United Natural Foods Inc (UNFI) 2012 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the United Natural Q1 2012 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. (Operation Instructions). Today's conference is being recorded November 30, 2011.

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

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

With us this morning from management is Steve Spinner, President and Chief Executive Officer, and Mark Shamber, Chief Financial Officer. We will begin this morning with opening comments from management and then we will open 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.

Additionally in today's press release and on today's call, you will find both GAAP and non-GAAP financial measures including operating expenses, operating income, net income and earnings per diluted share. The presentation of these non-GAAP financial measures is not intended to be considered in isolation or as a substitute for any measure prepared in accordance with GAAP. For a complete reconciliation of GAAP to non-GAAP financial measures, please refer to our earnings release issued earlier today available in our corporate website, www.UNFI.com, under investors.

With that, I would like to turn the call over to Steve Spinner. Steve, please go ahead.

Thanks, Scott. Good morning and thank you for joining us to discuss UNFI's first quarter fiscal 2012 results.

Our company is growing. Net sales grew over 15% to over $1.2 billion, an increase of over $164 million versus the prior year's first quarter. Recently the Company experienced its first $20 million day, further supporting our commitment to growth across our customer base.

Several items of note during the quarter related to our growth strategies. Our operating divisions experienced strong growth during the quarter led by continued demand for our core organic products, natural supplements, and specialty ethnic foods.

Of particular note were the sales and earnings results at our Albert's Organics division. With a strong focus on organic produce and fast-growing natural protein, Albert's results demonstrate that there is a strong demand for these categories of products.

Also UNFI Canada continued to show very promising growth. We've talked quite a bit about expanding UNFI's presence in this terrific market. Earlier this month, we furthered our strategy by completing the acquisition of B.K. Sethi Distribution Ltd., a specialty foods distributor in the Vancouver and Toronto markets. Our acquisition of B.K. Sethi will expand our ethnic product offerings in these important markets.

Looking at net sales growth further, adjusting for our Whole Foods acquisition in the first quarter of fiscal 2011, sales were up over 13%. Inflation during the quarter was 3.85% and seems to be stabilizing.

Our first-quarter fiscal 2012 was a critical one for us for three primary reasons. First and foremost, we had to plan for what was expected to be a very strong holiday lift and in planning, we had to ensure that our customers enjoyed a high service level by forecasting inventory requirements properly and gearing up from a labor and equipment perspective to satisfy demand. Sequentially, inventory grew 26% or $135 million, which is equivalent to approximately 7000 truckloads of freight.

Second, we onboarded the largest single customer at one time in the history of the Company. This implementation also required an incredible amount of supply-chain equipment and labor planning.

Third, we completed the transition out of our conventional non-foods and general merchandise lines of business. Specialty business that was served from our now closed Harrison, Arkansas facility was transitioned to several of UNFI's primary distribution centers, also requiring significant resources.

During the quarter, the Company incurred startup costs associated with new customer onboarding of approximately $1.6 million and divestiture costs of approximately $5.3 million.

Reflecting upon how we fared against these three primary and important objectives, I am incredibly pleased by the dedication of our associates who delivered record service levels in this critical holiday time period. Service levels were strong and our warehouses delivered exceptionally across our customer channels. Our teams demonstrated that they are able to perform at a very high service level with very high sales growth.

The quarter was also a strategic success as it demonstrated that we could manage effectively in an environment of high growth with many complicated moving parts. Sales across our super-natural, supermarket, and independent channels grew 19%, 18%, and 10% respectively, further supporting demand for our products across a wide variety of consumers.

Gross margin during the quarter was negatively impacted by an estimated $1 million in inventory damages or 8 basis points, the continued shift in our customer mix and our strategic decision to move inbound freight at our own costs to ensure the highest level of service about for the holidays. Gross margin dollars as reported were up almost 13%.

Also influencing our gross margin is the continued shift away from full-service customer programs. Full-service program costs to support in-store field sales representatives, our percentage base markup included in our gross margin.

During the last year, you have heard us talk about the need to reduce costs at a rate that exceeds the decline in our gross margin due to customer mix changes. During our first quarter of fiscal 2012, we continued to experience challenges with this goal as we focused on critical Q1 objectives that I just discussed.

Despite the focus on integrating these changes, we made progress during the quarter. In our warehouses, our productivity improved over 4% and 33 basis points versus the prior comparable period adjusting for the onboarding and restructuring expenses I mentioned earlier. These productivity enhancements were driven by completion of our labor management tools and standardized processes.

