents a 15 basis points improvement over the prior year as our operating expenses benefited from, amongst other things, transportation savings from our new Lancaster facility, continued year-over-year improvements in our warehouse throughput and our cost per case, further leveraging of our fixed costs, and slower growth in our consumption of diesel fuel, partially offset by higher health insurance and the incentive compensation costs.

Excluding our Canadian business which involves the use of third parties for deliveries in certain regions, diesel fuel had a negative impact of 9 basis points in operating expenses in comparison to the third quarter of fiscal 2010, as fuel represented 81 basis points of distribution net sales in the quarter. Sequentially our fuel costs increased by 4 basis points over the second quarter despite an 18.5% increase in fuel prices, as we are now reaping the mileage savings associated with our new DC and Lancaster, Texas. Additionally we continue to work to manage to reduce fuel costs as a percentage of sales despite rising prices by leveraging larger order sizes, updating and revising existing routes to reduce the miles traveled, reducing idling times and other similar measures.

Nationally our diesel fuel costs in the third quarter of fiscal 2011 increased by approximately 31% from the prior year's third quarter, while the national average price of diesel increased to $3.87 a gallon compared to $2.95 in fiscal 2010 per the Department of Energy. During the quarter we recorded share based compensation expense of $2.6 million consistent with the prior year, although in fiscal 2011 that share based comp represented only 21 basis points of expense, compared to 26 basis points in the prior year. Operating income was 3.2% for the third quarter of fiscal 2011, a 20 basis points decline over the prior year's operating income of 3.4% due to higher fuel, health insurance, and incentive compensation costs, and the continued challenges of driving costs out of the system fast enough to keep pace with the gross margin decline and our current growth.

Interest expense in the quarter of $1.1 million was approximately 23% lower than the prior year, and was 12% lower sequentially due to our lower debt levels following our equity offering in the first quarter and free cash flow generated during the third quarter. Interest income increased from $89,000 in the third quarter of fiscal 2010, to $750,000 in this year's third quarter. Almost the entire increase was due to a change in the accounting surrounding an existing investment with a supplier. Previously we were rebated a portion of our purchases each year and these rebates were reflected as credit to cost of sales. Going forward we'll receive interest income on our investments.

Our effective tax rate for the quarter was 40% bringing our year-to-date effective tax rate to 39.4%. For fiscal 2011 we currently expect our effective tax rate to be in the range of 39.2% to 39.6%. Capital expenditures were $10.2 million for Q3, and stand at $24.5 million or 0.7% of revenues for the first three quarters of fiscal 2011, which is well below our target of approximately 1% of revenues. Our capital expenditures in the fourth quarter of fiscal 2011 will continue to be focused on our supply chain initiative and investment in operations related CapEx.

The Company's outstanding commitments under the credit facility were approximately $198.8 million with available liquidity of $225.5 million including cash and cash equivalents. For the quarter we generated free cash flow of $8.7 million while our inventory days on hand improved by more than four days to just under 50 days which is at the high-end of our target range. As discussed in this morning's press release, the Company updated its net sales guidance for fiscal 2011 to a range of $4.48 billion to $4.52 billion, which represents a 19.2% to 20.3% increase in total net sales over fiscal 2010.

As a reminder, halfway through the fourth quarter the Company will anniversary its UNFI Canada acquisition. In addition, the Company narrowed its earnings per share guidance for fiscal 2011 to a range of $1.67 to $1.69 per diluted share which implies fourth quarter earnings of $0.42 to $0.44 per diluted share based on the $1.25 per diluted share that we have earned year-to-date fiscal 2011. At this time I would like to turn the call back over to the moderator to facilitate the question and answer session.

Thank you, sir. Ladies and gentlemen we will now start the question and answer session. (Operator Instructions) Meredith Adler with Barclays Capital.

Good morning, guys.

Good morning, Meredith.

Can you just talk a little bit more about these initiatives that you're coming up with on, it's pretty obvious what you're doing on the transportation side, but maybe some of the other things you're doing to improve or lower the cost per case, which seem to be pretty much unrelated to the new technology that's going to be rolled out so maybe just a little more detail about that?

