United Natural Foods Inc (UNFI) 2012 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the United Natural Foods fiscal 2012 fourth quarter results conference call. During today's presentation, all parties will be in a listen-only mode. Later, we will conduct a question-and-answer session.

(Operator Instructions)

This conference is being recorded today, Tuesday, September 11, 2012. I would now like to turn the conference over to Scott Eckstein from Financial Relations Board. Please go ahead, sir.

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; Mark Shamber, Chief Financial Officer; and Sean Griffin, Group President. 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 again to UNFI's fourth quarter and full year fiscal 2012 conference call. Our industry is growing. Demand for the natural organic and specialty products are accelerating. And UNFI's performance during fiscal 2012 was strong. Sales for the year grew almost 16% to a Company record $5.24 billion, while operating income grew by almost 20%.

For fiscal 2012, UNFI's operating margin grew 10 basis points to 3.1%, and our diluted earnings per share grew 15.5% to $1.94, on a higher share count. For the quarter, sales also grew by 16% and diluted earnings per share grew 19% to $0.51, excluding the restructuring and impairment charges in the fourth quarter of 2011.

Since 2010, UNFI's sales have grown over $1.4 billion or 40%. Our strategies are working. And our business continues to outpace the growth of the industry, as UNFI continues to expand its customer base and its product offerings.

Our teams executed extremely well against our targets for growth during the quarter and for the year, and several of our divisions performed extremely well. Net sales from Canada's -- UNFI Canada's broadline distribution grew 18% for the year, including the benefit from the first of several strategic acquisitions that I'll talk about shortly. Albert's Organics grew net sales by 16% by distributing fast growing organic produce and all-natural proteins. On the UNFI brand side, our Field Day brand, available only to our independent retailers, grew over 80%.

We remain focused on our core strategies. Enhancing our market share is our lifeblood. We accomplish this through new customer wins, through product extensions with existing customers and integrating geographic and product specific acquisitions. As a result of this strategy, UNFI sales grew almost 16% for the year, far outpacing the growth of the industry. And a comment on inflation, moderated towards the end of the fiscal year from a quarterly high of 4.4% in Q2 to 3% in Q4, reflecting underlying demand as the driver of our sales growth.

All of UNFI's core channels of distribution grew heartily through increased same store sales and new store openings. During 2012, UNFI successfully added specialty cheese and natural protein to its product offering and integrated specialty foods throughout North America. Today, these product categories represent approximately $150 million in added value -- added revenue. This strategy, as well as the introduction of specialty foods, has enabled UNFI to effectively compete in the conventional supermarket channel.

A critically important customer segment for UNFI is the independents. For the fiscal year, our sales to independents grew 9.1%, and even more encouraging, sales in this channel increased to 9.5% during the fourth quarter. UNFI has significantly ramped up the hiring and the training of territory managers and retail category managers to support this important customer group. And we are really committed to helping independents grow, expand, and compete with data, technology, and incredibly talented people.

Acquisitions are also an important part of UNFI's growth strategy. During fiscal 2012, we acquired B.K. Sethi distribution limited in Canada, and more recently, we acquired Disley Food Services, a Canadian distributor of dairy products. Each of these companies provided UNFI with additional expertise and product offerings and have been folded into our existing distribution network. These acquisitions in Canada serve as enablers towards further enhancing our position as the number one distributor of natural, organic, and specialty there.

In August, we also acquired certain assets of Purity Organics, also known as Pacific Organic Produce, based in San Francisco. Purity is the industry leader in sourcing and marketing of organic produce and will be merged into our Albert's Organics division. UNFI's Albert's division has been delivering very strong results in delivering highly perishable foods throughout North America.

And just last week, we completed the acquisition of Honest Green. Honest Green represents UNFI's entry into the distribution of natural and specialty products on a business-to-business basis via the Internet. By merging Honest Green products with UNFI's products, retailers will have the broadest product offering available for drop ship and fulfillment. And more exciting is the Internet-based opportunity this acquisition brings to our independent customers. We expect Honest Green to be merged into our select nutrition division early next year.

The key to our success during 2012 was our team's ability to reduce cost at a rate that was greater than the decline in our gross margin. This was a challenge that we've talked about during our calls and conferences over the last several quarters. For 2012, our gross margin fell 72 basis points. However, our operating expenses fell 80 basis points year over year.

During the fourth quarter, gross margin declined by 137 basis points, and operating expenses decreased by 148 basis points, including the restructuring and impairment charges in the prior comparable period. This was accomplished through enhancements made to our warehouse operating systems, labor management, and most importantly, the quality and the dedication of our operations teams throughout the United States and Canada.

Additionally, we recently converted our Richfield, Washington, center onto UNFI's newest technology platform. Based on the success of this implementation, we're confident that the roll-out to our remaining DCs will continue throughout the next several years. Over time, our new system will significantly improve service levels, productivity, and serve as our platform for continued standardization of supply chain and logistics.

During the fourth quarter, we implemented a new transportation management system designed to more efficiently manage our in-bound supply chain. More specifically, freight that moves product from the point of manufacture to UNFI's distribution centers. We did experience some disruption, which appeared in our gross margin, during the initial go-live. However, we are confident that these issues are behind us and the application will serve as a long-term driver of gross margin. As perspective, UNFI manages over 50% of its in-bound freight, and this system will drive efficiency through procurement of third-party freight, UNFI freight consolidation, and receiving.

As a result of our compounded three-year sales growth of 15% and our expectations for future growth, UNFI will be embarking on a three-year plan to increase capacity to meet forecasted demand. Our new facility in Denver, Colorado, is underway, and we expect to announce added facilities in the Northeast, Midwest, and Northern California within the next 6 to 12 months. Operating costs for bringing Denver online and moving our Albert's New Jersey facility are embedded in our 2013 guidance.