In the fleet, our fuel efficiency initiatives partially offset a $[0.77] per gallon average increase in diesel fuel prices driven by improvements in idle time, routing, and driver efficiency.

Looking forward, we expect continued improvements in our operations expenses as we settle into greater efficiency related to new and transferred business in our facilities.

During the quarter, we experienced several additional costs which also negatively impacted our operating expenses. Additional share-based compensation costs and bad debt expense related to a single customer amounted to approximately $1.9 million. With the very busy first quarter behind us, we are now moving towards the continued implementation of UNFI's supply chain and warehouse management technology platform.

On the balance sheet, inventory was up one day to support holiday lift and customer onboarding. Accounts receivable was consistent in 21 days and capital expenditures were approximately 64 basis points of sales. We expect our primary capital expenditures over the next 18 months will be further implementation of our supply chain initiative and the consolidation of our multiple Denver facilities into a new, larger facility, which we believe will provide meaningful efficiency gains.

Net income adjusted for the restructuring expenses and new customer onboarding was $19.4 million, an 11.2% increase versus prior year. Diluted earnings per share adjusted for the restructuring expenses and new customer onboarding was $0.40 per share on an additional 3.8 million diluted shares outstanding compared to the first quarter of last year as our secondary offering was not completed until October 2010.

Looking at 2012, we remain optimistic regarding continued sales growth and demand for our products. During the last several weeks, overall sales growth has accelerated an additional 150 to 200 basis points. We are confirming our previously announced diluted earnings per share and sales guidance for fiscal 2012.

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

Thanks, Steve, and good morning to everyone on the call. Net sales increased by 15.6% or $164.5 million to $1.22 billion for the first quarter of fiscal 2012 versus net sales of $1.05 billion in the prior year. Our business with Whole Foods, Rocky Mountain, and Southwest Region's grocery distribution positively impacted sales by $25.4 million in the quarter as we lapped last year's acquisition during the quarter. Excluding the impact of this acquisition, net sales increased by $139.1 million or 13.2%.

Inflation increased sequentially again to 3.85%, an increase of 92 basis points from the fourth quarter of fiscal 2011. However, we did note that while inflation did continue to increase during the quarter, the rate of increase from month to month moderated during the quarter.

For the first quarter of fiscal 2012, the Company reported net income of $19.4 million or $0.40 per diluted share excluding the impact of the restructuring and onboarding expenses disclosed in the press release, an increase in net income of approximately 11.2% or $1.9 million over the prior year.

Net income for the first quarter of fiscal 2011 was $17.4 million or $0.39 per diluted share. On a GAAP basis for the first quarter of fiscal 2012, net income was $15.2 million or $0.31 per diluted share.

As Steve discussed, in the first quarter sales to the supernatural channel increased by 18.5% over the prior year's first quarter. And supernaturals represented 36% of sales for the quarter. Excluding the impact of the Whole Foods acquisition, supernatural channel sales increased by 11.6%.

Independent sales rose by 9.8% year-over-year and independents represent approximately 36% of sales. Our supermarket channel experienced growth of 17.5% over the prior year and now represents approximately 23% of sales. Food service grew by 20.5% over the prior year and continues to represent approximately 3% of sales.

Gross margin for the quarter was 17.8%, which represents a 44 basis point decrease from the first quarter of fiscal 2011, which had gross margin of 18.3%. The year-over-year gross margin decline was largely due to the continued shift in our mix of sales growth by channel towards our conventional, supermarket, and supernatural customers; approximately $1 million in incremental inventory write-offs to certain product categories; and higher freight and service costs incurred that Steve just covered.

Operating expenses for the first quarter represented 15.1% of sales, a 33 basis point improvement compared to 15.4% for the same period last year excluding the restructuring and onboarding expenses of $6.9 million which were disclosed and broken in the press release.

Restructuring expenses associated with the disposition of our conventional nonfoods and general merchandise lines of business totaled approximately $5.3 million in the first quarter. This was approximately $0.8 million higher than anticipated due to higher severance costs as not as many UNFI associates transitioned over to the acquirer as part of the transition and other systems and buildings shutdown costs came in above the high end of the estimates we had previously provided.

On a GAAP basis, operating expense for the first quarter of fiscal '12 represented 15.7%, an increase of 24 basis points over fiscal 2011's first quarter.

