United Natural Foods Inc (UNFI) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the United Natural Foods third quarter 2012 conference call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be opened for your questions.

(Operator Instructions).

Today's conference is being recorded June 5, 2012. I would now like to turn the conference over to Scott Eckstein, of 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'll send you a copy, immediately following this morning's conference call. With us this morning from management is Steve Spinner, President and Chief Executive Officer, and Mark Shamber, Chief Financial Officer. We 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, we provide 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 on our corporate website, www.UNFI.com under Investors. With that, I'd like to turn the call over to Steve Spinner. Steve, please go ahead.

Thanks, Scott. Good morning, and welcome to UNFI's third quarter fiscal 2012 results conference call. This quarter exhibited strong results across our strategy to increase market share, efficiency and operational excellence. With 15.3% net sales growth, UNFI grew at a rate that exceeds the overall market. And most importantly, demonstrated that the demand for UNFI products and services continues to be quite robust. Inflation increased to 4.4% during the quarter. While significantly higher than the prior year's comparable quarter, inflation did begin to moderate in March and continued through April. Current trends reflect inflation continuing to moderate to between 3.5% and 4% for the next several quarters.

Third quarter of our fiscal 2012 was the sixth quarter of our previously discussed four to six quarter time period of wrestling down operating costs at a rate that exceeded gross margin decline, due to customer mix changes and new customer on-boarding. During this quarter, I'm extremely pleased with our results in this area. Not only did we grow our operating profit by 25% against the third quarter of fiscal 2011, which was significantly greater than our sales growth, we increased our operating margin by 27 basis points to 3.5%. This is the Company's highest quarterly operating margin since the second quarter of 2007.

We have talked quite a bit about operating efficiency through a variety of technology implementations. From on-board systems installed in our fleet, fuel efficiency measured through miles per gallon tracking, labor standards in our warehouses, productivity ranking and warehouse management, UNFI is well-positioned to continue to deliver exemplary service while driving out cost. And critical to these efforts, are our people. UNFI's team of associates has embraced our strategy and have delivered. Our service levels, including fill rates, accuracy and on-time delivery exceeded internal metrics during the quarter.

It is important to mention, continued opportunity. For perspective, we rank, track and incentivize our warehouses across approximately 10 critical metrics. And three of the most important are operations throughput, which us how many cases we can select per hour, transportation throughput, which is how many cases we can deliver per hour, and miles per gallon. Despite significant improvements in each of these areas, we continue to have gaps between the highest and the lowest ranking distribution centers, caused primarily by customer mix, miles traveled and the size of the distribution center.

For example, our operations throughput runs in the mid-50s to mid-80 cases per hour. And transportation throughput runs from the high 60s to mid-130 cases per hour, and miles per gallon runs from the low 6s to the high 7 miles per gallon. So our team is excited about attacking the continued opportunity in these areas. All of these efforts drive down our operating expenses. During the third quarter, operating expenses as a percentage of net sales were 14.1%, down 81 basis points versus the prior year.

In looking at demand across product at categories, several high-growth areas continue. Organic produce leads all categories with 30% growth year over year, followed by frozen, predominantly poultry, seafood, and fruits and vegetables, and dairy, predominantly yogurt and milk, at 20% and 12%, respectively. Also growing quite rapidly are our specialty food offerings, led by ethnic foods in particular. Additionally, specialty cheese, a new product category for UNFI has been growing, and is expected to contribute approximately $40 million in net sales during fiscal 2012. All natural, hormone and antibiotic-free frozen protein has been introduced throughout our network, and we are optimistic regarding it's growth during fiscal 2013. UNFI's Albert's Organics division, the country's largest distributor of organic produce and perishables, has seen significant increases in demand for it's products during the last six quarters.

In looking at customer mix, all three of our core groups had strong growth, led by supermarkets at 28%, super naturals at 15% and independents at 9%. And we have spent considerable time organizing our internal teams to further support the innovation, growth and profitability of our specialty and organic retailers, and feel good about this important customer group's future. Gross margin declined 53 basis points during the quarter against third quarter fiscal 2011, primarily driven by continued customer mix changes.

Looking at our balance sheet, UNFI continues to apply a disciplined approach to leverage and capital expenditures, which provides us with tremendous flexibility to invest in our growth. Additionally, given the nature of our high SKU count and slower moving inventory business model, access to capital to invest in inventory to support service level and breadth of products is paramount. And looking at capital, expenditures during 2012 we will under spend versus our original guidance. For the third quarter of fiscal 2012, UNFI had approximately 0.5% of revenue in CapEx spend.