Mark will provide some specific CapEx guidance for fiscal 2013 shortly. However, our plan is to manage CapEx as a percentage of revenue closely, adhere to a range of 1% to 1.3%. Our CapEx during fiscal 2013 will be approximately 1.1% to 1.3% of revenue. We view this need to add capacity as a terrific opportunity. Our history demonstrates that with added capacity comes lower cost to serve local markets and increased sales growth to support growing demand.

We also have been committed to maintaining a strong balance sheet, providing flexibility to grow through acquisition, increased inventory, and CapEx. Our debt to EBITDA is less than 1 times, and the Company created approximately $35 million of free cash during fiscal 2012.

In summary, I am really proud of our teams. While delivering exemplary financial results, we also continued to expand our sustainability and philanthropic initiatives. During the year, we announced UNFI's Foundation to promote healthy organic and sustainable food systems. Additionally, we'll be installing a 1.12-megawatt solar power plant, powering over 30% of our distribution center, on our Southern California facility, and we will be striving towards LEED Certification on our new Denver DC.

Driven by strong sales and our ability to manage expenses, UNFI's operating profit grew almost 20%, and our operating margin grew by 10 basis points to 3.1%. Earnings per share on a year over year basis increased 15.5% and $0.26, despite a higher share count resulting from our secondary offering, completed in October 2010. And for perspective, our stock price since the secondary offering has moved from approximately $33 to approximately $60 per share.

We remain confident that our annual objectives are attainable -- sales growing at 10% to 15% per year; EBIT growing 10% to 19%; operating margin expanding at 9 to 12 basis points per year; CapEx range of 1.1% to 1.3% of revenue; and free cash at $30 million to $50 million per year.

Looking forward, our data points, to increase demand in organic, natural, and specialty products as consumers seek out healthier alternatives with ingredients that satisfy their own tastes and desires. And during 2013, we expect revenue of $5.88 billion to $5.98 billion and earnings per share of $2.14 to $2.24. Now I'll turn the call over to Mark to provide additional information on our fourth quarter fiscal 2012 and give guidance related to fiscal 2013. Mark?

Thanks, Steve. Good morning, everyone. Net sales for the fourth quarter of fiscal 2012 were $1.34 billion, which represents growth of 16% or approximately $185 million over the prior year's fourth quarter net sales of $1.16 billion. As Steve mentioned, inflation declined significantly sequentially, as inflation was 3.01% for the fourth quarter, compared to 4.43% in the third quarter, a decline of 142 basis points.

On a year over year basis, inflation was up 80 basis points. For fiscal 2012, net sales totaled $5.24 billion, yielding sales growth of $706 million or 15.6% over the prior year. Excluding acquisitions, fiscal 2012 growth was 14.9%.

For the fourth quarter of fiscal 2012, the Company reported net income of $25.1 million or $0.51 per diluted share, an increase of approximately 46.4% or $8 million over the prior year. As a reminder, the prior year's fourth quarter included restructuring expenses associated with the disposal of our non-foods business and the write-down of our Harrison, Arkansas, facility, totaling $6.3 million or $3.7 million net of taxes.

After adjusting for the prior year restructuring and asset impairment costs in the fourth quarter, net income increased by $4.2 million, a 20.1% over prior year net income of $20.9 million or $0.43 per diluted share.

Our sales by channel remained strong across all of our primary channels in Q4. Sales to the supernatural channel increased by 17.5% over the prior year's fourth quarter and represented 36% of sales for the quarter.

Independent sales rose by 9.5% year over year, and independents also represent approximately 36% of sales. Our supermarket channel experienced growth of 24.6% and now represents approximately 23% of sales, and food service grew by 23.6% over the prior year and continues to represent approximately 3% of sales.

For fiscal 2012, supernaturals represent 36% of sales, independents represent 35% of sales, supermarkets represent 24% of sales, and food service represents approximately 3% of sales.

At 17.2%, gross margin for the quarter was down approximately 1.4% compared to the prior year's fourth quarter gross margin. The primary drivers of gross margin on a year over year basis were some purchasing and logistics inefficiencies, combined with a continued shift in the growth mix of business towards supernaturals and conventional supermarkets. Gross margin for fiscal 2012 was 17.5%, compared to 18.2% in the prior year, a decline of 72 basis points.

Our operating expenses for the quarter were 14% of net sales, compared to 15.5% for the same period last year, after adjusting for the $6.3 million in restructuring expenses. This represents a 150 basis point improvement over the prior year, as operating expenses benefited from continued year over year improvements in our warehouse throughput and our cost per case, further leveraging of our fixed costs, and both slower growth in our consumption of diesel fuel, as well as moderating increases in the cost of diesel.

These savings are partially offset by higher workers' compensation and incentive compensation costs, along with rising health insurance expenses, due in part to the new rules phasing in as part of 2010's healthcare legislation.

Excluding our Canadian business, which involves the use of third parties for deliveries in certain regions, diesel fuel had a positive impact of 2 basis points on operating expenses in comparison to the fourth quarter of fiscal 2012 -- fiscal 2011.

Fuel represented 82 basis points of distribution net sales in the quarter, while our fuel costs increased by 3 basis points sequentially. Nationally, our diesel costs -- our diesel fuel costs in the fourth quarter of fiscal 2012 increased by approximately 5% from the prior year's fourth quarter, while the national average price increased to $3.81 a gallon, a decline of 4% compared to the $3.97 a gallon that occurred in the fourth quarter of fiscal 2011 per the Department of Energy. The increase in our cost during the quarter was a result of entering into higher fixed price contracts in fiscal 2012 compared to fiscal 2011.

