United Natural Foods Inc (UNFI) 2013 Q2 法說會逐字稿

Thank you for standing by, and welcome to the United Natural Foods first half fiscal year and second quarter results conference call. During today's presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be open for your questions.

(Operator Instructions)

Today's conference is being recorded, February 26, 2013.

I would now like to turn the conference over to Scott Eckstein from 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 Calibrison in our New York office at 212-827-3772, and we will send you a copy immediately following this morning's conference call. With us this morning from Management is Steve Spinner, President and Chief Executive Officer, and Mark Shamber, Chief Financial Officer. We will begin this morning with opening comments to 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. The same language applies to comments made on this morning's conference call. Additionally, in today's press release and on today's call, we will provide both GAAP and non-GAAP financial measures including operating expenses, operating income, net income and earnings per diluted share.

Presentation of these non-GAAP financial measures is not intend 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 released issued earlier today available on our corporate website, www.unfi.com under Investors.

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

Thanks, Scott.

Good morning, everyone, and thank you for joining us this morning to discuss UNFI's second quarter and first half fiscal 2013 results. Demand for UNFI's products and services continued to be strong. For the first half of our fiscal year, our net sales grew 14%, again reflecting the dynamic and expanding organic natural and specialty industry. While we have now lapped the on-boarding of Safeway, our sales during the second quarter grew an impressive 12.3% compared to the prior year quarter. Additionally, when you consider the impact of very modest inflation at approximately 2%, all data points to very strong and continuing growth.

In looking at the industry data for 2012 recently published by SPINS, 97% of US households bought natural products and 70% bought USDA certified organic products, reflecting a very nice increase over prior year. In fact, SPINS also commented during their annual review that natural and organic products continue to outpace overall store growth across all channels.

On top of that, non-GMO, gluten free and other third party certified products grew in excess of 13% and other product categories such as organic produce, natural supplements and organic yogurt product categories continue to grow significantly. These trends reflect continued positive growth in the category supported by UNFI for the next year. As you know, for the last 18 months, we have talked a lot about gross margin compression and expense control. And in the second quarter, our gross margin was consistent with our first-quarter margin, although our gross margin compared to the prior year quarter declined 62 basis points.

Gross margin shift continues to be driven by several factors including, one, our retailer base continues to shift toward lower gross margin customers. In looking at our customer mix change during the second quarter, and compared to the prior year quarter, super naturals grew to 37.2% from 36.5% of our net sales. Super markets grew 25.4% from 25% and independents declined to 32.7% from 34%.

Interestingly, all three channels are growing rapidly, with super naturals leading growth during the quarter with 14% sales growth over the second quarter in the prior year. Our independents are also growing nicely, and UNFI is deeply committed to this very important customer base. We recently completed our first national recruiting, training and on-boarding of independent territory managers, who are now focused on expanding retail sales in geographies across the US. New lines of SKUs and the rollout of proprietary IUNFI hand hold technology will fuel continued growth in the independent channel.

Two, as I first mentioned in our November call, during our first quarter of fiscal 2013, we began to face higher than normal supplier out of stocks. This environment continued during the first half of the second quarter. And with higher out of stocks, manufacturers reduced promotional spending and again, UNFI moved freight around the country to support delivering higher service levels. We believe this issue has subsided as manufacturers have geared up production to meet increasing demand.

Three, finally, with the majority of our business priced on a cost plus basis, lower levels of inflation of at or below 2% also places pressure on UNFI's gross margin. We typically buy into rising markets, which enhance our gross margin. I am pleased with the stability in our gross margin sequentially this year, and continue to be bullish towards controlling gross margin as UNFI's business model evolves. From Q1 to Q2 2013, gross margin stabilized. More importantly, our operating expenses fell at a great rate -- at a rate greater than the year-over-year decline in our gross margin, which drove our operating margin up four basis points on an adjusted basis.