However, next quarter and into fiscal 2013, we will begin two major building projects located in Denver, Colorado and New England. Additionally, deployment of our new warehouse technology platform will advance at two to three distribution centers per year. And while we're not yet in a position to discuss fiscal 2013 guidance, we expect CapEx during fiscal 2013 and fiscal 2014 will be greater than our prior three years run rate.

One of the highlights of the quarter for me was the announcement of UNFI's Foundation. Always a Company with a culture of social responsibility, sustainability and philanthropy, UNFI's Foundation provides us with a more formal process via 501(c)3 to invest in important several areas which are quite important to us. These issues are centered around promoting a healthy, organic, and sustainable food system. For more information regarding our foundation, please visit www.UNFIfoundation.org.

Additionally, we are in the final stages of completing our second annual sustainability report. And I'm quite happy to be on target towards achieving our goal of reducing carbon emissions by 5% from our 2009 levels. This has been accomplished through a commitment made by our associates towards zero waste through recycling, and conscious use of energy. UNFI also continues it's pledge towards using technology to further reduce our carbon footprint. Both construction projects identified earlier will seek LEED certification, and we continue to invest in solar, hydrogen, and natural gas-powered equipment.

Looking forward to the fourth quarter and based on the solid results during our third quarter, we are revising our net sales guidance to a range of $5.18 billion to $5.22 billion, which represents a 14.3% to 15.3% increase in total net sales over fiscal 2011. Additionally, adjusting for approximately $6.8 million to $7 million in expenses associated with previously announced restructuring and on-boarding costs, UNFI expects diluted EPS for fiscal 2012 in the range of $1.92 to $1.96, which represents an increase of approximately 14.3% to 16.7% over prior year. And reflected in our revised guidance is approximately $0.02 per share, related to estimated costs associated with an ending collective bargaining agreement.

I'm quite pleased with UNFI's performance during the third quarter 2012, and credit the strength of our industry, continued demand for UNFI's services, and the dedication and perseverance of our people. And now, I'll turn the call over to Mark Shamber, UNFI's Chief Financial Officer. Mark?

Thanks, Steve. As Steve mentioned, net sales for the third quarter of fiscal 2012 were $1.39 billion, which represents growth of 15.3%, or approximately $184 million over the prior year's third quarter's net sales of $1.2 billion. Inflation more than tripled on a year over year basis. Although the growth in inflation moderated significantly sequentially with inflation at 4.43% for the third quarter, compared to 4.36% in the second quarter, an increase of only 7 basis points. During the quarter, inflation appears to have topped out, as fiscal March showed only the second sequential month-to-month decline in over two years.

Year-to-date net sales are $3.9 billion, yielding sales growth of $521 million or 15.5% over the first nine months of fiscal 2011. Excluding net sales from acquisitions of approximately $28 million, our year-to-date growth is 14.6%. For the third quarter of fiscal 2012, the Company reported net income of $29 million, an increase of approximately 24.3%, or approximately $5.7 million over the prior year's third quarter net income of $23.4 million. Earnings per share increased by 23.2% to $0.59 per diluted share, compared to EPS of $0.48 per diluted share for the third quarter of fiscal 2011.

On a channel basis, super natural sales increased by 14.7% in the quarter, and now represent approximately 36% of sales. Sales growth in the independents channel was 9.1%, but independents declined from a mix standpoint to 35% of sales due to the growth in the supermarket channel. The supermarket channel sales increased by 27.9%, and conventional supermarkets represented approximately 24% of sales for the third quarter, while food service comprised approximately 3% of sales after growing by 21.8% in the third quarter.

At 17.6%, gross margin for the quarter showed a 53 basis point decline over the prior year's third quarter gross margin of 18.2%, and a 28 basis point improvement sequentially. As we have discussed in previous quarters, the primary driver of our lower gross margin on a year over year basis was the continued shift due to growth in the mix of business towards both the super natural and conventional supermarkets channel. Our improvement sequentially was due in part to the seasonal strength of our Albert's organics division, increased sales of Kosher products for Passover, and a greater percentage of sales to the independent channel.