During the quarter, we recorded share based compensation expense of $2.4 million, compared to $1.8 million in the prior year, representing an 18 basis points of net sales in the fourth quarter of fiscal 2012, compared to 15 basis points in the prior year's fourth quarter.

Adjusted for our previously mentioned restructuring expenses in the prior year, operating income of 3.2% for the fourth quarter of fiscal 2012 represented a 12 basis point improvement over the prior year's operating income of 3.1%. On a GAAP basis, operating income improved by 66 basis points over the prior year, when operating income was 2.5%. Interest expense in the quarter of $1.2 million was essentially flat compared to the prior year and was 5% higher sequentially.

As I covered on our third quarter earnings call, during the fourth quarter, we successfully entered into a five-year amended and restated senior secured credit facility agreement in May with a $500 million limit. As part of our new credit facility, we repaid our term loan and terminated the associated interest rate swap. Both the term loan and the interest rate swap were due to mature in July 2012.

Under the new facility, our borrowing costs are approximately 50 to 100 basis points higher, depending on usage. However, we expect our overall cost to be close to neutral, due to savings generated by terminating the interest rate swap, which was at a higher rate.

Other expense represented an increase of approximately $885,000 over the prior year, due to weakness in the Canadian dollar and its impact on our Canadian operations. Our effective tax rate for the quarter was 39.5%, while our fiscal 2012 effective tax rate remained at 39.4%.

Capital expenditures were $11.5 million for Q4 and totaled $31.5 million or 0.6% of revenues for fiscal 2012, which is favorable to our target of approximately 1% of revenues. Fiscal 2012 CapEx expenditures came in lower than we had previously guided due to delays in two projects.

We experienced delays in permitting associated with our new Aurora, Colorado, facility, which was announced in a separate press release this morning. And our planned installation of solar panels at our Moreno Valley, California, facility was delayed as we addressed concerns by the landlord. Both projects are now moving forward, and the associated capital expenditures will be incurred in fiscal 2013.

The Company's outstanding commitments under our credit facility were approximately $142 million, with available liquidity of $358 million, including cash and cash equivalents. For the quarter, we generated positive free cash flow of $90 million, and for fiscal 2012 free cash flow came in at $35.2 million, which was at the low end of our target range for the year. Inventory days on hand improved by almost 2 days at just under 50 days, as inventory levels declined by $61 million sequentially, associated with lower sales volume.

As discussed in this morning's press release, the Company also has provided its financial outlook for fiscal 2013 ending August 3, 2013, which will be a 53-week fiscal year. For fiscal 2013, the Company expects net sales in the range of approximately $5.88 billion to $5.98 billion, an increase of approximately 12.3% to 14.2% over fiscal 2012.

GAAP earnings per diluted share for fiscal 2013 are expected to be in the range of approximately $2.14 to $2.24 per share, an increase of approximately 15.1% to 20.4% over fiscal 2012 GAAP earnings per diluted share of $1.86.

Excluding the impact of the fiscal 2012 expenses associated with the restructuring of the unified specialty and startup expenses associated with on-boarding a national customer, fiscal 2013's earnings per diluted share represent an increase of approximately 10.3% to 15.5% over fiscal 2012 earnings per diluted share of $1.94, excluding those expenses.

Included in our fiscal 2013 earnings guidance is approximately $5 million to $5.5 million of non-recurring expenses associated with our new Aurora facility and a new facility for our Albert's Organics division, of which $3.5 million to $4 million are duplicate rent payments, with the remaining balance comprised of relocation costs to consolidate the existing facilities in the back half of fiscal 2013.

Finally, CapEx is expected to be in the range of approximately 1.1% to 1.3% of revenues or approximately $70 million to $80 million during fiscal 2013. At this time, we'll turn the call back over to the moderator to start the question-and-answer session.

Ladies and gentlemen, we'll now begin the question-and-answer session. (Operator Instructions). Our first question is from the line of Scott Mushkin with Jefferies & Company. Please go ahead.

Hey, guys, thanks for taking my questions. So I guess the first question is where you ended, Mark, why the GAAP guidance versus kind of GAAP and then non-GAAP with the charges. Are you guys just trying to direct everyone towards GAAP at this stage?

Yes, I mean, the issue, Scott, is that for those that have followed the Company for a number of years, we used to call out the start-up expenses for new facilities, whether they were duplicate costs and/or relocation costs. And we actually got a comment letter on that topic about three or four years ago from the SEC.

And the arguments, as they relate to sort of the non-recurring costs, are that if you have them in more than every two years, they shouldn't be viewed as non-recurring. And while we don't open a new facility or the same facility, we don't have an issue every two years. We do tend to open facilities less than two years apart.

So as part of that comment letter, we've stopped referring to them from a non-GAAP standpoint, because that was the direction we got from the SEC. So we call it out. We list the information from an investor standpoint, because we think it is important. They're not ongoing operating expenses. But from the SEC's standpoint, they felt that those should not be viewed as non-recurring.

And the follow-up to that, thank you for the clarity, and the follow-up to that, the $5 million to $5.5 million seemed pretty large. Is this a -- if you were going to kind of think over the next few years, is this on the larger side of what we should expect as one-time recurring charges?

Scott, this one's a little bit unique. We're actually merging three existing buildings into a singular building, so a lot of it is move costs associated with actually combining those three separate centers into one.