In addition, the quarter contained $0.6 million in bad debt expense associated with a bankruptcy filing by one of our customers. Fuel had a negative impact of 12 basis points in operating expenses in comparison to the first quarter of fiscal 2011 as fuel represented 87 basis points of distribution net sales in the first quarter. Sequentially our fuel costs increased by 3 basis points over the fourth quarter of fiscal 2011 when fuel costs represented 84 basis points.

Share-based compensation expense during the first quarter was $3.9 million or 32 basis points compared to $2.7 million or 25 basis points in the prior year. The majority of this increase was due to lower-than-expected forfeiture rate on restricted stock units that vested during the quarter. Under the true-up provision requirements and accounting for share-based compensation, we were required to record additional expense in the period the shares vested as our actual forfeiture rate was lower than expected.

Excluding the impact of the restructuring and onboarding expenses, operating income for the quarter was 2.7%, an 11 basis point decline over the prior year's first quarter operating income of 5.8%. On a GAAP basis, operating income was 2.1%.

At just under $650 million at quarter end, our inventory averaged 52 days for the first quarter, an increase of three days over the prior year when we were at 49 days. The primary drivers behind the higher average days on hand were initial purchases to support our newest national customer and the normal inventory build that occurs each year leading up to the holidays. Sequentially inventory levels increased by about three-quarters of a day compared to the fourth quarter of fiscal 2011.

DSO for the quarter was in line with the fourth quarter at 21 days, which is favorable to our target range and slightly less than a day increase over the first quarter of the prior year.

Capital expenditures were $7.8 million or 64 basis points of net sales for the three months just ended which is well below our target spending as a greater portion of our CapEx this year is anticipated in the back half of fiscal 2012.

Outstanding commitments under our credit facility were $207.1 million at quarter end with available liquidity of $209.9 million including cash and cash equivalents. Our leverage increased to approximately 1.4 times on a trailing 12 months basis due to our investment in inventory going into the holidays and the associated increase in debt.

As Steve mentioned in his comments, we are confirming our guidance for the fiscal year ending on July 28, 2012. For fiscal 2012, we expect net sales to be in the range of approximately $5.0 billion to $5.1 billion, an increase of approximately 10.4% to 12.6% over fiscal 2011. We expect GAAP earnings per diluted share for fiscal 2012 in the range of approximately $1.75 to $1.87 per share. Excluding the impact of the restructuring and onboarding expenses incurred in the first quarter of 2012, the Company expects earnings per share -- earnings per diluted share for fiscal 2012 in the range of approximately $1.83 to $1.93 per share.

And capital expenditures are expected to be in the range of approximately 1% of revenues or approximately $47 million to $52 million.

At this point, I will turn the call back over to the moderator for the question-and-answer session.

(Operator Instructions). Andrew Wolf, BB&T Capital Markets.

Good morning. This is Ashby Price in for Andy. We want to ask you about the next round of systems installations. Can you be more specific in which quarters systems will be installed, how long will the installation take? Is there a meaningful cost that you anticipate? And lastly, could you just discuss specific measures you are now taking to add more assurance that new systems will come online without a significant disruption? Thank you.

Sure. You know, we took a little bit of a hiatus from the continued technology rollout during the very busy first quarter that I talked about in my commentary. We are ready to again move forward on our initiative. Ridgefield, Washington will be the next facility. We're still narrowing down to an actual implementation time.

The beauty of this platform for all of our implementations going forward is that we are running two systems and what that provides us is that during the implementation time period if we run into trouble we can always revert back to the current system so that we don't have any outage to our customers and that was a very important feature that we required moving forward. So feel very comfortable about the transition.

Regarding the expenses, those expenses are built into our guidance and they are built into our CapEx guidance. So we wouldn't specifically notate any expenses related to the continued rollout of that platform.

Okay, thank you very much.

Scott Mushkin, Jefferies & Co.

Good morning. This is actually Mike Otway in for Scott. Thank you for taking the questions. Mark, just on the gross margin and the $1 million inventory write-off, did that have to do with the divestiture of the nonfood business? So it would be more one time in nature?

It actually wasn't related to the divestiture. It was something with regard to some chocolate products that we carry where -- not to go into all the detail -- but some of the chocolate had bloomed and it wasn't -- while it was still edible, it wasn't salable to our customers.

It resulted from some very high temperatures in a couple of our DCs, which causes the chocolate to get some white spots on it. We just couldn't sell it.