Year-to-date gross margin in fiscal 2012 was 17.6%, compared to 18.1% in the prior year, a decline of 49 basis points, caused by a combination of the same channel mix factor I just noted, as well as the issues we covered on our first and second quarter earnings calls. Our operating expenses for the quarter were 14.1% of net sales, compared to 14.9% for the same period last year. This represents an 81 basis point improvement over the prior year, as operating expenses as percentage of net sales benefited from a variety of areas, which Steve covered in his comments.

Excluding the portion of our Canadian business which involves the use of third-party transportation in certain less populated regions, diesel fuel had positive benefit of 2 basis points in operating expenses, in comparison to the third quarter of fiscal 2011 as fuel represented 79 basis points of distribution net sales in the quarter. Fuel expense in the third quarter also decreased by 1 basis point versus the second quarter, despite a 2.1% increase in our fuel prices during the time frame, due to our continued focus on reducing costs and miles traveled. Our diesel fuel costs in the third quarter increased by approximately 3% from the prior year's third quarter, while the Department of Energy's national average was up approximately 5% over the prior year.

Share-based compensation expense totaled $2.5 million in the quarter, compared to $2.6 million in the prior year's third quarter. Share-based compensation expense as a percentage of net sales represented 18 basis points in the third quarter of fiscal 2012, versus 21 basis points in the prior year's third quarter. At 3.5%, operating income for the third quarter represents a 27 basis point improvement over the prior year's third quarter, and was our highest quarterly operating income margin in the past five years. Interest expense in the quarter of $1.1 million was approximately 3% lower than the prior year, and was about 20% lower sequentially due to our lower debt levels associated with the free cash generated during the quarter.

Inventory was at approximately $640 million at quarter-end, as days inventory on hand averaged just under 49 days for the third quarter, an improvement of almost six days from this year's second quarter, and one day improvement over the prior year's third quarter, when inventory days were at 50. DSO for the third quarter was consistent sequentially at 22 days, and represented a 1.5 day increase over the prior year, due to increased volume with conventional supermarkets which typically pay more slowly.

Capital expenditures were $7.1 million or 51 basis points of net sales for the quarter, which is below our targeted spending. As a result, and as announced in this morning's press release, we have revised our full-year CapEx guidance to a range of $35 million to $40 million. As Steve mentioned, certain projects that were originally expected to begin incurring costs in the second half of fiscal 2012, will now occur in fiscal 2013 resulting in the adjustment to our full-year guidance. Outstanding commitments under our credit facility were $190 million at quarter-end, with available liquidity of approximately $224 million including cash and cash equivalents. Our leverage improved to approximately 1.2 times on a trailing 12 month basis. Leverage should further decrease in the fourth fiscal quarter of 2012, as we generate the majority of our positive free cash flow during the second half of each fiscal year.

As covered in our Form 8-K filing with the SEC last week, we successfully entered into a five year amended and restated senior secured credit facility agreement in May with a $500 million limit. The amended and restated credit facility was led by Bank of America Merrill Lynch and JPMorgan Chase, with US Bank and RBC Capital Markets as our co-documentation agents. As part of our new credit facility, we fully repaid our term loan, and terminated the interest rate swap related to our term loan. The term loan and the interest rate swap were due to mature in July of 2012.

As discussed in this morning's press release, we are raising our net sales guidance for fiscal 2012 to a range of $5.18 billion to $5.22 billion, which represents a 14.3% to 15.3% increase in total net sales over fiscal 2011. We had previously provided net sales guidance of $5.11 billion to $5.17 billion on March 6, 2012. In addition, we are narrowing and raising our GAAP diluted earnings per share guidance for fiscal 2012 to a range from $1.84 to $1.88 per diluted share. This reflects the impact of our year-to-date sales trends, and leverage and operating efficiencies. Our previous GAAP earnings guidance was $1.79 to $1.86 per diluted share.

During fiscal 2012, we expect to incur a total of approximately $6.8 million to $7 million in operating expenses, associated with our previously announced divestiture of our conventional non-foods and general merchandise lines of business, and the start-up expenses associated with the on-boarding of our new national customer. Excluding the impact of these expenses, we expect diluted earnings per share for fiscal 2012 in the range of approximately $1.92 to $1.96 per share. At this point, we'll turn the call back over to the moderator for the Q&A session.

Thank you. (Operator Instructions). Our first question comes from the line of Meredith Adler with Barclays. Please go ahead.