Operationally, we continue to shine. Our warehouse and transportation teams have delivered exemplary service while driving down costs. During the second quarter of fiscal '13, our operating expenses, excluding the impact of Auburn, Washington labor action, were down 65 basis points to 13.8% of sales. This was a milestone for us as we continue to confirm that UNFI's shifting customer base can be supported through a very efficient cost model. Looking into the numbers during the quarter, there were several interesting data points.

First, our transportation expenses, which are driven largely by fuel, had significant improvement versus the second quarter in the prior year. And this was accomplished by several factors including continued fixed price fuel contracts; service reroutes, which drive down miles traveled; technology, which monitors truck engine idle time; and reducing the freight on each load we dispatch. Also on the inbound freight side of our business, UNFI's recently implemented Transportation Management System or TMS is fully online and working as designed.

Second, in our warehouses, we have been quite successful in implementing strategies that improve productivity to warehouse layout, accuracy and safety. During the quarter, we had several warehouses that achieved record throughput. I'm extremely proud of our operations team as they have demonstrated an incredible discipline towards achieving our vision of reducing operating expenses at a rate is that faster than the customer mix-driven decline in our gross margin.

It's also important that we address our recently ended labor action in Auburn, Washington. I'm very pleased that we were able to bring the nine week strike to an end. This was a very difficult situation for everyone involved. UNFI was determined to ensure that all associates were and are treated equally and fairly across all of our divisions and distribution centers. Additionally, we had to assure our customers that they could rely on us for service during the extremely important holiday retail seasons.

During the quarter, UNFI incurred costs of approximately $3.6 million, which included temporary labor, hired labor, security and costs associated with bringing our team back to work. I expect there to be modest costs related to this issue in our third quarter, as the strike did not end until mid-February. While costly, some respects to UNFI, we made long term decisions that were in the best interest of our constituents. With a new five-year agreement and terms that are consistent with our Company's national benefits, wages and work rules, we believe that our response to this strike and ultimate resolution were appropriate.

Our capital expenditures during the quarter were 1.1% of net sales and were driven primarily by construction at our new Denver facility expected to open early summer 2013. CapEx will continue to ramp up as a percentage of sales as we build new capacity to support our growth. New buildings are in the planning stages in Wisconsin, New York State, Northern California and the Pacific Northwest. With growth expected to be in the low double digits over the next several years, UNFI must add capacity to satisfy demand for our products and services. We are quite fortunate to have a level of growth that makes new construction necessary.

Additionally, I'm quite pleased with the progress we are making on the technology front. Migration to a single item number across the US, national data warehouse and inventory demand planning are in the works, and progressing throughout the next 12 months. Also with the success of our warehouse management system roll out in Richfield, Washington, we are now planning for the implementation of two centers per year. Environmentally, we are excited to be launching a new solar project on the roof of our Marino Valley, California location. This new power plant furthers our commitment towards reducing our carbon footprint by 5% over five years.

Net income increased 18.8% during the first half of fiscal 2013 compared to the first half of fiscal 2012, and our operating margin increased 11 basis points versus the prior year to 2.6%. We are also revising fiscal 2013 GAAP guidance to a range of $2.12 to $2.18 from previously provided $2.14 to $2.24 per diluted share, an increase of approximately 14% to 17% over 2012. The revision is not a reflection of any challenges in our back half 2013, and points directly to the impact of our Auburn, Washington labor action, which is expected to cost up to $5.6 million this year or approximately $0.07 per share on a nonrecurring basis. In fact, adjusting for Auburn, UNFI's performing ahead of projections.

I am really confident that we have a strong team in place to manage through these opportunities. Our associates are incredibly passionate about delivering long term success through innovations; disciplined while always upholding our important goals of increasing market share; driven to operational excellence, and committed to the principles of one Company, sustainability and philanthropy.

And now, I will turn the call over to Mark Shamber to discuss our financials for the period. Mark?

Thanks, Steve, and good morning, everybody.