And the way it works, Scott, is in this particular case, we're building from the ground up in this location. But because we're overseeing the construction, we have to start incurring rent expense immediately, even though as we sit here today, we haven't even -- we only broke ground, and the actual official ground-breaking is tomorrow.

So we're already taking rent expense from straight-lining rents, even though there's not even a frame of a building up yet. So it's just an instance of how the accounting rules sometimes come into play, where we've got to take rent expense starting now, even though we won't occupy the building for 9 to 10 months.

I think your friends in Austin are very well aware of those accounting rules (multiple speakers).

Yes, they impact many of us.

Okay. So second line of questioning, if I was going to look at gross margin, I think you guys said there was some one-time stuff. I don't know if you want to give us some highlights there. But it does look like that maybe there was some one-time stuff in SG&A to offset that. There's a pretty large reduction in the fourth quarter in SG&A expenses.

So I was wondering if you could just give us some color with the big movements around gross margins and SG&A in the fourth quarter. How much is one-time, how much were you just stretching to make a quarter, as someone called and told me or asked me is that what happened here? Maybe you could respond to that, and then I'll yield. Thank you.

I'll answer the portion about the expenses, and I'll let Steve or Sean cover the margin side of it. I think people forget some of the challenges that we had in fiscal '11 and how the year played out. So the reality is, is that fiscal 2011's fourth quarter expenses were higher from a run rate standpoint than where they really would have been. Just to revisit, the first quarter of fiscal 2011, we opened up the Lancaster facility. We had some challenges there, and we talked about the fact that in the first half of fiscal 2011, we were accruing below run rate from an incentive comp standpoint, because we were behind our own plan.

In the back half of fiscal '11 we actually had much stronger results. And as a result of that, the expenses from an operating standpoint were not necessarily higher, but we did have to accrue for the bonuses and the incentives that were associated with that.

So the back half of fiscal 2011 in both the third quarter and the fourth quarter had a much higher level of incentive comp than they had this year. If anything, we didn't -- we had some extra charges that -- not extra, but some items that hit us in the fourth quarter associated with redoing the credit facility where we took write-offs of $600,000 in the quarter versus any scenario where we were stretching to make the quarter.

From our standpoint, had we executed a little bit better and not done a couple of things, we may have been at the high end of our range from an earnings standpoint.

And then on the gross margin, we still have a lot of noise around a lot of the lower margin business that's been on-boarded during the last, let's call it 18 months, that is still being flushed through the system that's negatively impacting our gross margin.

During the quarter, we actually implemented a new transportation management system that I referenced in the commentary, which is a critically important tool for us to more effectively manage the costs of our in-bound freight and the way it gets flushed through gross margin.

Whenever you install a new system, it takes a little while to train up the associates to use it as it was intended, so we had a little bit of that noise going on as well. Sean, any other commentary on TMS?

Well, I think, again, Steve, as you outlined in your initial comments, UNFI manages over 50% of our in-bound freight. So when we're experiencing a learning curve, that creates some short-term pressure. We did experience that. I feel confident that our teams have covered that and flattened that curve and that the system is working as it's intended today. And as we look forward, we'll pick up the efficiencies that we had designed in the model.

Great. Do you guys want to quantify any of that for us?

You know, not really, because it's a very hard number to get our arms around, and we certainly wouldn't want to be held to that.

Yes, it's a little bit subjective, Scott, as to when there are issues on backhauling as to would it have occurred even without the system. And that's where we wanted to speak to it in generality that it was a big element for the quarter but not necessarily put a hard number on it where it might be a little more subjective as to the actual number. But a range we felt we were comfortable, that it might have been a third to 40% of the impact in the quarter.

Thanks very much, guys.

Thank you. Our next question is from the line of Meredith Adler with Barclays Capital. Please go ahead.

Thanks for taking my question. I'd like to go back and talk a little bit about distribution. It sounds like you're going to have a lot of projects underway in coming years. I don't know how soon you're planning to start on the three facilities you mentioned. Are we likely to see costs in 2013 associated with that -- those facilities?

Well, we're looking at Denver in this fiscal year. We're looking at another facility in the fiscal year '14 and another facility in fiscal year '15. So there will be a little bit of cost associated with those moves in each one of those years.

On the comment earlier, Meredith, this building in Denver is a little bit unique, just because of the magnitude of the move, just because we have three buildings merging into one. The other ones won't necessarily be a move, a wholesale move, but more a folding out of business from part of one DC to a new one. So there will be some costs. I'm not sure that they'll be to the level of the costs associated with Denver.

Okay. I guess that makes sense. Could you talk a little bit about the capital cost for Denver and how you think those other facilities will compare? And then maybe talk about the free cash flow that you guided to for 2013. I assume that's net of the CapEx cost.

Yes, free cash is net. I'm sorry, your first question?

What is the cost for the facility and the others you're planning?

Well, I mean, I think it -- there's not an easy answer. It depends on the size of the facility, and it depends on whether we lease versus own it, and the decision varies by market.

In the case of the Denver facility, the portion of the construction that ends up being on our books under the current accounting rules is probably in the range of $15 million to $20 million, of which probably 75% of that is construction and the other 25% of that is racking and equipment that goes into the building. But we've talked in the past that when we put on a, say, a 400,000 square foot building and we've owned it, the cost could be in the $30 million to $40 million range.

Just as a point of clarification, while we're putting about $15 million into the Denver facility, the total cost of construction is probably in the $50 million range.

$50 million.

So this is a leased building.

It's a $50 million building. This is a leased building with UNFI contributing about $15 million of the improvement.