Well, good morning, and congratulations.

Thanks, Meredith.

I would like to just talk a little bit more about expenses. You are clearly doing a great job in that area. And I am wondering whether, putting aside the new technology that goes into the warehouses, the things you've done recently, is that going to be like a continuing benefit year-over-year? Or should we expect that once you've cycled what you have done this year, that it will kind of level off?

Well, we are certainly hoping to get continued benefit out of continued improvement. That's kind of why I directed the comments to some of the ranges in operations throughput, transportation throughput, and miles per gallon to reflect that. While we've made a lot of headway, we still have a lot of opportunity, because a lot of the DCs for a variety of reasons, still perform in a place that we think we can get considerably better throughput and miles per gallon. So I mean, I think the short answer is, we are certainly hoping that for the next couple years we can continue to get more expenses out of the system.

So the differences in the DCs, in terms of their performance is, even though there are reasons for it, those are not so structural that you can't get them at least, to get closer to the best performance? Is that right?

Yes, I mean, generally speaking, there are some structural differences in size of the DC or customer mix, or the amount of miles they need to run. But adjusting for those things, we still think that there is a ton of opportunity, just based on maturity of the workforce in each one of the DCs, the level at which our national teams have put forth their best efforts. So we feel pretty good about continued opportunity in those couple of areas.

Great. And then I have a question about the new DCs, you have Denver and New England. Obviously -- well, I'm just wondering, is there anything in the way you are going to be building those facilities, the way they will be structured, that will be vastly different than what you're doing now? I assume they'll have the new warehouse management system, but is there anything else that you think you can do to drive productivity, simply by the way the facilities are --?

Yes, I mean, that's a great point, Meredith. The Denver situation is, today we operate out of three buildings. So as you might imagine, the cost to do that is pretty significant. So just by, getting from three buildings to one building, gives us a tremendous amount of scale and opportunity. In New England, it's a little bit different. We've got two distribution centers that are out of room and are land-locked. So that will be a longer-term project, by which we build a new center, and gradually put the volume into the new facility and build scale, which obviously gives us the ability to drive down costs as well. So it's really a matter of the bigger you can build it to a point, the greater your ability to drive up your EBIT margin within the facility.

So does that mean you -- well, maybe you haven't said anything yet about closing the two DCs that are in New England now? Or will you just try to relieve some of the pressure on them because they're at capacity?

Yes, we are just going to relieve the pressure.

Okay. Got it. Great. Thank you very much.

Okay.

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

Hi, thanks for taking my questions. I wanted to follow on with what Meredith was talking about the margin discussion, and I wanted to start with gross margins. I think the basis point decline was just a smidge greater than it was in the second quarter on a sequential basis. And I guess, just kind of looking at that gross margin line, do we start to cycle some of the big declines at some point, as we cycle the Safeway contract? And how should we be thinking about gross margins, the pressure there going forward?

Yes, Scott. I think that you are dead-on with that question. I mean, we probably have from a year-over-year standpoint, we will see some pressure for Q4, and not as great of a pressure in Q1 of fiscal '13. But from a sequential standpoint, we should revert back to some of the normal seasonal patterns that we see. So using Q2 to Q3, this current quarter as an example, we usually see a lift in the gross margin by virtue of the products being sold, and the fact that the independents are stronger sequentially usually from Q2 to Q -- or Q3 versus Q2, even though on a year-over-year basis, with the higher super natural and conventional supermarket basis they may have declined. So I think you've got another quarter or two, where we will have measurable numbers from that standpoint. And then, we should go back into -- I would rather, I don't want to say necessarily single digits, but I think you'd see much less pressure on the gross margin than you have seen for the last six quarters, six to eight quarters.

Okay. That's great clarity. I appreciate that. So I wanted to kind of take that discussion a little bit further, on what Steve had said about kind of the expense, and trying to continue the momentum there. I mean as we go out, and think about UNFI out over the next few years, and the operating margins, if you look back, 3.5% was kind of the cap there. I think it's the best you have ever done on a yearly basis. Do we still think that is the top end of your range? Or do you feel with some of the changes that are being brought to bear on the Company that 3.5% is not a cap anymore, that over time we could actually see operating margins actually exceed that over a long -- this is over a long view, obviously?