Meredith, can you repeat the question? I didn't hear the beginning part of it.

Just to talk about the steps you're taking to become more efficient, you talked a little bit about fuel, but maybe you could talk in more detail about lowering the cost per case?

Sure. No problem. That is the key driver of us getting the costs out of the system at a pace that expands the decline in the gross margin that we talked about. The key drivers of that are 2 things. One is the implementation of labor management and all the facilities which is now complete. And labor management requires our selectors to scan in and out and gives us the ability to track their speed, their accuracy, we rank their performance, and using labor management, we have a much tighter control over the workforce in the facility, and ultimately it is the single biggest driver to drive it down our cost to select and get product loaded onto a truck.

The second biggest driver of cost savings are engineered labor standards, and engineered labor standards will follow each implementation of our new warehouse management system. An engineered labor standard is basically a time study that is done within each facility to properly layout the spot locations within the facility to make sure that we're selecting in the most efficient possible way. That takes about 4 to 6 months per distribution center to implement, but those two things combined are the single biggest driver to significantly increasing our productivity in the warehouse.

That means that when you do Richfield in the next 6 months after that, you will be able to do the engineered labor standard, and we will see a sort of rolling benefit of that?

You should.

Is that right?

That's correct.

You won't see it -- it all won't happen any one particular point in time, but we should sequentially see improvement in our warehouse operating costs as we continue to implement labor management and engineered labor standards.

The labor management part of it, how long does that really take to benefit the bottom line --?

Again, we again, we have it fully implemented throughout the core UNFI DC's now. We are seeing the improvement in the DC's related to total throughput. Now it is a matter of training and further implementation, so again we have the technology today to start seeing sequential improvement month after month, quarter after quarter, in our warehouse operating costs.

Okay. I just want to go back to your comments about the slowdown in sales. Can you talk at all about, were there particular categories or categories of your customers that particularly saw the slowdown and is this a reflection of, I don't know, more mass oriented customers who might be very careful? Is it specialty? Just more detail, please.

I think that generally speaking it happened across all the categories, and we think there is probably a couple of different factors influencing it. Number one, we had a late Easter this year, and we think that certainly influenced the fall off. Two, as I mentioned in the commentary, fuel starts to migrate towards $4 a gallon. That certainly has the potential to change consumer behavior. Fortunately we have seen some fall off in the price of fuel over the last couple of weeks. And then we have got some higher comps which are clearly making it more difficult.

And just the last piece is that we are lapping some of the business we have gained last year that we had some that started right at the start of the fourth quarter, so that is an additional factor coming into play.

Okay, great. Thank you very much.

Okay.

Thank you.

Our next question is from Scott Mushkin with Jefferies & Co. Please go ahead.

Yes, hello, this is actually Brian calling in for Scott. Thanks for taking our question. Just to kind of dig into that a little more, the sales slowdown, could you just break out maybe the impact that each one of the factors that you listed is having, the lapping customer wins, the UNFI Canada, and maybe the declining customer demand?

That's not something we would break out. We have not done that historically at this point in the quarter, so we wouldn't provide it. Just a note on the Canada piece, we actually haven't lapped that yet. That will occur midway through the quarter, but wanted to remind folks of that. That's part of the reason the guidance was updated the way that it was.

Okay, great. Thanks. The technology rollout to the DC's. Once the next one comes online, how quickly do you think you can kind of roll that out to -- once and you have sorted through the bugs, how quickly can you kind of put them in the place at the rest of the DC's? How quickly do you think that opportunity can be realized?

We're going to take a very conservative approach to this. The hardest one is done, which was Lancaster, and that certainly had some challenges. Most of those challenges were related to the fact it was a brand new facility without a legacy system, so we think that the further -- the next implementations will be considerably easier and less complicated. And I think over time once we get our teams in place, I think every 4 to 6 months is probably a reasonable expectation.

4 to 6 months for each of the individual rollouts?

That's correct.

That's great color. Thanks very much for taking the question.

Ed Aaron with RBC Capital Markets.

Great, thanks for taking the question. I just wanted to follow up on an earlier comment about the Easter influence. If memory serves, Easter would have been in the April quarter both years, so I am kind of struggling to understand why that would have had a meaningful impact on May either way?