Net sales for the second quarter of fiscal 2013 were $1.45 billion, which represents growth of 12.3% or approximately $159 million over the prior year second quarter net sales of $1.29 billion. Excluding the $14 million in incremental sales from the three acquisitions that closed in the first quarter, our sales increased by 11.2%. Inflation continued to moderate both sequentially and on a year-over-year basis for the quarter, coming in at 1.98%, a 17 basis point decline from Q1 and a more than 50% decline from last year's second-quarter inflation of 4.36%.

Year to date, net sales of $2.86 billion, yielding sales growth of $351 million or 14% over the first half of fiscal 2012. Excluding the acquisitions, our year-to-date growth is 13%. For the second quarter of fiscal 2012 -- '13, the Company reported net income of $22.6 million, or $0.46 per diluted share, an increase of approximately 2.8% or $0.6 million over the prior year.

Net income for the second quarter of fiscal 2013 was $22 million -- sorry, for the second quarter of fiscal 2012, was $22 million or $0.45 per diluted share. Earnings per share increased by 2.2% as EPS growth was impacted by the higher average share count in fiscal 2013. On a channel basis, both super naturals and supermarket sales increased by 14.4% in the second quarter, with super naturals representing approximately 37% of sales and supermarkets representing 25% of sales. Sales growth in the independents channel was 7.9%, but declined from a mixed standpoint due to the slower growth, and for the quarter, represented approximately 33% of sales. Food service comprised approximately 3% of sales after growing by 23.4% in the second quarter.

At 16.7% of gross margin for the quarter showed a 62 basis point decline over prior year second quarter gross margin of 17.3% and was flat sequentially. As Steve mentioned, major drivers of our lower gross margin were fewer opportunities to buy into price increases due to lower inflation; the continued shift in the growth mix of business toward super naturals and conventional supermarkets with limited or no service components; as well as increased sales of customers private label brands.

In addition, while the issues in the first quarter associated with our Transportation Management System or TMS are behind us, we had the carry over effect for some of the products we moved in the first quarter as we've sold through that inventory and continued those efforts into November. Finally, we are generating lower back haul income due to higher year-over-year inbound costs. Gross margin for the first half of fiscal 2013 was 16.7% compared to 17.6% in the prior year, a decline of 85 basis points, again, driven by the factors I just noted, along with the additional freight expense we incurred in the first quarter associated with higher manufacturer out-of-stocks.

Our operating expenses for the quarter were 14% of net sales compared to 14.4% for the same period last year. This represents a 40 basis point improvement over the prior year, as operating expenses as a percentage of net sales continued to benefit from the mix shift in our Business, positive trends in our self-insurance areas, along with continued execution by the general managers in our broad line distribution centers.

As an example, we have increased our warehouse throughput by almost 5% over the prior year led by our distribution centers in Atlanta, Georgia under Doug Tatum and Chesterfield, New Hampshire led by Chris Richmond. As was covered in this morning's press release, the strike and related contingency planning in our Auburn, Washington distribution center negatively impacted expenses by $3.6 million in the quarter, or 25 basis points. We expect additional strike-related costs in the range of approximately $600,000 to $1 million to impact the third quarter, as the strike did not end until mid-February.

Similar to the first quarter, we incurred $0.9 million in non-cash straight line rent expense associated with our new Denver, Colorado area distribution facility. Year to date, these nonrecurring expenses are $1.6 million, which is in line with the full year guidance provided during our September 11, 2012 earnings call discussion.

Excluding the portion of our Canadian business, which involves the use of third parties for deliveries in certain regions, diesel fuel had a positive impact of 9 basis points in operating expenses in comparison to the second quarter of fiscal 2012, as fuel represented 72 basis points of distribution net sales in the quarter. Fuel in the second quarter decreased by 10 basis points versus the first quarter, as our fuel expense decreased by 9.6% sequentially due to our continued focus on reducing costs and miles traveled by our re-routing and increasing the [fube] on our trucks.

Our diesel fuel prices in the second fiscal quarter increased by approximately 1.1% from the prior year second quarter while the Department of Energy's national average was up approximately 1.9% over the prior year. Share based compensation expense totaled $3.2 million in the quarter compared to $2.5 million dollars in the prior year second quarter. Share based compensation expense represented 22 basis points as percentage of net sales in the quarter, a 2 basis point increase over the prior year.