Well, I think Mark and I probably have two perspectives. I would give you one, and that is that we are still pretty comfortable with the 9 to 12 basis points of margin improvement every year, going out the next couple of years. Whether that gets us there, or if you do the math, it certainly will. Mark, you probably have some commentary as well.

Yes, I mean I think from my standpoint, Scott, what I have said to folks when asked the question, is that we still think that we can get to 3.5% for a full-year number. And that depending on what levers we've had to pull and what -- where we stand in using the say, the warehouse management (inaudible) as an example, what we still have for levers that we might be able to pull further, would influence that.

So I think it's premature to say, whether it's kind of a high end, as to the ultimate as to where operating margin could get to, or if it could get any better. But as Steve said, we're comfortable with the 9 to 12 basis points we have laid out. And I think that when we're at a position where we're at 3.5%, we would be better able to evaluate, as to what we think the ultimate high-end operating margin for this business could be.

So just one more point of clarity. There is a very large food service distributor who has done a good job, certainly in their earlier days of building their operating margin to a point that's north of ours. They did it by scale. More volume through bigger centers gives a distribution Company the ability to spread out those fixed costs over a much wider berth, which is the reason why we are intending to build bigger centers. Our York, Pennsylvania center, our Moreno Valley, Southern California center, our new Denver center and our New England center are all what we would consider mega centers, which give us the ability to have that scale. Without it, it would be really hard to do.

That's great color. And I just want to slip one last follow-up question in there, and then I'll yield. Is acquisitions any part of that scale drive? Any thoughts there?

It could be. We don't have M&A in our internal models that help us build the scale. But certainly if those opportunities were there, they would help us get there sooner.

Perfect. Thank you for taking my questions. Appreciate it.

Thank you. Our next question comes from the line of Karen Short with BMO Capital. Please go ahead.

Hi, congratulations on a great quarter.

Thanks, Karen.

Just to follow up on the data that you gave on those three key metrics, I guess what I'm wondering is when you talk about engineered labor standards and the warehouse management system, does this get -- would it get the -- I guess the weaker facilities up to the high end of the ranges in all three kind of categories? Or does it raise what the potential range would be? Maybe can you give just a little bit, and say that, I mean, the same question for your stronger facilities?

Yes, I mean, for the smaller facilities, it's much harder to get them to the higher end of the range, just because they don't have the scale. But they certainly have tons of opportunity to improve. Engineered labor standards by themselves, will drive significant improvement across all of the DCs. Today, we only have engineered labor standards in one location. And so, they apply to all DCs, large and small. On the bigger ones, we know historically that we can continue to drive improvements on those three metrics, as well as quite a few others just through continuous change and continuous improvement in pick pass, and a whole variety of other things. So I would guess, that at some point, there's a limit to how much expense you can take out. But I am not sure that we're even remotely close to that yet.

Okay. And then on the two DCs, Denver and New England, what's the timing on when those will be up and running?

The Denver facility should be up and running by next summer.

Okay. And New England?

And possibly a year from now.

Okay.

And then, maybe a little sooner. And then the New England facility probably, what, late '14 --?

Yes, I mean it will be a fiscal '14 event, where timing, I don't know that we would be able to commit yet. We don't have a defined location as we stand -- as we sit here today.

Okay. And then any update on Ridgefield?

Yes. We're still scheduled for summertime. Things look pretty good, and we are optimistic.

Okay. And then Mark, just with your new credit agreement, is there any update or anything to think about in terms of interest expense?

I would say that effectively, Karen, it would be neutral. We had a term loan with a swap that was locked in at 5.7%. So while the pricing is higher on our new credit facility, it's offset by the -- no longer having the swap in place. So I wouldn't expect any measurable difference, I mean, maybe $100,000 one way or the other. But from a standpoint of what we will be paying, it should be close, just based on where we're currently tracking. I mean, it should keep a run rate we've had.

Okay. And just in terms of next year, any color on what the extra week should do for your -- to EPS next year? Is it kind of $0.03 to $0.04 maybe? That sound about right?

Until I give you sales guidance, I can't really comment from that standpoint. But I mean if, if you were to go back and look, I think it was fiscal '07 or '08 was the last time we had it. You could look at the fourth quarter. I mean, it's generally, whatever the run rate is at that point in time, it's an extra one-thirteenth

Right. Okay. Thanks.

You're welcome.

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

Hi. Good morning.

Good morning, Andy.