The reason it has an impact on May, Ed, is that we usually see from a week to week standpoint, we usually see a noticeable drop off for 1 to 2 weeks after whenever Easter falls. Don't know exactly the reasons behind it, but we see a mid-single digit drop off right after Easter for 1 to 2 weeks, and so given that it fell late in the April quarter, it did impact May in that sense.

Okay, thanks for the color on that. And also just wanted to ask about the year-to-date cash flow numbers there. You have a sort of annual free cash flow target that you talk about, and it seems like that's looking like a bit of a stretch. How should we think about kind of the ability for you guys to catch up on that in the fourth quarter?

Yes, I think we still feel we have the opportunity to hit the low end of the range for the full year if we achieve our inventory targets in the fourth quarter. We're at the high-end of the range. Obviously I prefer to be at the low end of the range or a bit below that, and I feel that if we can get to the low end of the range, continue to work and manage our inventory better that we certainly still have the opportunity to achieve that.

You're right, looking at where we currently stand, it would seem to be a difficult challenge, but I wouldn't say that we feel it is necessarily out of reach. We may miss it by a small amount, but we still feel that it is achievable at this point even if we may fall a bit short.

Okay. Just one last one if I could. There were some unusual gross margin factors that affected the quarter relative to Q2, and you called out the higher surcharges, the inventory adjustments, and the inbound freight difference. Can you just give us some order of magnitude of how much those each affected things on a sequential basis?

On a sequential basis year-over-year I might have had a better shot. I would say on sequential basis it is probably the higher inbound freight is larger, the inventory adjustments would be in the middle, and obviously that leaves the balance as the lowest order of magnitude. The biggest thing year over year continues to be the customer mix shift, but sequentially that's not as much of an impact.

Okay, thank you.

Okay.

Greg Bagishkanian with Citigroup.

Great, yes, hello. With respect to you gained market share, have you noticed any change in terms of pricing strategy of your competitors who might be losing a little bit of share?

We really haven't. No major changes in the competitive environment.

Good. And I was just looking over my note from last year, and it looks like the fourth quarter accelerated about 220 basis points versus the third fiscal quarter, so certainly you have tougher comparisons there. Was it pretty consistent throughout the quarter last year in the fourth quarter, or is May a little bit stronger than the rest of the quarter? Because that kind of takes care of at least a majority of the drop off in the 300 to 400 basis points you talked about.

I am not sure I understand the question, Greg. Are you kind of asking about kind of guidance in the sales guidance in the fourth quarter?

Yes, yes. So like May, just because last year you had the comparison got -- the fourth quarter you had 13.2% sales growth organically, and it was 11% in the third quarter, so you have like an acceleration of 220 basis points.

Yes. I would tell you that last year, Greg, the average that we have for the fourth quarter last year on the comp side was pretty consistent. So while we averaged 11, or a little north, a little south of 11 last year in the third quarter, the acceleration occurred up through the beginning of May, and then it helped steady through June and July. We have a pretty steady number. That 13 is a relatively consistent number all during the fourth quarter this year that we're comping against.

All right.

You can just reverse the math based on our revised guidance.

Yes.

To kind of back into what we view as guidance for the fourth quarter is.

Right, right. Okay. That's helpful. And then so a change in 100 to 200 basis points in terms of if you exclude the tougher comparison, I know have you Easter and a bunch of other stuff. Is that kind of normal in terms of normal volatility month to month, or is that very substantial? Just trying to break out the component of outside of tougher compares, and the Easter and some of the other factors.

I think that we were a little bit surprised by the fall off that occurred in the early couple weeks of this quarter. We have what we would typically see the fall off following Easter. I think it fell off a little bit more than we anticipated and for a longer period of time.

I think if you look at last year's fourth quarter as much as we had the acceleration on the comp, we picked up new business that we began shipping in the quarter and that helped in some respects. But if you were to go back and look at our fourth quarter for the last 4 to 5 years, you would see that in most years, other than when there is maybe an extra week in the fourth quarter, most years we're down 1% to 3% sequentially and just overall sales in the fourth quarter compared to the third. So I think the portion of it that we expected, and as Steve mentioned, a little bit that was more than we expected at least what we have seen to date.