GAAP operating income for the second quarter was 2.7%, a 21 basis point decline over the prior year. Adjusting for the $3.6 million and 25 basis points associated with the Auburn strike, operating income was 2.9%, a four basis point improvement over fiscal 2012 second quarter. Inventory was $674 million at quarter's end, as days inventory on hand averaged 53 days for the second quarter, an improvement of about 1.5 days over the prior year's second quarter when we were at 55 days.

The lower average days on hand resulted primarily from lower inventory levels going into the holidays due to the supplier out-of-stocks we've highlighted previously. Our service levels improved throughout the quarter as suppliers were able to address many of the issues, and we started to build back our inventories in those areas. As a result, sequentially, inventory levels increased a bit more than four days compared to the first quarter of fiscal 2013.

DSO for the second quarter increased sequentially by 0.5 days to 22 days due to a higher concentration of supermarket business in the quarter. Capital expenditures were $15.5 million or 1.1% of net sales for the quarter, which is within our target range for fiscal 2013. Year to date capital expenditures are $20 million of 70 basis points net sales.

Consistent with past years, a greater portion of our CapEx is planned for the second half of the fiscal year. Outstanding commitments under our credit facility were $208 million at quarter end, with available liquidity of approximately $286 million including cash and cash equivalents. Our leverage increased modestly to 0.8 times on a trailing 12 month basis due to the normal investment in inventory for the holidays.

As discussed in this morning's press release, we are reaffirming our net sales guidance for fiscal 2013 with a range of $5.88 billion to $5.98 billion, which represents a 12.3% to 14.2% increase in total net sales over fiscal 2012. In addition, we are narrowing and lowering our GAAP diluted earnings per share guidance for fiscal 2013 to a range from $2.12 to $2.18 per diluted share and establishing non-GAAP guidance in a range from $2.15 to $2.21 per diluted share. This reflects the impact of the items that have occurred in the first half of fiscal 2013.

Our previous GAAP earnings guidance was $2.14 to $2.24 per diluted share. As a reminder, included in our fiscal 2013 earnings guidance is approximately $5 million to $5.5 million of nonrecurring expenses associated with our new Aurora facility and the new facility for our Albert's Organics division. Of which, $3.5 million to $4 million of duplicate primarily non-cash rent payments, with remaining balance comprised of relocation costs to consolidate the existing facilities in the back half of fiscal 2013.

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

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session.

(Operator Instructions).

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

Great, thank you. I was hoping you could maybe start by just discussing in a little bit more detail how sales kind of trended through the quarter, and then what you've maybe seeing kind of thus far into Q3?

Yes, hi, Ed. Sales have been relatively consistent. And we feel pretty comfortable that despite a lower inflation number and lapping Safeway, that -- if you look at the net sales growth year over year, we are actually doing fairly nicely and feel pretty comfortable that it's certainly going to continue through the end of the fiscal year.

Thanks for that, and then next on just the gross margin, in your prepared remarks, it sounded like you were relatively pleased with where that checked out in the quarter from a -- kind of from a stability perspective relative to Q1. But I had kind of thought maybe we would see something higher just given the improvement that you had seen exiting your first quarter. Can you maybe just talk a little bit more about how that number shook out relative to your own expectations going into the quarter?

Yes, I really wish that I could. I was really pleased that we had a sequential improvement, and it really demonstrated that we could continue to drive costs out of the system at a rate that's greater than potential decline in gross margin. So I felt very good about that. I do feel as though we should be able to start to see some increase in gross margin. It's certainly not going to be significant over the next year or so as we kind of settle into the new model, but I certainly wouldn't want to provide any guidance to that.

And then the last question for me and I will pass it on. I think in the first quarter, you had accrued for kind of below normal incentive compensation levels. How do those accruals look in the second quarter?