I also wanted to ask on the big margin expansion -- pretty basically, I mean you are back -- at least for another quarter, you are back to a period where the whole business for a few years is running at 3.5%. So, is there anything exceptional that helped the quarter? I mean, was it -- beyond the sales leveraging? And it seemed like the business has just stepped up to a new level of operating profit that is closer to it was, in the period that you cited back in '07?

Yes. No, I think, Andy, you certain hit on it with the sales leverage that we got in the third quarter. Historically, the third quarter is always our strongest quarter, and this is no exception. So I think it's attributed to all the work, both on the associates and the operations and the warehouse side, as well as on the SG&A side of it, being conscious of expenses, and continuing to make improvements. So there's nothing exceptional in the quarter, from any perspective.

Is it fair to say the Safeway contract has matured, in the sense that -- I'm not talking about the special or the cost, the on-boarding cost that spoke -- that you carved out -- just the normal cost of getting that business to be efficiently merchandised in the stores, and delivery schedules set up, and routes and so forth?

Yes, we're in a great position with Safeway. I think both companies value the relationship, and we are pretty excited about moving forward.

Okay. So there is no more margin drag, is what I'm really getting to?

No.

It's now fully profitable? Okay.

Yes.

Yes. I mean, as I answered to Scott, there will be from a year-over-year standpoint on the growth side, because we haven't had it. But from a sequential standpoint, there's nothing.

And back to the -- those interesting statistics on throughput, through the supply chain and miles driven, that's not unusual for distributors. And obviously, I think, Steve, you mentioned that over time you build bigger DCs, that is a big source of that structurally. But in the intermediate term, where not every DC is going to be doubled or what have you, what role does the systems installations play in -- if you got the same customer mix and so forth, what role does systems installations play in, in just getting that -- getting those margins to harmonize, getting the lower ones to go up?

Yes, I mean, I would tell you the biggest structural change that we made a year and-a-half ago, was elevating the position of the folks that run our DCs. They used to be operations managers, and we had a variety of departments working in the DCs. They didn't necessarily report to those folks. We changed the job pretty significantly, about a year and-a-half ago to general managers. And as part of that process general managers have responsibility for 100% of what happens in the DC.

We promoted quite a few folks internally, and we also hired quite a few folks from outside to come in and run these centers. And these folks are well-versed on what's required to drive down cost through increased efficiency. So I would tell you the biggest difference in the last year and-a-half has been just the terrific general managers that we have running our DCs.

The second component, is some technology that we put in, which is labor management which is now in 100% of our DCs. And it's just a relatively simple technology platform that allows us to rank speed, accuracy, by selector, by shift. So between labor management and just the quality of the people, that is what has driven the majority of the results. I think we'll see continued lift, as we move the WMS platform in, and engineered labor standards. But that's just going to be a gradual process, that is going to take place over the next several years.

Very good. Lastly, I just wanted to ask about a couple smaller parts of your business. Canada, you talked about doubling it over time, and you did a small acquisition in November that boosted it 5% or so. In that acquisition, I mean I'm just trying to under -- you have talked about the Canadian market as kind of being a hybrid between a distributor and a broker, because there is product exclusivity. In the business you bought, Sethi, was that more of a typical like a fill-in acquisition? So was it more buying a customer list, or enhancing your customer, or is it because of structure of distribution/broker in Canada? You also -- was it more of a products business to existing customers?

And the reason I'm asking that is, it sounds like there is -- I'm trying to understand the structure of the Canadian industry as well. Sounds like it's pretty fragmented, where a lot of these small distributors get pretty good profits, because they kind of have exclusivity on products? Is that how you can kind of -- on the roll up side of growing Canada, is that how you roll up Canada?

Yes. I mean, you are exactly right. Sethi was an ethnic foods company, very similar customer base. We acquired the business. We moved it into our existing distribution center, eliminating a whole layer of costs, and providing the existing customers with a much greater product offering. So, yes, and you are right, again on the fragmentation of the market. There's lots of small SKU-based distributors that we think would do really well under our umbrella, and we're going to continue to do that. So we will grow in Canada by continuing to make some of these smaller fold-in acquisitions. But we still have a lot of customers that we serve in the US, that have retail locations in Canada. And we are leveraging the relationship between the US and Canada, in order to ensure that we take on the distribution in Canada as well, and that's happening. So we'll grow organically by selling more to existing customers, taking on new customers. And we will continue to be acquisitive, by acquiring these smaller distributors that specialize in a very narrow set of SKUs.