Got it. Okay. And then I have to say that I ended up still being somewhat confused about expenses and gross margin. It sounds like -- I don't know. What would you describe as being a permanent change, something that's fundamental to the way the business is running within what we saw in the fourth quarter in the gross margin and the SG&A?

Well, I mean, I think generally speaking what we would like to see happen over the next year or two years is the stabilizing effect in the gross margin. And we will not have the same kind of expense leverage that we've had over the last 12 months, because we took a lot of expenses out of running our warehouses. And I think that that's going to happen directionally, primarily because we've on-boarded the majority of the conventional lower margin business. We lap that, the latest chunk, I think in --

Beginning of October.

Beginning of October. So that should give us the ability to see some stabilizing in the gross margin, and I think as a result of that as well, we'll see a much lower degree of expense savings. But I think that our objective is to continue to make sure that the costs reduce at a rate that's greater than any further reduction in the gross margin. I think as far as the SG&A, I think the bulk of the SG&A in comparing year-over-year was related to incentive comp, '11 to '12.

Okay. And you're confident now that, given everything you've been doing and are going to be doing, that you will be able to achieve sort of a matching of gross margin decline and expense decline?

I mean, that's the hope. We certainly had a great deal of success in 2012. We had some success to a lesser degree in 2011. All of the data points to -- we've lapped all the new conventional business that's come on board. We're seeing some growth in the independent channel that we hadn't seen before. So without being able to look into the crystal ball, I would say that that's the direction that we're moving.

I'm sorry, I'll just be selfish and ask one more question. That does seem to imply that you are not anticipating bringing on any more large conventional customers or even small conventional customers.

Well, I mean -- we didn't -- we certainly didn't give guidance to that, and that's certainly not what I'm suggesting. We don't have any large scale supermarket on-boarding scheduled, certainly for the next quarter. What happens thereafter, I really can't comment on. But I would still say that we're accountable to making sure that those expenses drop at a rate that's faster than any further decline in the gross margin. But there's nothing on the horizon, Meredith, that would cause us to think that what I just said isn't going to happen.

Wonderful. Thank you very much.

Thank you. Our next question is from the line of Sean Naughton with Piper Jaffray. Please go ahead.

Hi, thanks for taking the question. When you started the conference call, you said organic and natural food trends are accelerating. I was just wondering if you're referring to continued acceleration in the business that we've seen to start the first quarter, or was that really more of a review of fiscal year 2012?

And then secondly, anything in terms of merchandise trends in the quarter, in the fourth quarter, around organic food or specialty foods that you saw? And what do you think some of the opportunities are in those categories for 2013?

Yes, I mean, we obviously had a very strong '12, and I did -- was referencing, so you caught that properly, that we have seen continued accelerated growth in the first quarter, so over the last several weeks, by about 100 basis points. So we're very optimistic that the demand is continuing.

As far as product categories, it's still the same ones. It's organic produce. Demand for organic produce is fantastic. Organic dairy, which includes all of the yogurts, are still doing quite well. So I wouldn't call out any special category -- any certain category that's growing more than it has in the past 12 months, but the demand is accelerating, which is fantastic.

That's great to hear. I guess on the -- Mark, maybe the inflation outlook for 2013, how should we think about that line item? And are you hearing anything from suppliers around potential price increases that are coming through the supply chain? Thanks.

I think from our standpoint, inflation dropped off a bit faster than we had expected in the fourth quarter. We had previously indicated we thought it would be at 3.5% to 4%, and we ended up closer to 3%. As we go into fiscal '13, I probably wouldn't be comfortable looking out beyond the first six months. But I think it's probably in the range of 2% to 2.5%, maybe 2.75% for our first and second quarter, which gets you through January.

We have seen a couple of our suppliers, couple of our largest suppliers putting through price increases in the range of 2% to 3%. But what that effectively does is it keeps us in that 2% to 3% range. It doesn't really lead to any noticeable uptick in inflation. So as we sit here right now, that's our expectation for the next six months, and beyond that it gets a little more difficult to project.

Fair enough. Thanks for taking the questions, and best of luck this year.

Thank you.

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

Thanks for taking the questions. First one, can you address the potential strike situation at Auburn and how much you've maybe accounted for that in your fiscal '13 guidance?

Yes, I mean, there was a press release put out yesterday by the Teamsters, rejecting our latest offer. The commentary, Ed, is that we've got a long-term relationship with this union. We've been negotiating for five months. We feel as though we've put an extremely fair and equitable offer on the table, which unfortunately they rejected.

We have agreed to go to mediation to try to resolve the differences, and we're prepared to service the customers in any way we have to, in any circumstance that comes our way. It's very difficult to ascertain the costs, because we're in active negotiations, and so we're not really sure how this is going to play out. So other than to say we're prepared to do whatever we have to, I think it would be unfair at this point to talk specifically about any costs that we may incur.

Okay. Although I mean just to be fair, last quarter you kind of did give a potential cost impact for fiscal '12, so I guess it's not entirely clear why you couldn't do it for fiscal '13.

Well, I mean, I think generally speaking, we felt and still feel confident that we're going to get this thing resolved. So I guess the short answer to your question is there's not a considerable amount built into our '13 budget. So we feel like we're just going to have to see how it goes.

Okay. That's fair. And then on the Ridgefield conversion, it sounds like that went fairly well. Is there an opportunity to maybe kind of with one under your belt to maybe accelerate the roll-outs maybe more quickly to other DCs than you had planned in the past? Or can you maybe just kind of give a little bit more commentary around just how that conversion went, relative to your expectations?

Ed, good morning, this is Sean.

Hi, Sean.