Okay, but not something that we would probably see happen next quarter or anything like that?

That's correct.

And I guess a follow-up to the first question. You've talked about this before but your standardized labor measures that you are going to be implementing, can you maybe in conjunction with that talk about what you will be doing first and kind of maybe the lineup of how you -- when you are going into these new DCs, what the rollout looks like? What you are implementing first to king of through the end of the process?

Sure, yes, our first documentation was putting in labor management across all of our DCs. That has been completed and labor management really is nothing more than selectors scanning in and out, tracking time, tracking accuracy, and setting some rankings and standards. That is complete.

The next step is to actually convert the system from the legacy system to the new system, which involves voice selection, a different put away methodology, and actually puts into effect something called engineered labor standards, where we actually use industrial engineers to tell us the fastest pick path, the safest pick path, the most accurate pick path. That is a very time-consuming process.

We have one DC fully implemented. We are going to the second DC in Ridgefield, Washington and that is going to take the better part of two to three years to fully implement that process.

The third aspect of it is on the supply chain side and these technologies are all tied together. And the supply chain side will give us the ability to buy, fulfill purchase orders and manage categories from a single location. So in other words today, we may buy from suppliers across three or four different locations, east, west, and divisional. The new technology will give us the ability to buy for example across frozen entrees in one location for all DCs in all divisions. It also provides a much more robust forecasting tool which we desperately need. That again is going to take a couple of years to fully implement.

Great, I really appreciate the color. Thank you.

Meredith Adler, Barclays Capital.

I am going to [show] my confusion here, but the things that you just talked about in terms of like the management and then moving on to converting the systems to use voice select, engineered labor standards and then all the stuff on the supply chain, is that -- when you talk about rolling out the new system, that is what you're talking about? That's the functionality that the new system will give (technical difficulty)?

That's correct.

Other than labor management, which is a part of it but it's already implemented.

Okay, got it. And do you have any sense -- estimates about how much money this saves you once you've got it fully rolled out or is it just way too early to say?

We certainly have that model built because that's really the justification for the spend. It's not a number that we have disclosed because it's just way too early in the process. We have seen significant gains from labor-management and that quite frankly is what's driving a lot of our operating expense control in the warehouses. We have seen the same thing on the transportation side. It's not exactly labor-management but it's a lot of standardized practices.

The big gains just in terms of if you look at, we handle all these processes in so many different places today. The platform gives us the ability to do it in one place. Today if you look at forecasting demand planning, today it's very manual. The system gives us the ability to use a very robust technology platform to do it. Engineered labor standard is the single biggest gain that we will have in our warehouses just by making sure that we are selecting as efficiently as we can.

So unfortunately the answer is we certainly have the numbers which justify the cost but we are certainly not in a position yet to disclose what they are until we get much further into the process.

Okay and I have two other questions. The first is it sounds like not only you save labor when you centralize procurement but do you believe there is a chance to actually lower your procurement costs?

I think that there is the opportunity to lower the cost on the supply chain side so in other words, moving the freight more efficiently across the country versus negotiating better cost of goods with the suppliers.

Okay. And then my final question is I might have misheard you but did you say something about that there was a problem this quarter in terms of the cost-cutting effort or just that it had been delayed?

No, the only thing I had mentioned was that we intentionally delayed further implementation until we got through this first quarter because between the holiday lift, the transfer of all the non-foods business and the new customer onporting, that would not have been smart to continue down the new technology platform while we were doing all those three important things.

Actually, just the one final question. Is your salesforce out there still aggressively trying to win new business?

Without a doubt, absolutely.

Thanks.

Robbie Ohmes, Bank of America Merrill Lynch.

Good morning, guys. Steve, I think you mentioned the sales growth acceleration into the fiscal second quarter. Can you just maybe give us a little more color on what is driving that and do you expect to continue in sort of traditionals versus supernaturals in terms of what's pushing that?

And then the second question would just be competitively are you seeing things get even easier for you from a competition standpoint? Thanks.

Thanks, Robbie. We have been really pleased with 150 to 200 basis point acceleration. I wish I could tell you exactly why it's happening. I really can't other than what I've talked about the last couple of quarters, which is more and more crossover consumers buying more and more organic, natural, and specialty. We don't have the detail related to specific channel growth but my guess would be that it's pretty consistent across the same numbers that we reported from the prior quarter. So again optimistic, feel good about the growth and certainly see it through the second quarter.