Okay. Thank you.

Okay.

Thank you. Our next question comes from the line of Greg Badishkanian with Citigroup. Please go ahead.

Great. Thanks. Two questions. First is, with respect to your very strong sales growth in the quarter, how much of that's coming from organic food industry growing, versus your picking up some market share?

Well, we know that the overall industry is probably growing around 9%. We, inflation at least lately, has been, 3.5% to 4%. So the balance of it is market share gains.

As well as sort of our mix, where we sort of benefit more from categories in which we focus on, versus sort of the overall industry. We've said, Greg, on previous couple of quarters, that roughly 2.5%, taking the benefit of the Safeway business, as well as the disposal of the non-foods, is really the majority of the share gains. I mean there is some other noise in there, picking up some customers and losing some customers. But it sort of nets out to about 2.5%. So if you back that off of the 15.3% for the quarter, you're at roughly 12.8%, with the inflation reflected in there.

Right. And I guess, some of your -- it seems like maybe some of your customers might be growing faster, than the overall industry if you've got like Whole Foods in it so.

Yes.

Yes. The other part is just inflation, if it's growing 3.5% to 4%, I am assuming you'll be able to pass that on? Or are there any categories that have sort of very high levels, double-digit types of inflation where maybe you can't pass that on?

No, at 3% to 4%, it's pretty easy for us to pass it through.

Right. Good. Nice quarter, thanks.

Thanks.

Thank you. Our next question comes from the line of Jason DeRise with UBS. Please go ahead.

Hi, it's Jason DeRise at UBS. A couple questions. One, on inventory days, obviously, it's back below 50, as you said. What's the outlook for the end of the year? I guess earlier in the year, you commented that you didn't think it would end below 50, if I remember that correctly. And maybe if you can give some comments about next year?

No. Yes. No, actually what I was saying, is that it would take us a couple of quarters to get back into that range, by virtue of the investment we had made, (inaudible) for the business we had taken on. I would expect that we probably end up 4Q, in the range of 48 to 49 days, Jason.

Okay. And --

There is a little bit of uncertainty, just in case the sales trends accelerate or slow down, that we can't react as quickly from that standpoint. But I would expect around 48, 49 days.

Okay. Great. And then going forward, is the target still to get to the lower end of the historical range? Or has anything changed about the way that you are servicing your various customers that would prevent that?

No, I think the target -- I'd certainly prefer to be at the lower end of the range. But what's most important is ensuring that our customers are serviced appropriately. So you will generally see, going into the second quarter, that we will start to build inventory. And we will usually be at the high end of the range coming out of the second quarter which includes the holiday season. We may be, again, at the high end of the range or may even exceed it, because we would rather be in a situation where we have to work to get back down to our targeted range, than be in a level where we hit the targeted range, but negatively impact service levels.

Right.

Usually the back half of the year, Q3, Q4, we're in the range. The first half of the year, we're at the high end of the range or slightly above it.

Okay. Great. I want to ask a bigger picture question. But before I do that, I wanted to ask just a very quick clarification. On the CapEx comment that you said, you thought that the run rate would be above the last three years. Was that as a percent of sales, or are you talking absolute terms? Or I think it (inaudible) but --?

The comment was made as a percentage of sales. We haven't given guidance yet as to what the percentage of sales would be. But we think it's probably going to be north of 1% revenue. How much north, we are just not sure yet. Not significantly, but it will be north of 1%.

Okay. I am glad you commented, not significantly, because your rate used to be much higher, prior --

Right.

To those three years. Okay. And then, so the bigger picture question, obviously you have your different retailers growing at different rates. I'm wondering if you're seeing anything that the retailers are doing differently, perhaps on the independents, as supermarkets are increasing exposure to these categories? And as Whole Foods is rolling out their stores, if you're seeing anything different from them as a way to compete?

The only comment I would make, Jason, is the independents tend to be pretty innovative. I think that they also tend to respond fairly slowly to changes in market, whether it be from a price point, new product offering. And I think that's been the case over the last 18 months for the independents. But based upon, I think they grew 9% this quarter, which is pretty strong growth for them. And so, we are starting to see a lot of innovation in the stores. A lot of the independent retailers who may have one or two stores, are starting to open new stores, which we didn't see for a couple years. So we're pretty optimistic. Other than that, we haven't seen a lot of changes in the other two channels.