I think it is important to note that when you look at our overall sales growth both for the year and for the quarter, versus the growth of the industry, even perhaps the growth among other distribution, we're still pretty pleased with our overall sales growth.

Yes. It is really strong, and I am wondering also maybe in terms of inventory levels at the retail level, have you noticed any changes there? Has that been pretty consistent?

That's been consistent.

And then finally, just in terms of fuel price surcharges with higher fuel costs for you, there is usually a lag on the kind of on the way up. When does that kind of catch up in terms of the fuel surcharges totally covering the higher fuel costs?

Yes. The lag either up or down is not as great as it used to be because we converted away from a quarterly change to fuel surcharge to a monthly change of fuel surcharge.

Right.

So it is nominal.

Yes.

Non material.

Right, good. Thanks. Appreciate it.

Thanks.

Karen Short with BMO Capital Markets.

Hi, there. Just wondering I guess more housekeeping than anything to start with, you previously talked about how a dollar increase in fuel prices would affect your expenses, kind of, you said $500,000 to $750,000 impact prior to Lancaster. Can you give us an update now that you smoothed out Lancaster how to think about the impact of fuel prices on your expenses?

From that standpoint, Karen, I probably, it's probably something I would have to go back and just confirm the math. I wouldn't want to try to do it off the top of the head, but I would say that I think the example that I sort of walked through last quarter, if you were to go back to last quarter's transcript, there is still 2 questions that were asked then, and I think in the second one I clarified it a little better than I did the first time I was asked it, but I would say that right now the net exposure in any given quarter is probably in the range of $250,000 to $400,000 for a dollar increase, but to be able to give you an exact number, I would have to go back and rerun it based on our current volumes.

Because of the hedge and the fuel surcharge, even with the significance of the fuel increase year over year which is north of 30%, our overall exposure, uncovered exposure during the quarter was still $450,000. It is a big number in itself, but overall not particularly material.

Okay. That's helpful. And then I guess looking at capacity a little bit, you obviously your top line has been very strong, and I am just wondering what your thoughts on in terms of capacity in fiscal '12 and beyond, given that, I understand you will have a bit of a slowing in the top line in the fourth quarter, but you seem to be beating your original goals, so how are you looking for capacity in fiscal '12 and beyond?

It is going to be very different by geography, by distribution center, and we have facilities that have plenty of capacity, and we have facilities that ate getting a little tight. So in our 1% of revenue guidance for CapEx, we actually have for 2012 a couple of expansions. Fortunately we're in a situation, as we have discussed over the last couple of quarters, that we don't feel like we have any new distributions required that would cause us to go beyond that 1% of revenue target. So the bulk of our need for added capacity will be accomplished by expansions.

And if you were to win another large scale contract, that would still be the case?

I would say yes, that would be the case.

I would say that if we were to win any business that was spread out amongst multiple DC's, we're certainly well positioned to handle it. The only time we would ever face any challenges if we were to gain $200 million of business or $100 million of business and it was all going into one DC, that's usually where we would face a strain depending on the facility that it hit.

Okay. And then any update onto the extent you keep winning business, especially in the more lower margin conventional supermarket space, and any updates on how you think about your 3 year annual or your annual operating margin goals?

No. I think we're going to in this particular year from an operating margin perspective we'll be a little challenged, but we're very comfortable with the revised 3 years guidance that we provided on our Investor Day that I made reference to in my commentary.

Okay. Thanks for taking the questions.

Ann Gurkin with Davenport & Co.

Good morning. I want to start with your 3 year guidance. I guess operating margin came in lighter than we were expecting, so I was just curious if you still think you can still meet the 9 to 12 basis points expansion laid out in your 3 year objective, and is that more of a back end loaded objective than now?

Yes, and I don't know if you caught the end of what Karen had just asked Steve. I think what we said at the analyst day in what we think still holds through is that, yes, this year will be probably fall short of the low end of that range, might be in the low single digits, and it is more back end loaded to fiscal '12 and '13 as we continue to move forward with the rollout supply chain and getting our new -- our DC's up and running in the new warehouse management system. But we're still comfortable with the targets we put out there over the 3 years from an average standpoint.