In regards to your second question about competition, haven't seen any real change in the competitive landscape. We have some very good competition in specific markets around the country and again, our biggest competition -- and this is really nothing new today than it has been the last five years -- is direct where as items pick up more speed, large supermarket customers in particular tend to take those SKUs into their direct model.

So our challenge is to continually roll out more and more SKUs at a rate that exceeds the ones coming out. So no real changes in the competitive landscape.

Terrific, thanks so much.

Greg Badishkanian, Citi.

Great, and in terms of the acceleration business the last few weeks, is that from -- that's not from getting new business. That's your existing customers, is that right or --?

Correct. The only new business which was already partially in the first quarter would be that new national customer, but other than, that there's no other incremental new business coming on board, so its customers we already had accelerating.

Got it, that's helpful and good to hear. The other is just maybe some -- I know some of the perishables seem to have done well. Any other categories where you can give some color on in terms of either underperforming significantly or outperforming significantly?

Not really, Greg. The categories of organic yogurt continue to be strong. Bulk continues to grow very quickly although we had a fair amount of inflation in bulk. We are seeing fairly strong growth across many of the categories in which we trade.

You had mentioned that inflation -- you are seeing a stabilization so the acceleration isn't from inflation, that's more volume-driven, right?

Yes, that is correct. Inflation over the last year -- and Mark, you can correct me if I'm wrong -- has been rising from a low of 2% to where we just finished just under 4%. We had just under 4% I think in the previous quarter.

From an inflation standpoint last year at this time, it was about 76 basis points. So we are up maybe 3% year-over-year. Sequentially it's just under 1% because it was just under 3% last quarter. But if you looked at on a month-to-month basis I would say that it probably only went up about 25 basis points during the quarter.

So it went from a scenario where it accelerated 150 basis points from Q3 to Q4 last year from the start -- end of the quarters to only 25 basis points and we will start to lap some of the increases we saw last year in the next couple of quarters.

Great, very helpful. Thanks, guys.

Ed Aaron, RBC Capital Markets.

Thanks, good morning. I just wanted to quickly clarify first the 150 to 200 basis points of acceleration. Is that relative to the 13.2% organic growth that you had in the quarter or is that versus where you exited the first quarter?

It's a relative number.

Okay.

Relative to 13.

Relative to 13. Okay. And you had a pretty big working capital build this quarter presumably to support the Safeway ramp. Obviously that hurt your cash flow. Can you just talk maybe a little bit about how that is going to unwind in the coming quarters and roughly where you expect to be on a full-year basis from a free cash flow standpoint?

Yes, I think if sales -- what I would say is, I would expect that it would still probably be above our target range, which is 47 to 50 days. I wouldn't be surprised if we're still a couple to three days above that as of the end of the second quarter. But what I would expect is you'd see us start to unwind in the third quarter and continue into the fourth quarter.

Another big piece from our free cash flow standpoint of course is that with Safeway just starting to ship in the month of October, we will start to get into a cycle where we complete the cash collections process in the second quarter, whereas we had a lot of shipments going out but not necessarily getting paid because the shipments occurred late in the quarter.

So from that standpoint, I feel comfortable that we will probably see -- I would expect that from a free cash standpoint, Q2 would be relatively neutral, maybe positive as much as $10 million. But for the full year, we would still be looking to achieve that $35 million to $55 million that we had put out as sort of a three-year target and the fluctuation within that range basically is where we fall within our days on hand target.

So if we're at the lower end, we're probably closer to the $55 million, or if we're at the higher end, we're probably closer to the $35 million.

Okay. And then I just wanted to ask a question about kind of the new wins you were asked about earlier. It sounds like you are actively pursuing that post the holidays when we usually hear news along those lines. Can you maybe just talk a little bit about how much is out there this year from your perspective? And then just sort of tactically, you've taken on a lot of new business recently. Is there any thought to maybe just taking a breather to digest what you've already got versus being aggressive to get more on such a short-term basis?

Yes coming you know, the challenge -- let me answer it two ways. When you look at the independents, we have got to be foot on the gas 52 weeks a year. They come slowly and they tend to come in very small pieces. So we never took our foot off the gas there. We won't take our foot off the gas. I agree with you that certainly on the large chains, it certainly will be nice to take a breather. We don't anticipate any large wins looking out over the next quarter or two and that's a good thing. But the challenge is if you get an opportunity presented to you by a customer, you get one shot to take a look at it or else you've got to wait another three or four years.