Yes, I mean, we -- I would say that what we were below in Q1, we haven't clawed back, but we are sort of moving towards target for Q2. So there was no change from the accruals in Q2; everybody tracked towards the same level that they had planned from a budget standpoint. But whatever they were short in Q1, they did not make up.

So Q2 was a more normalized number?

Yes, yes.

Great. Thanks, guys.

Thanks, Ed.

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

Thanks. I'd like to start just by talking a little bit, you mentioned a number of capital projects. Maybe you could just talk a little bit about the timing of those projects? I think some of them you mentioned before, but maybe go through all of it, and then what you think the costs for each facility were, in aggregate, will be?

Yes, good morning, Meredith. The only project that's really going to be completed and have any significant costs in this fiscal year is Denver. As we look out to 2014, we will have the cost of two facilities; one that we have already announced, which is in Wisconsin; we have announced that location. We haven't announced the second location yet. As far as the guidance for 2014, we really haven't provided any kind of look into what our CapEx is going to look like next year.

We are still -- at this point, we are in the heart of our planning process from that respect, Meredith. And so I think there is some decisions that we need to come to as we look at the facilities as to whether they are going to be owned, whether they are going to be sales lease backs, whether they are going to be leases. And that really dictates what the CapEx associated with those locations is because an owned facility can be anywhere in the range of $40 million to $60 million of CapEx, where a strictly leased facility might be in the mid-teens to $20 million. So until we make a final decision on those locations and actually identify, as Steve mentioned, the second location, it's difficult to really set some parameters for CapEx for fiscal '14.

And generally speaking, the general rule we are using is if the market is a big growing market that we are going to be in for a long time, our preference is going to be to buy it. Just because it's just far cheaper on the long term to own it than to lease it. If it's a market that looking out 10, 15 years, we're just not sure, then our tendency would be to lease it.

And we also are factoring into our equation some of the expectations about the leasing rules changing at least from a balance sheet presentation, and that does factor into the decision.

Great, and then I have a question about the ability to continue to make progress on expenses. I think you highlighted two facilities, in particular, Atlanta and Connecticut, I think, that did -- (multiple speakers)

Yes, Atlanta and Chesterfield, New Hampshire, on a throughput standpoint.

Sorry -- (multiple speakers).

We still have a pretty big gap between the highest performing DCs and the lowest performing DCs. Now, some of that is driven by market and size of the DC because certainly, its common sense would lead you, the larger the DC, the greater it is to become more productive. But we still have plenty of opportunities operationally in a lot of our DCs to further enhance our operating costs. You know, we have deployed labor management throughout the DCs, but we are still really in the early innings of engineered labor standards, and engineered labor standards tend to have the greatest savings and productivity increases than any other technology we have installed.

And would you say there is a process to share best practices, a formal process?

There is. All of our operations are nationalized; they are no longer regional. So they all pass up through general managers and our -- who run our DCs up through regional operations managers and up to our nationalized operations group, so there is a tremendous amount of standardized procedures already in place. It's just a matter of getting the technology deployed as fast as we can.

And then I don't know if you want to comment at all about -- most of the companies don't want to, about the results of the labor actions? And you made a comment about wanting to make sure that the pay and benefits was matched across the country.

Right.

Did that require you to do anything different anywhere else, or was that all just focused on Auburn?

No, no. It was only focused on Auburn. We were not going to allow our Auburn associates to have anything that was better than what we did in the rest of the country because in the rest of the country, we believe that we have got a great environment with lower than -- much lower than average industry turnover. And we just were not going to be in a position to have an environment where one group of associates has benefits or wages that are much greater than everybody else, other than adjusting for geography.

Okay, and they came to that agreement eventually?

Well, we were out for nine weeks, so it took us awhile to get there, but ultimately, we did.

Well, congratulations on that, and thank you. My questions are done.

Thanks, Meredith.

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

Hi, there.

Hi Karen.