You still think that 9 to 12 is something you could obtain in fiscal '12?

We didn't give fiscal guidance for 2012 yet, but we're certainly comfortable with that number over the next 3 years.

Great. And then, Steve, in your comments you talked about the organic category up mid-single digits. I guess that is a little lighter than I was expecting to hear. Can you comment on that? Is that a change in the overall category growth rate or just a temporary --?

No, I think it is pretty consistent. We haven't seen the last, kind of industry updated number. Some of the numbers are 5% to 6%, some are 7%. Some are a little bit higher, so we are much more comfortable giving a mid-point range.

There is really only 1 industry survey done and it comes out once a year, and if it is not out yet it should be out any day. But, so we're basing it off of where we know it was for '09, and based on the growth that we have seen we're presuming that the industry is growing by at least a couple hundred basis points to get to the mid-single digit.

I thought the numbers were running more like 7%. That's why I was curious. Okay. Finally, are there opportunities for acquisitions here either in the US or Canada, and are valuations still maybe an attractive levels? Can you comment on that?

Yes. We talked about further M&A in Canada. It is still very high on our radar. We have a very strong balance sheet as you know, so we certainly have the capacity to make an acquisition.

Yet we're very careful about the acquisitions that we make, we want them to be accretive. They need to be strategic. So we're certainly always on the look, but on the other side we certainly wouldn't comment on any imminent acquisitions until we got to the point that we were ready to announce them.

Great. Thank you all.

Okay.

Andrew Wolf with BB&T Capital Markets.

Good morning.

Good morning.

A couple follow-ups. On the operating margin question Karen and Ann were asking about, just given the math, if you come below the low end this year, mathematically you will have to pretty much hit if not the high-end pretty close or even above, depending where the math works out, averaging over 12 and 13. That's just the math of it.

Or are you saying sort of fiscal '11 because of Lancaster something of a throw away year, and you are going to be somewhere in that 9 to 12 range over the next 2 years? Just really trying to understand that.

Yes. I think the first part of the question is really how we're thinking of it right now, Andy, is that we think that certainly to your point if we hit the low end, or if we're outside the low end and we're in, let's say, 2 to 4 basis points just so I have a point of reference, that would imply that to hit the range we either need to be at the high-end or exceed that, we still feel very comfortable and particularly even in light of what we have seen with Lancaster now that we have the WMS up and running as fully and as we expected it to do, that some of the results that we have seen with the voice pick and some of the other elements have been exactly in line with our expectations.

So I think that '12 and '13 could exceed that high-end and still allow to us achieve the range for the full -- for the 3 years from an average standpoint. But even if they fall at the very high-end of that range we would still hit the low end over the 3 years.

Okay, thanks again for the clarification. Second fall off is around sales. I didn't -- I joined the call a little late. I understand May is down for the reasons you cited. How about during the quarter itself? How was each month? I know you said the year ago was pretty consistent Q4, year ago. How about this year's Q3, the 3 months of February, March and April.

This year is Q3 was very consistent.

The only other than the shift in Easter which made 1 or 2 weeks look really strong and 1 or 2 weeks look rather weak, the rest of the quarter matched up pretty consistently week to week. There wasn't a lot of volatility that we had seen, let's say during the recession, we didn't have the volatility in swings from week to week.

Okay. The other thing I want to ask about is gross margin. It is a bit of a hypothetical. Maybe if you thought of this assuming a way big customer wins going forward, if your customer mix were to stay hypothetically such as it is, is there any systemic reason with current customer mix, either the marketplace or the contracts that you've entered into, is there any systemic reason that gross margin would be continuing to trend down on the current book of business in terms of customers?

No. On the contrary, it would normalize, and if anything it would expand just based on our ability to buy more efficiently for that new set of customers. But that's not the case. The biggest noise around the gross margin is the full service programs, and full service programs where UNFI associates actually merchandise the shelf at the retail location, the costs for that full service program is embedded in our gross margin. So as the industry kind of moves towards less full service programs, that creates a lot of movement in our overall gross margin. So as the industry kind of moves toward less full-service programs that creates a lot of movement in our overall gross margin.