Okay. Thank you.

Thank you. Our next question comes from the line of Eric Larson with CL King. Please go ahead.

Yes, thanks for taking my question. Steve, I just want to talk about the structure of -- I know we have talked a lot about operating margins this morning, but ultimately the operating margins will depend upon the industry structure. And you referred to a large distributor, who we all know this morning, that has margins higher than yours. The good thing is that your margins are higher than a traditional wholesaler.

But at the end of the day, and I remember you talking about this at Performance Food Group, the ultimate margin structure that you will achieve, is the level of service that you can provide to that customer and charge for. And at the food service level, they can menu plan, and do a lot of other things for restaurants, et cetera. Can you just kind of compare and contrast, the types of service levels in the natural organic distribution side that you can provide, that would be different from a traditional wholesaler? And where you might sit relative to a food service provider in that same context?

So let's see, let me try that one. I think number one, the expense structure is very different between the two industries. And I would tell you that the opportunity, the biggest opportunity to increase our operating margin is to continue to take costs out of the system. Because when you look at our cost structure today, versus the cost structure at a typical food service distributor, ours is higher. There is a whole variety of reasons behind that, but ours is higher. And I think that we can continue to do a lot of work that drives up service level, but also takes out cost.

On the service side, again, totally different model. We tend to deliver much bigger deliveries, with very different equipment. We also tend to provide added value services, which in many cases the customer pays for, in field sales charges which kind of complicates the gross margin and expense line. I think that the trend -- and I think I talked about this, the trend is for the full service programs to gradually go away, as retailers need to meet a certain price point.

So there are some structural differences between the two businesses. But at the end of the day, the DCs are the DCs. And other than the fact that our DCs have many more slower moving SKUs than food service, I think there's a ton of room for us to bring down our expense structure to get more in line with your typical food service distributor so.

Okay. Just to follow up on that. And I am assuming that you are referring to the expense structure of the food service side, is that they need many, many, many marketing associates. They need a higher sales organization expense line, than what you all need at UNFI. I assuming that is what you mean. And with that, you're saying that your expenses are higher, than what you classify as a traditional food service operator, and that the opportunity really is kind of in that whole arena?

Yes, it's more -- if you look at the expense, our overall expense structure versus the overall expense structure at a food service distributor, ours are higher --

Okay.

Today. Regardless of whether it's because of territory managers, or a whole host of other issues.

Okay.

Ours are higher. I think that that is where our greatest opportunity is, is to increase our operating margin.

Okay. Thank you.

Thank you. (Operator Instructions). And our next question comes from the line of [John Rich] with JPMorgan. Please go ahead.

Hi, I was wondering if you could talk about the cadence or the phasing of sales trends throughout the quarter by month, even if just structurally? And then, were there any big new product launches in the quarter that drove the top line strength? Thank you.

John, generally, we don't provide month-to-month. So I wouldn't want to break with that now. I think we could say that the sales trends were relatively consistent during the period. But we have not historically, nor would I want to break with that now, and provide month to month sales. With respect to individual products and anything that was launched, we carry such a wide assortment of products that no individual product really has significant impact. In any given month, we can add anywhere from 700 to 1,200 SKUs, and discontinue just as many. So with north of 60,000 SKUs overall, no single SKU really has the significant impact, or even a 100 SKUs don't necessarily have a significant impact on the given quarters.

Now the trends that we've seen historically and for the last few quarters, with respect to gluten-free, as well as the Greek yogurts, a lot of products with coconut water, I mean those trends hold strong. And if you were interested in learning a little bit more, sort of in some of the broader categories, I would recommend that you go to our website, where we have a trends video that we put out quarterly, that we talk about what some of the individual trends are. But from a standpoint of individual new product introductions, nothing occurred during the quarter that would have a material impact on the results.

Thanks. Congratulations, again.

Okay.

Thank you. I am showing no further questions in the queue at this time. I would like to turn the conference back to management for any final remarks.

I want to thank you for participating in UNFI's third quarter 2012 earnings call. Have a terrific summer. And we look forward to discussing our full year results, and forecast for fiscal 2013 later this year.

Thank you. Ladies and gentlemen, 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 4538642, followed by the pound sign. Thank you for your participation. You may now disconnect.