Just looking at your guidance, I know your prior guidance, you've indicated that incorporated the worst case scenario on Auburn. And in this press release, you say there is maybe an incremental $600,000 to $1 million in expenses associated with Auburn, so that's kind of $0.01 to earnings, by my math. I get your low end -- I get the change in your guidance on the low end, I guess I'm not sure what is affecting the high end, because the high end is about $0.04 or is $0.04.

Sorry, you lost me on the back part. I think that we -- as to why it came down, is that what you are trying to --

Well, the Auburn -- the incremental Auburn you call out is about $0.01 a share, so I can understand why you came down on the low end. But on the high end, you are bringing your guidance down by $0.04, so I'm just wondering what else might -- (multiple speakers).

I think the answer is that the Auburn cost in aggregate, were $5.5 million versus an estimate of $2 million to $3 million, and so that -- I think that is the difference.

Okay.

Yes, I think the strike went on longer than we had envisioned, and so while we had some factor of expense in there, it ended up, I think at the end of the day, it ended up exceeding -- at least, certainly, as we go into Q3. What we had initially projected and/or it ate into some -- as I talk about things going right and things going wrong and setting the guidance range, I think it took away some of the flexibility for any risk in the back half of the year. And so we would have to have everything go perfectly in the back half to have left the guidance at the high end of the range. So we took it down with the expectation that it's not all going to play out favorably.

Got -- so just to paraphrase it, you could have fine tuned your guidance at the first quarter earnings release, but you didn't really feel a need to. Because you hadn't really figured out what the total cost would be, but you still thought you would be within the range.

Yes, and I think if you look at the guidance, for the most part, we are still in that range. We have just narrowed it as we would normally do at mid-year. I think the difference this year is that we took the high end down, where as in past years, we have really raised the lower end.

Right, okay. And then on the supplier shortages, I don't know if you said -- I missed this. Did you give any color on what the dollar impact might have been this quarter? I know you said it kind of lasted halfway through the quarter; the dollar impact and gross margin?

We really didn't because it was really only a phenomenon during part of the quarter, and we have seen some steady improvement, so we really tried not to quantify it.

Okay. But you think that we are past that now?

Yes.

Okay, and then just looking at the top line or the organic growth rate in super natural and independent, it did seem to decelerate. I mean, not materially, but there was a deceleration on a one- and two-year basis, is there anything you can point to there?

You are talking -- did you say on the super natural or the supermarket? I'm sorry, I missed the first part.

No, super natural and on the independent. Your super natural is 16% in the first quarter, 14% in the second; independent, I'm splitting hairs a little bit, 9% and then 8%. Maybe it's just inflation, more than anything?

It wouldn't be inflation so much sequentially, that would more come into play on the year over year.

It could have been a factor of new store openings.

At the end of the day, we have not seen any real change in the overall growth rate.

Okay, that's helpful. Thanks.

Thank you. Our next question comes from the line of Kelly [Vanyo] with Bank of America. Please go ahead.

Hi, good morning. Thanks for taking my questions. Just another follow-up question on the non --

Kelly, we can't hear you that well. You're breaking up a bit.

Sorry, is that better?

That's better, yes.

Sorry about that. Just another follow-up question on the non-GAAP EPS guidance for the year. Can you just remind us, I think, how much the Auburn expenses are in there or not?

The -- so the non-GAAP does not -- all of the -- I will put it this way is that the only expenses that are excluded in the non-GAAP are the intangible write-down that occurred in Q1, the unclaimed property settlement that occurred in Q1 and then the tax NOLs that we took back in Q1. All of the Auburn expenses, the $4.6 million that we have incurred to date, are included in the range, so they are not backed out of that number.

Got it, and they are just coming in $2 million higher than originally expected.

Yes, yes. They are probably a little bit more than $2 million higher than originally expected, but we've -- to Steve's comments, we have had some great results on the operations side, which have offset where those expenses have come in higher than planned.

Right, and then maybe you have mentioned this, but can you just comment on the service level that you were able to maintain out of that Auburn facility during the quarter?