So I don't anticipate that happening and I think we will digest what we have. But we also have to be opportunistic in looking at what becomes available. We are also very focused on growing Canada as we have said before. We think there's a ton of opportunities there and our team in Canada has a lot of bandwidth to do more.

Thanks and then one more brief follow-up. Because since you mentioned Canada, you snuck in a comment earlier about an acquisition that you did there that was kind of news to me. Can you maybe just talk a little bit about what that business does for you?

Yes, overall, it's less than 10% of our total sales in Canada. But it adds a lot of specialty categories that we didn't have prior to the acquisition. And we will go ahead and integrate that business into our existing footprint over the next couple of months.

And Ed, just to add a bit of clarity. The transaction didn't occur, didn't close in Q1. It actually closed in Q2. So there's no impact in any of the Q1 results from that transaction.

Thank you.

Karen Short, BMO Capital Markets.

Just back to the Ridgefield facility, just to clarify, will you start rolling out the engineered labor standards in the second quarter or what's the timing on that?

No, it will not go into effect in the second quarter. Engineered labor standards will be part of the implementation at Ridgefield and we are just not sure what the exact date is. We are in the process of trying to button that down now.

Okay, is there any potential that you might be able to accelerate and roll out to other facilities in fiscal '12 or is that unlikely?

I would say it's unlikely. If we could do it, if we had a really successful implementation at Ridgefield, maybe we could get one other but I doubt it at this point. It's a big deal to do these conversions and we are -- at this point we are relatively risk-averse.

Right, okay. On the supply chain opportunity that you discussed, is that something you can start to implement at the same time that you are rolling out the engineered labor standards or is that something that you had tackled kind of after you have rolled out?

No, you're absolutely right, we can do them at the same time. We're doing some background work now to get that done in terms of common data warehouse, common item number, those kinds of things that are precursors to having a true national supply chain platform. So that work is going on as we speak and it's virtually invisible to anybody outside of our IT and procurement departments.

Okay. And then I guess just -- I know you're reluctant to give any estimate of what the opportunity is on the margin side but I know you guys did -- were part of this type of implementation at Performance Food. I don't know if you could just talk directionally about what it did for margins at Performance Food once you had rolled the engineered labor standards out to all the facilities there just to help us get some sense.

Yes, the reason that you do it is you can manage your expenses down in a very significant way when you have downward pressure on your gross margin due to customer mix, competitive pressures, and all the things that we've talked about. Statistically looking back when we had full implementation of the program in my prior life, our actual labor rate per case was lower when we had full implementation than it was three or four years prior. So it is a significant win and the end result is that it allows fewer associates to make more just because of the technology and the platform that you have managing the warehouses.

Okay, that's very helpful. And then I just -- just looking at your next couple of quarters, obviously you only had -- your largest new customer win on board this quarter for one month. But it is fair to say then looking at your margin -- gross margin specifically, the deterioration in the margin should be a little more significant for the remainder of the year based on margin pressure of that contract?

I think there's a chance that you'll see a little bit more but because we did have the inventory issue that led to about $1 million, you will get some basis points back there. I wouldn't expect necessarily to see a material shift, Karen, but you could see a little bit more erosion on the gross margin side.

Okay. And then on the tax rate, is that something that you think 39% is probably a good run rate?

We booked it roughly 39.4% for the quarter. I think it will be 39.5% for the year. The only thing that might change it is that we still -- we generally try to complete a number of sustainability projects during the course of the year. Some of them come with federal tax credits and so if we were to do another project, it could lower the tax rate but it wouldn't occur until the project was actually up and running.

So I would say 39%, 39.5% is a pretty good range and if it was to change because of one of these projects, I would probably give the heads up a quarter before it changed.

Okay, great. Thanks for taking my questions.

Scott Van Winkle, Canaccord Genuity.

Thanks, most of my questions have been answered. Maybe a little more probing on the Canada acquisition. Can you discuss magnitude relative to your current Canadian business? And then I thought there was already a specialty mix in the UNFI Canada operations.

Yes, Scott, it was less than 10% of our total Canadian business. So not material to UNFI overall and we do have a pretty healthy specialty mix in Canada, but this was specific to categories that we did not have. And so this gave us the expertise and the variety of SKUs in those specific categories.