We're very pleased with how the implementation went in Ridgefield. Our plan all along and continues to be worked is to evaluate the performance. We have a very specific dashboard for measuring our production volume and -- as well as service levels in Ridgefield versus where they were prior to, make sure we're gaining the efficiency. We're kind of in the optimization stage for the next 60 days or so.

We're presently evaluating where we go next. We haven't determined where that will be, but our game plan today will be one or two additional go-live WN installs in FY '12. Of course, we're also looking at standing up a new distribution center in Denver that we've previously discussed.

I would say that, Ed, we learned some lessons from Lancaster, and so we're taking an extremely conservative approach. And we're comfortable with one to two, and I think that's probably a pretty good goal for us.

Okay. And then just my last question is a follow-up to Scott's earlier question about the operating expense leverage. So I understand kind of the year-over-year comparability dynamics that you spoke to. But if you look at like the operating expense dollars in Q4 on a sequential basis, they did come down. And like the last few years, there's maybe been like one year where that's happened. So was there anything unique on a sequential basis that we should consider as it relates to the operating expenses in Q4?

No.

Thanks.

Thank you. Our next question is from the line of Robbie Ohmes with Bank of America Merrill Lynch. Please go ahead.

Hey, guys. Good morning.

Good morning.

Just a couple quick follow-ups. I was wondering if for the fiscal '13 guidance you gave, should we assume similar growth rate assumptions for supernaturals, independents, and supermarkets?

I think the mix -- if we could predict the mix, Robbie, we would be much better at predicting sort of where the gross margin's going to play out. I think the only comment I would make is, I don't see anything foreseeable changing on the supernaturals or the independents, at least as relates to the overall trends.

The conventional supermarket growth will certainly slow starting in the first quarter, once we annualize the business that we took on. So we'll have two months where we're comping against not having that business, and then beginning in October, we'll have annualized it. So you will definitely see the conventional supermarkets slow down while the rest of the business, barring some shift in the overall trends, should stay at roughly the same rate.

And then on adding the capacity, the Northeast, Midwest, Northern California, are you foreseeing in that, are there new customers that you're seeing a couple of years out that you're targeting? You mentioned some of that being a growth driver, maybe a little more detail on what's driving that. Or is it just a situation where your existing structure is overburdened?

We're growing. We grew almost 21% last year and almost 16% this year. There's a certain level of growth that you need to expand to keep pace. We don't want to find ourselves in the situation that we did in '05, '06, where we were doing two or three facilities a year, because we didn't keep pace with the growth.

Based on all the data points and the analysis that's been done, it certainly points you to continued industry growth of roughly 7% to 9%. But just based on the industry growth alone, we're going to have to make sure that we have the capacity in the right markets to meet the increased demand.

We also know that there's a tremendous amount of continued opportunity for us in customers that we don't currently service or service to a much smaller degree than we'd like. And we've got to have the capacity available in order to take advantage of those opportunities when they come our way. But we can't operate facilities at 95% capacity, because the cost of doing that just doesn't make sense. It's very hard to run a distribution center efficiently at 95% capacity.

Last question, obviously with Safeway coming onboard, that's supporting the supermarket growth. But can you give us a sense, the sell-through rate in the supermarket business, because it's obfuscated by the on-boarding of Safeway? Is the sell-through rate in the supermarket business in line or above or below what you would have thought it would be?

I think when we look at the comps ex the new business that we've taken on, we find that the supermarkets are growing a little bit faster than the independents. And part of that is because they continue to expand the number of SKUs that they're carrying, whereas the independents, really, they're not -- they're trading off one SKU for another. So as natural and organics continue to gain adoption with the consumer, the supermarkets grow a little bit faster than the independents from that standpoint. But stripping out the new customer, they're in line probably a bit faster.

Got it. That's very helpful. Thanks so much, guys.

You're welcome.

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

Thanks. Good morning.

Good morning.

In your comment talking about how you look at margin to play out this year, that sounds like it's in relation to guidance and not into sort of what's going on in the market. So I was wanting to ask you, as you look at the market for conventional chains and contracts that might be up and ones that you control -- you're providing or ones that competitors do, what the landscape kind of looks like, number one.

And related to that, are you implying that if you add a large new supermarket chain, what does that do to contribution margin? You're running a little over 3%, 3.1% EBIT margin. Are you implying that it's dilutive, neutral or -- I know it obviously depends a lot on the bid and so on, but overall, what are you trying to tell us about whether that's -- what effect that has on the current operating margin?

Sure. Well, let me answer the second question first. One, we're not implying that we're adding any new supermarket business. Certainly, that's not in our guidance. Two, and more importantly, I think that if we did look to take on another chunk of supermarket business, it would have to be accretive to our existing margin.

We would not take on at this point of the game a supermarket chain that we would go into the relationship knowing that it would be dilutive to our 3%-plus operating margin. That's just not something that I think we're interested in doing.

As it relates to the landscape for the new business, there's still tons of opportunities out there for us. We're very actively involved throughout the United States and Canada in terms of meeting with the likely candidates. There will be some business that comes up for bid during the year, and we'll be an active participant. But I just want to make sure everybody's on the same page. There's no implication that we're going to add a large chunk of supermarket business in our guidance.

I realize that. I just wanted to get the margin question answered. I appreciate that. Kind of to piggyback on Robbie's capacity question, and if you answered this and you're repeating it, I apologize. But are there parts of the country, like Denver, the Rockies, where you're kind of at that 95% capacity? Or do you have the ability to do a decent chunk of new business in the market -- in a market, let's say, like Colorado?

Look, if we get an opportunity and it's a viable opportunity, we're not going to walk away from it because of capacity. But having said that, Denver is a great example of where we have a building at 90%-plus capacity.