So there is, right now there is just a lot of noise when you look at gross margin and expenses.

Right. The only thing I would add, Andy, is from time to time some of the contracts you will have customers come up for renewal and they may have tiers so you may see pricing shift as they hit those tiers and there would be a minimal impact, unless they all happen to hit during a given quarter in which case you may see something noticeable on the margin.

Let me just go back to your one comment on kind of the operating margin question. I am not sure whether it was yours or Karen's. During the quarter we had about a 20% increase in net income. We had a nice improvement in our operating profit, and one of the balances that a distributor in particular always has to kind of evaluate is net earnings or operating profit growth versus operating margin expansion. And so the reason that we kind of updated our 3-year guidance to have a higher earnings number and a more modest operating margin expansion number was so that it would give us the benefit of doing both.

So continue to stay very focused on margin expansion, but understanding that we were going to have some shift in our business which was going to move us more --to a more substantial net income or operating profit growth.

Okay. So you're not giving up on getting new customers is what you're saying?

Correct.

We're also -- we also think it is very important to continue to expand our operating margin, and we think that the nationalized warehouse management system supply chain, all of that was done for the purpose of continuing to improve our operating margin.

Thanks for the color.

Robby Ohms with Bank of America Merrill Lynch.

Hi. This is actually Kelly in for Robby. Just another question on the gross margin during the quarter. I understand that the majority of the year over year decline is the mix shift, but I am wondering was the delta versus your expectations because I think you were looking for down about 10 basis points. Was that majority -- was the majority of that just fuel, and how should we think about the fourth quarter?

Well, what I had said last quarter and it had gotten a little confused is I thought that we could have some erosion, deterioration in the third and fourth quarter of up to 10 basis points in each quarter. I think that there is a couple of components that played a bigger role in the third quarter is that from the mix shift standpoint, the independents continue to expand from a sales growth standpoint, and while there is still a bit below proportionately, they were stronger in the quarter than I anticipated when we gave the updated guidance.

And then fuel prices continued to rise during the quarter, and as Steve mentioned, we're now adjusting on a rolling 4 weeks basis and so we got far more fuel surcharge revenue which was offset down below the line and operating expenses with increased fuel costs, but we had more fuel surcharge revenue in the quarter than I anticipated because we didn't have fuel going to the levels that it ultimately ended up at for the quarter.

We didn't have it staying there, so I think those were the 2 bigger pieces. We anticipated and it came in line with expectations that we saw improvements in sort of the inventory write offs and adjustments that we were having across the Company because a large piece of that was isolated to the Lancaster facility as we were starting up operations there.

We were extremely pleased with the 33 basis points improvement in gross margin over the last quarter.

Got it, thanks. That was helpful. And then the $96 million that you mentioned from Canada and the new Whole Foods business, where does the Giant Eagle portion fall? Is that included in the 12% year-over-year comp growth ex acquisitions?

Yes. We would -- when we win new customers or gain customers or increase our share with existing customers, we put that all into the comp. So the acquisitions, the $96 million is strictly the UNFI Canada acquisition as well as the incremental Whole Foods business that we took on.

Thanks. Then just one last one. Can you provide any more color on some of the inflationary trends across your different product categories?

The bulk of the inflation that we have seen is pretty consistent with the last couple of quarters which is in the bulk grains, commodity nuts, and those kinds of items.

Thanks.

Eric Larson with Soleil Securities.

Good morning, everyone. Just a few sales related questions. First you didn't mention explicitly in the press release or in your prepared comments any new customers that you may have won in the quarter. Do you have any comments on that, Steve?

No. We didn't have any customer wins that were material in the quarter, so, no, we do not have anything to announce there.

Okay. And then just from an acquisition timing point of view, I think in the fourth quarter you will pick up and, Mark, maybe you can help me on this one, you will pick up about 6 weeks of the Canadian business. I think you acquired about mid-quarter that in the fourth quarter.

That's correct. So 6 weeks will be against no comp, and 7 weeks we'll be comping against what we acquired last year, and last year I believe it was about 22.7 million was the benefit in the fourth quarter.