The Canadian business is a little bit different than the US. In the US, distributors tend to carry a wide variety of items. There's very few exclusives that exist in the United States and in Canada, it's much different. There are many more exclusive relationships with suppliers so only one distributor may have it and this gave us some access to those types of situations.

Got you. And then sticking on the acquisition front, has there been any change in kind of the strategy of maybe acquiring categories in the North American operation?

No. We've had the good fortune of being able to take on a pretty significant mix of specialty cheese and so we are hoping we're going to see some considerable growth there across the country. We don't have to do any acquisitions to do that. There are some categories that we're going to take a look at over time. We don't have anything that's certainly pending but it does present a nice opportunity for us in specific regions to increase our intellectual talent as well as our SKU mix related to higher-end specialty natural protein. So those are all things that we continue to look at.

Great, thank you.

Eric Larson, Ticonderoga Securities.

Thanks for taking my questions, guys. I just want to drill down a little bit on your guidance for the year. And just for simplicity sake if you just take the mid part of the range on your GAAP guidance and then the mid part of the range on your adjusted guidance, it's about $0.07 a share. The difference in the first quarter was $0.09 a share.

So is it fair to say that the first quarter is reabsorbing or will reflect the majority if not all of your one-time items for this fiscal year?

That's correct. Almost everything from a nonrecurring one-time sort of standpoint hit during the first quarter. The new customer we have onboarded, most of those costs were in the first two months of the quarter. The expenses that occurred in the third month of the quarter was less than $60,000. So I feel comfortable that is completely done. There may be a little bit of severance or some final shutdown costs associated with wrapping up the facility associated with the nonfood and the general merchandise. But I would say that that is probably less than $0.25 million and it's unlikely that we would break it out if it was that small.

So I would say that almost all those costs were limited to the first quarter.

Okay, good. And then just one other follow-up question -- maybe this one is kind of for Steve. Steve, the organic growth rate in the industry has been kind of trending in that high single-digit range I think now for the last let's say four to six quarters for sure. You're in that low double-digit range because you are getting some share in the category. Are you also seeing an acceleration in the industry organic growth rate as well or is it specifically related to UNFI and what you guys are doing on the sales side?

Yes, I haven't looked at the overall industry rate lately but I think you are right directionally it's in the high single digits. So I would say that you answered your question and that is that UNFI is growing at a rate that exceeds the rate of the industry and that's just as a result of taking share across new categories.

Okay. Thanks, guys.

Sean Naughton, Piper Jaffray.

Thanks for taking my question. On your operating margin objectives, you've talked about improving 9 to 12 basis points annually for 2013, obviously a little bit of a difficult start out of the gate in fiscal year 2011. If we assume no more acquisitions and we just kind of run through to 2013, do you feel pretty comfortable about your ability to really meet those goals based on some of the learnings that you have had with the new system implementations?

Yes, I think we certainly do, Sean, and we talked probably three quarters ago now, might even be four -- Steve had mentioned at one point when we started taking on some more of these big slugs of business that we would have probably four or six quarters where we had some difficulty keeping pace and absorbing some of the changes in the margin split and such and I think that we are now at the point where we have started to cycle through all of that. Maybe there's a bit more impact in Q2 a little bit but we are now at the point where we would expect to start to see some of the margin expansion in the back half of fiscal 12.

And as Steve mentioned in his comments, we continue to see progress from a standpoint of the operations improvements and I think the gross margin has now sort of settled with lapping some of these acquisitions and with some of the business we have taken on where we continue to make those improvements in operations and the gross margin stays level and you will see the expansion occur.

Got it. And then I guess secondly in terms of the product that you are shipping today, is there any changes in pack sizes that you are seeing or any mix in the SKUs towards -- skewing towards more organic product?

No, I don't think so.

Relatively similar? Okay, great. Then just lastly on Canada, and I know we've had a number of questions about this. If you could just remind us how big is this as a potential opportunity here? And then is this accretive to the operating margin of the Company overall? Thanks a lot.

It is accretive to our overall operating margin and again, we think that our opportunity in Canada is roughly 10% the size of our Company in the United States. So if you do the math, we think that Canada should certainly be a $450 million to $500 million business for us.

Great, thanks and best of luck for next quarter.

(Operation Instructions) Ann Gurkin, Davenport.

Good morning. I want to ask you about your comments in reference to holiday lift. You said you increased the service level. Is that in line with expectations or do you increase that more than expected?