More importantly than the capacity issue in Denver is the inefficiency related to what we're doing in Denver, because we're shipping out of three different buildings, and that is really tough to make work, especially when all three of the buildings are at capacity. This one's going to make sense, just from the pure optics of merging them all into one facility versus trading as three.

In subsequent new construction, it will be a combination of adding capacity in an adjacent facility and also adding capacity in a market that we don't currently play in. And the reason that we'll look at doing that is because in some circumstances, the transportation costs -- in other words, being closer to the consumer -- are a much better way of adding capacity than just building on an addition. And so those are essentially the two ways that we'll look at adding capacity in the markets that we talked about.

Got you. If I could just ask a quick housekeeping on Denver. Is the rent expense cash, or is it a full rent holiday until the distribution center is up and operating? Or is it sort of somewhere in the middle?

It's not cash. But it's not -- at this point, it's not even a rent holiday. Because the way the agreement is written with the landlord, we don't start getting the holiday until we're able to occupy the building. But the way the accounting rules work is because we're controlling the construction, we're deemed to take possession, even though right now it's just open pasture land. So we're paying rent -- we're straight-lining rent or incurring expense for a building that doesn't exist that hasn't broken ground officially until tomorrow. We love that rule.

So there's no rent -- no cash rent. That $4 million, $3.5 million to $4 million is a non-cash number, right?

Yes. In the fourth quarter, Andy, there might be a couple hundred grand or so, but there's no cash going out the door until the fourth quarter.

We're also relocating our largest Albert's facility. We have a building in Bridgeport, New Jersey. They're at capacity. And so we've got a new building under construction, and we'll move out of that facility into the new one during this fiscal year as well.

Yes. That's about $0.25 million to $400,000 of the total rent number.

Okay. Thanks. Last housekeeping, on the mediation with the Teamsters in Auburn, has the union also agreed to mediation?

Yes.

Okay. Great. Thanks.

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

Hey, there.

Hi, Karen.

A couple questions, just on the timing of the conversions at the other two facilities in fiscal '13. Can you give a sense of what the timing will be, and do you know which facilities you're going to transition next?

Yes, we haven't announced the new facility, and we haven't announced the timing yet. We know we're going to knock off one or two this year. But we just haven't -- we're just not sure of the exact timing and the locations yet.

Okay. And then, I guess just looking at Denver and how you're operating now in terms of the inefficiencies, I mean, can you maybe give a sense of what the operating margin might be at the facilities now versus what you think it could get to once the new facility is open?

Well, I mean, I can't talk specifically about Denver, but I think I've made this reference point before, that if you look at the operating margin at our largest facility, and then you look at the operating margin at a facility that is the size of one of the Denver facilities, there could be as much as 400 to 700 basis points of difference.

Okay. That's helpful. And then, just looking at your guidance on the top line for fiscal '13, is there -- can you kind of outline what the acquisition benefit might be in the top line? It sounds like these are both -- the acquisitions you called out were pretty small, but just asking.

I would say that from a full year standpoint, they probably are between 75 and 100 basis points on the full year number. So somewhere in the range of $45 million to $60 million on an annual basis.

Okay. And then last question. Could you maybe just make some comments (technical difficulty) cadence of sales was in the fourth quarter and then into the first quarter?

Karen, you actually broke up a little bit. Could you repeat that?

Sorry, the cadence of sales throughout the fourth quarter and then into the first quarter?

Yes, I mean, I would say that sales were relatively strong and consistent throughout the fourth quarter. And as we got into the last month or so of the quarter, heading into August, as Steve mentioned, we saw an acceleration where it's probably about 100 basis points from where we averaged for the fourth quarter.

Okay. That's helpful. Thank you.

You're welcome.

Thank you. Our next question is from the line of Scott Van Winkle with Canaccord Genuity. Please go ahead.

Hey, following up on that last one there, is that 100 basis points extrapolated into the full year guidance?

No. I mean, it's -- at this point, Scott, the full year guidance is in some respects front end loaded because of the Safeway business annualizing. And as most of you who follow us know, we tend to be a bit conservative where we would rather adjust upward if the trends continue to be as positive as they are, than to immediately take five weeks of the year and extrapolate that into the full year numbers.

Okay. The benefit of the 53rd week, obviously, it's kind of clear on revenue. Is there anything else we should consider? Is it a better margin week? Is it a lower margin week? Is incentive comp not get that extra week added in? How do we think about the impact of that 53rd week on margin or earnings on top of revenue?

Yes, I mean, I would say that's as you think about the 53rd week, there's no extra leverage that we really gain. I guess you could say on the incentive comp, but in the grand scheme of all the different numbers, that's not a huge impact. It's relatively the same contribution from an operating margin percentage.

The one thing that I would highlight is that July and the fourth quarter usually is a step down from a sales standpoint of where the third quarter is. So that extra week in and of itself is probably one of our slower weeks of the year. But it doesn't give us anything from a leverage standpoint on the operating margin.

And you usually build inventory into this fiscal first quarter. Last year was a big build. Was last year's big build more to do with taking on Safeway than the sequential build?

Yes, yes, most definitely. The sequential build that we start to have for the first quarter usually starts right around now. So if not this week, next week, we will start to build from an inventory level standpoint.

Last question, just to make sure I got the end of Andy's questioning about rent. Did you say $1.5 million to $2 million of that $5 million to $5.5 million would be in Q4 this year? Or did I catch that wrong?

I don't --

Throughout the year.