Yes, remarkably, the day of the strike, we probably had 30% to 30% some-odd service level. In other words, we could service 30% of the demand, and within three days, we were at 100% of the demand. And we had done, I think a pretty good job communicating what was going to happen, how it was going to happen, but within 2.5 days, we were at 100% of capacity, which is remarkable. It was expensive. It was expensive to do it, but we had to do it, and I think it's ultimately what got us to the resolution that we did.

Great, thank you.

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

Good morning. Just on the guidance, another way to look at it is, convert your -- the old guidance, add in $0.03 for your -- sounds like your estimate for the strike at that point. Take the new guidance, add in $0.06 for the strike, and basically, it looks like you have done what you have done in the past, which is bring up the bottom of -- the bottom end $0.03 and kept the high end where it is on [next] strike basis. I just want to make sure that's -- my math is right, and that sounds like -- kind of confirms your thought, what your message, I guess, that the business is kind of trending on plan.

Yes, I think that that's right, Andy. I mean, we've -- as much as the expenses have come in higher, if you -- due to the strike, or as part of the strike, we have gotten the efficiencies elsewhere. So yes, I mean, if you're -- we are not trying to back the strike out of the non-GAAP, but to what you were saying, yes, if you took the strike out and took the other items that we are considering nonrecurring, we would be higher and we would be raising the range accordingly.

Yes, I just want to -- yes, okay, fine. Follow up on the non-cash rent, that's -- I think you said that's associated with Denver, and then you've said Wisconsin -- you break dirt on Wisconsin. I guess, is Wisconsin part of that, or do we start to get non-cash rent for -- in Wisconsin, as well, or does that $0.01 a quarter go away, or does it increase? Could you just give us a sense of how --

Yes, I mean, we -- as it stands right now, we haven't set what the plan is for Wisconsin. I think if anything, we are probably leaning towards either owning it or engaging in a sell lease back. And depending on when we might sell that facility would determine whether or not we would have any non-cash deferred rent for Wisconsin, but I would expect that there is nothing from Wisconsin impacting fiscal '13. And probably when we get to the third quarter earnings call, we will be in a position to sort of lay out what our approach would be in Wisconsin and what impact it will have on -- and how it will treat that, whether it is going to be owned or sale lease back. But nothing so far associated with Wisconsin has hit the P&L, and I wouldn't anticipate any non-cash deferred rent associated with Wisconsin in fiscal '14 -- or fiscal '13, to the extent that we go the sale lease back route.

And then on -- staying on those two centers, just operationally, it's my understanding both areas, Denver and the Midwest are -- have [dis] economies to scale because they are above capacity. So, I mean, do these things -- x -- within a month or whatever it takes, it sounds like versus let's say a Greenfield, these are going to actually add to margins straight away. Is that how we should think of those?

Well, Denver is just a complete building replacement today. We operate out of four different buildings in Denver, and we are migrating into a single building. So obviously, there is a tremendous amount of operating efficiencies that we get by not having to transport the product back and forth, or send independent loads versus segregated -- versus combined loads. In the Denver scenario, it's just pure operational efficiencies. In the Wisconsin scenario, we are actually building the building based on a formula that brings us much closer to the customer. So your statement is correct about Wisconsin because we are essentially taking what we currently deliver out of Iowa in that market, and moving it into the market, so it -- there is a tremendous amount of savings related to doing that. Very similar to what we did when we opened Texas and eliminated all of the miles that we used to incur because we serviced Texas from Denver.

Mark, I think you [made a mistake] -- you said back haul income was down, and I just didn't understand your explanation. Could you go over that?

Well, I was saying that we are making less from a back haul standpoint because we are incurring higher expenses. We talked about in the first quarter, in particular, where we were moving things around multiple times as part of the supplier issues that we had, so we are still feeling some of that in the second quarter. Because that -- when you move things around and handle them a second time, versus just back hauling them into a location, you incur that additional expense, but you are not able to pass it on. So it's the same statement we made in Q1.