Okay. And can you give me -- can you give us just a quick snapshot on the Whole Foods piece of that as well? When do you finish lapping the pickup of that business?

We won't finish lapping the Whole Foods business until probably about two-thirds to three quarters of the way through the first fiscal quarter of 2012. We closed the Whole Foods transaction in 2 parts, so it is really like the end of September and then mid-October, so you put 9 to 10 weeks into the first quarter would be roughly when we lap that next year.

I remember the 2 pieces which is what was sort of confusing me, so that helps a lot. Finally, this is a question for Steve, my last sales question. Your organic growth rate in independent is impressive at 8%. That is always been the barometer for the industry, and yet you're saying the industry might be 200 to 300 basis points -- in growth below what that number is. What is contributing to your market share gains, or is it programs specifically you have with your customers, they have better SKU count? Is there something specifically that is giving you and your customers an advantage relative to other independents out there?

Yes. First clarification, the 14% does include acquisitions, so the net increase in sales to the independents I think was about 8%.

8%, yes.

Right. That's what I was talking about, yep, the 8% versus mid-single digit.

Yes, which is still very strong number, and I think that we are extremely focused on the independent category. It is very important to us. They rely heavily on us, we rely heavily on them. A couple things have happened over the last quarter that I think are really helping us.

Number one, we rolled out specialty, clean specialty for independents. So we now have a full offering around the country of clean specialty that the independents can now retail in the stores. We never had that before. So that's certainly helping the growth.

Two, the introduction of our Wowzaville website which is specifically designed to assist independents in the way they merchandise the stores. And the Wowzaville site is an extremely sophisticated tool, web-based, where an independent can log into the site and can actually planogram any category of products in 2-foot, 4-foot, 8-foot, 24-foot sections with data that is specific by geography. And that is an extremely helpful tool, so that the independents who want the assistance can make sure that they always understand what the right products are to be merchandised in the stores.

Third, the key point of differentiation for UNFI is our breadth of line. There is nobody in the industry that has the product offering across specialty, natural and organic, that UNFI does, and that continues to be a huge point of differentiation. And then probably lastly is that we have been extremely aggressive. We have a very motivated sales force across North America, and they are responding well, and it is evident in the sales numbers.

That's very, very helpful, Steve. And just as a quick follow-up to that, too, have you added net new sales people or more sales associates to that business as well that might be contributing to that?

We certainly hire sales associates every year. I wouldn't say that the number of new sales territory managers we have this year is out of line with the increases that we have made in the last couple of years.

Okay, good. That is very helpful. It is a highly profitable business, so that's why I am so focused on it myself. Thank you.

Sure.

Thank you. Scott Van Winkle with Canaccord Genuity.

Hello, thanks. All of my questions have been answered. Maybe just a clarification, Mark. When you talk about the inventory adjustments lower and write-offs, et cetera, you were talking about Q2 and Q1. Does that imply that what we saw in Q3 was back to maybe a normalized level as a percentage of sales?

I think it is pretty close. There was still maybe a bit lingering from the end of Q2 into the say the first month of Q3, Scott, but, yes, I would say that Q1 and Q2 were heavier in that respect than what we have historically experienced. It was more centralized to the Lancaster, DC, and then some of the impact that it had on our Denver facility as well by virtue of trying to make that switch, make that transfer of product.

So there was no benefit in that segment of cost of goods sold on a year over year basis, just consecutively?

Yes, you're correct. From a year over year standpoint there wasn't a benefit, there wasn't a pickup versus what we had say as a percentage or basis point standpoint because obviously it was more sales volume will you have higher adjustments or higher write offs because you are carrying more inventory. But from a year over year standpoint it was basically a little bit worse than what we would normally have, but sequentially it was much better.

Great. Thank you very much.

Thank you. That's all the time we have for questions today. At this time I would like to turn the conference back to management for closing remarks.

Thanks again for joining our call this morning, and have a terrific day.

Ladies and gentlemen, this concludes the United Natural third quarter 2011 conference call. (Operator Instructions) Thank you for your participation, you may now disconnect.