The rent is throughout the year. I think what I was sort of saying to Andy is that maybe $200,000 to $300,000 of the cash would be in the fourth quarter, but the rest of the year, there's no cash associated with it. The relocation costs, all the rent -- the rent will be spread relatively evenly throughout the course of the year, but it's the cash charges will all -- associated with the moves will all occur in the fourth quarter. So the $1 million that I gave associated with the actual relocation and getting from one building or getting from three buildings to one building, that will all occur in the fourth quarter. It's not the rent aspect of it. It's the actual physical relocation.

And then one more. The low end of your EPS guidance range, what does that assume?

It assumes the sales being at the low end of the range and almost all the different possibilities that we have going wrong. So it assumes a significant amount of cost for the relocation beyond what we expected. It assumes that we don't gain leverage. It assumes that we see a bit more pressure on the gross margin. And it assumes some of the costs associated with a possible labor action in the Northwest, but not all, because again, we have no idea whether it will even amount to that or how long it would be. So it's kind of a lot of things going against us, far more going against us than for us.

The bottom end of the range, I think the math is right, is still 10% ahead of this year.

Worst case scenario type of number. Okay. Thank you, guys.

Thanks, Scott.

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

Hi. It's Jason DeRise. I have a question on the cash flows, actually. I'm surprised we've gotten to this point and really haven't talked about it. But your cash flows you said were at the low end of what you expected for this year. And then the CapEx guidance is ramping up significantly, especially since the CapEx was below what you expected. So I'm just trying to understand the bridge of how we get to your expectations of still meeting a $30 million to $50 million free cash flow number.

Yes, I mean, there's two components of that. One, obviously, is the increased profitability. The second is that we were at the higher end of our range from an inventory level perspective, and so right now, Jason, a day of inventory for us is roughly $12.5 million. So from a working capital standpoint, if we were at $48 million -- I'm sorry, if we had 48 days versus 50 days of inventory on hand, that would be an extra $25 million of free cash.

Until we continue to roll out a lot of the technology that we're putting in, we still have to rely on a larger or higher amount of inventory to ensure that our service level stays up. We know that if we bring our inventory down, we run the risk of having a worsening service level. And that's just not a position that we're going to operate in, especially as we gear up for the holiday season. We know that we're going to have to make the investment in the inventory to keep the service level up and satisfy the customers, at the risk of our free cash.

Okay. And so when I think about this coming year, you do expect to get to at least $30 million in free cash flow, and I should think about the improving inventory as what closes that gap? Or it's not quite yet this year, maybe the next year?

No, I mean, I think as we sit here today, we still think that we'd hit the low end of the range, and I think that the inventory is one aspect that helps us maintain that number. If we take -- if you look at it from the standpoint that we're at $35 million, and we finish next year at, say, 48 days on hand versus 50 days on hand, that's an incremental $25 million, along with the additional profits that we make, which you can put anywhere in that range. And those two factors combined in general would allow us to still hit at least the low end of the range, if we hit our guidance from a free cash standpoint.

Okay. That definitely helps clarify that. Just, I guess, one last one. You've talked about adding produce capabilities, and you've done some acquisitions there. How does that change the complexity of what you're trying to do from a distribution point or view, or is that a non-issue?

Yes, it's not an issue because the produce acquisition we did within our Albert's business, which is a produce distribution company.

Okay. And it just -- you just run it separately? There's no -- you're not trying to integrate it anymore in any way?

Well, the produce Company that we bought is essentially a sourcing entity, and that's being merged into our existing sourcing business. And so they're not really engaged in the wholesale distribution of produce. They're more engaged in the sourcing of organic produce. So --

That makes sense.

Yes.

They have a lower operating margin which will provide a little bit of drag on us, probably a basis point or two in fiscal '13, but they're not taking physical possession of a lot of the inventory that they're selling as part of that role.

Okay. Makes sense, makes sense. Thank you.

Your next question is from the line of Colin Guheen with Cowen and Company. Please go ahead. Colin, your line is open.

First question, just any update on the size of the addressable market in supermarkets? I was glad to hear your comments around margins, but how big can the supermarket business be?

Well, I mean, if you look at the total organic and specialty industry, it's certainly close to $100 billion. So UNFI in total is just under $6 billion. So there's tremendous amount of opportunity in front of us. If you look at the supermarket channel specifically, while we do sell a large number of them, there are at least 15-plus that we have either a small relationship with or don't sell at all. So there is a tremendous amount of opportunity for UNFI, both in the specialty, the natural, the organic product mix in the supermarket channel. And the same thing holds true with independents, just across a different product set.

Great. And then on the other end of the spectrum, just some commentary on the profit trends and maybe some of these drop ship models that have emerged, where they are today, where you think they go in the future.

You're talking about the fulfillment business?

Correct.

You know, it's a relatively small part of our business today, so I think the margin profile is probably similar to our overall margin profile. But it's extremely fast growing. And while we have a position in that market today, the acquisition of Honest Green and their technology will really serve to help us accelerate growth in the business-to-business fulfillment side.

And any comments on what that technology is or just a little background there?

You know, they are essentially a site, and you can look at it, it's www.honestgreen.com, that has done a couple things. They've gone out and they've sourced fantastic sustainable general merchandise, natural and organic products that they sell on a B2B basis. They've got a fantastic store front that we're going to be using. And it creates a whole slew of opportunities in terms of us assisting independents in setting up their own store fronts to sell products that they market within their own stores over the Internet that we can do the back of the house fulfillment for.

Great. Thanks a lot.

I think that's our last question, operator.

Thank you. Ladies and gentlemen, that does conclude our conference for today. If you would like to listen to a replay of today's conference, please dial 303-590-3030 or 1-800-406-7325. The access code is 4559038. Thank you for your participation. You may now disconnect.