We actually overall, our service level went beyond where we thought we would be. We had several weeks where I think we had some of the highest service levels we have ever had in the history of the Company.

Okay and then if I can just get the number for the bad debt related to the customer costs. What was that number again?

The bad debt related to the specific customer was $600,000. But we obviously have normal provisions that we make for different customers during the course of any given quarter. So from that standpoint, bad debt increased probably over $1 million compared to the same quarter last year but I would say that only about $600,000 of it was really associated with the bankruptcy of a particular customer that jumped out.

That's great. That's all I have left. Thank you very much.

Scott Van Winkle, Canaccord Genuity.

A quickie on inflation. Does the velocity of inflation rate changes going from 2 to 3.5 rather than 3.5 to 3.8 or something like that, does that have an impact on short-term ordering patterns and is there any one channel that's more impacted by another if it is?

Well, typically it takes us about 60 -- 60 to 90 days to pass through price increases. I wouldn't say that it was specific to any one channel. I am not sure that is getting at the answer to your question.

Yes, well I'm trying to wonder if the rate of inflation growth slows, does it benefit the ordering patterns you see from customers? In periods of rapidly rising inflation, do people pause, pull back, second-guess ordering sizes, things of that nature? The comment about the rate of acceleration slowing and more normalizing, is that good?

I think, Scott, that the answer is that as a distributor who works primarily on a cost-plus, 2% to 4% inflation is very good because we pass it through relatively quickly and the math or the basic arithmetic works in our favor just because you would rather have a percentage markup on a product cost that has been inflated 2% to 4% than not. And at 2% to 4%, it tends to pass through very quickly from the distributor to the retailer, from the retailer to the consumer.

So the opposite of that is when you get north of 4%, it's much more difficult for us to pass it through and it's much more difficult for the retailer to pass it through.

On the opposite side, when you have no inflation or deflation, then you have the opposite effect where you are delivering the same or more cases without getting the benefit of a lift in the cost. So it really has to do more with the actual rate than maybe how quickly the rate is rising.

Yes, thank you very much.

Meredith Adler, Barclays Capital.

I just want to go back to something that Mark was talking about about what you think margins will do in the latter half of the year or the next three quarters. First, I wanted to make sure you were talking about gross margin as opposed to operating margin or were you talking about operating margin?

And then you said there will be some expansion and I'm wondering whether you are including those -- I don't like to call them one time but unusual costs all of them -- from that when you say that there's going to be an expansion. Or are you saying excluding those costs, there would still be an expansion?

Okay. I will try to answer that, Meredith. I think I know where you are going at. In talking about the margin, I covered both so I think when Karen asked her question -- it could be wrong on the individual -- I think that gross margin now that we've onboarded Safeway, we don't have any other major wins at least at this point to announce or coming on board, I think that the impact of sort of some of the operational issues we had in Q1 not reoccurring in Q2 as well as sort of annualizing some of the other new business we've taken on that gross margins should be relatively stable in Q2 and the rest of fiscal '12.

Again, it doesn't mean that it couldn't shift up or down depending on where some of the mix comes and where the growth comes in those quarters but I wouldn't expect a movement of more than 10 basis points barring anything significant happening.

From a standpoint of the operating margin, when you are comparing it from a year-over-year standpoint, I think that we have the opportunity to get greater leverage in Q3 and Q4 and see an improvement in operating margin in those quarters that is more in line with our targets and allow us to sort of reach our targets for the full fiscal year. We have to have that occur in Q3 and Q4 to offset, say, what occurred in Q1 and if Q2 doesn't -- even if Q2 is just in line from a nine to 12 basis standpoint, in order to get that for the full year, we would have to have more than that in the back half of the year.

But from a standpoint of when we are comparing it, we are from our perspective we are backing out the onboarding cost as well as the disposition costs or the restructuring expenses. So from our standpoint, the $6.9 million we are backing out of those numbers in saying that we would hit the 9 to 12 basis points of expansion year over year.

Got it. Thank you very much. That was very helpful.

Thank you. I show no further questions in the queue at this time. Please continue with any closing remarks.

Thanks for joining us today. Sales are strong and demand continues for natural, organic, and specialty foods across our consumers. Thanks again for joining us today and have a terrific holiday.

Ladies and gentlemen, this concludes the United Natural Q1 2012 conference call. If you would like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030 and enter the access code of 4488370#. Thank you for your participation. You may now disconnect.