I mean, basically, what happens is we have a very sophisticated cross dock system where we try to buy at a full truck load from as many suppliers as we can. We bring them into a consolidation point in the east and the west, which is one of our DCs, and then we aggregate mixed loads of products to go out to our DCs in full truck loads. And that obviously gives us the ability to keep the freight on the inbound and the outbound extremely low. But when we run into service issues, we can't wait to get an aggregated truck load to send back out to the facility. So in a lot of scenarios, we have to send out in LTL or less than truck load, and that is the most expensive way to do it. But when you are backed into a corner of do you fill the orders and move the freight LTL, or do you wait to consolidate the load, sometimes we just got to bite the bullet and spend the money.

Is that all -- that inefficiency, is that all showing up in -- which expense line item? Cogs or --

Yes, all cogs.

Okay, that's helpful. Last thing I want to ask is on this hand held technology for the independents, could you just elaborate? It's the first I have heard of it, and a little on what it is. Is there much investment for you or the independent, and what are the capabilities with -- is it going to get -- (multiple speakers).

Yes, a couple of years ago, we started down a path of providing independents with technology that would make it really easy for them to order from us. And very easy for them to use data from us, whether it be suggested retails, average movement, average suggested retail margin. And so we talked a little bit about this wows of a website that we rolled out probably 18 months ago, and at the same time, we deployed an iPod Touch, iPad, iPhone technology that gave our retail customers a web enabled mechanism to scan products at the shelf to place the orders directly with us.

We now have about, I guess just under 2,000 units deployed, and they are deploying rapidly. And there will be several iterations of deployment, as we add more functionality to the hand helds including being able to place orders from non-UNFI vendors. So we partnered with another technology provider for retailers who only want to use one piece of technology, they can run those orders through a third party. And the UNFI piece comes to us, and the other vendors goes directly to that vendor so that the retailer can use one technology to place all their orders. So it's exciting, and all of those costs are included in our IT expense and have been for the last two years or so.

Thank you.

Thank you. Our next question comes from the line of Stephen Grambling of Goldman Sachs. Please go ahead.

Good morning. Thanks for taking my question. So I guess what I would like to actually talk to you is the guidance on the back half, and anything that you can talk to in terms of what's embedded in your assumptions for inflation, as well as anything we should be aware of by product type that's going on.

Sure, I think from an inflation standpoint, that's relatively straightforward. I mean, we have talked before that we think that inflation will probably continue into the low-2%'s, so we're -- we finished the second quarter at just under 2% on a weighted average standpoint. I would expect that the third quarter is likely in that range of 2% to 2.25%, maybe a little bit under 2% depending when any price increases hit. And then as we look into the fourth quarter, it's a little bit wider range, but it's probably 2% to 2.5% because we are just not seeing significant levels of price increases flowing through, at least as we sit here today. So that's it from the inflation standpoint. As it relates to products, there is really -- some of the familiar trends that we have seen, whether it's the Greek yogurts, it's the product with -- a lot of the coconut waters, things of that nature, probiotics, I mean there is really -- gluten free continues to be a strong category. There is not anything within specific product categories that is recent that has really shifted from a trend standpoint.

The fastest growing category of products from us, now, taking into account that it's off a relatively small base, is the non-GMO certified products. They grew at over 18% in calendar '12, which was the fastest growing category that had some kind of certification.

As a quick follow-up, maybe if you can just discuss maybe what's imbedded within gross margin and SG&A, or any kind of guidance you can give there?

Yes, I mean, we honestly try to stay away from that, so it gives us the flexibility as to where certain events might happen. But I think from our perspective, there is the expectation that gross margin is relatively consistent sequentially. That with the third quarter typically being a little bit stronger from the independent side of the business, that there may be a modest ten basis points- type of item expansion if the independents keep with the historical pattern where there are a larger percentage of sales in the third quarter. Correspondingly though, if we get the gross margin expansion on the independents' additional volume, we typically have higher expenses.

That's very helpful. One last one before I jump. In terms of your leverage standpoint still being very far below the target of 2%, 2.5%, how do you think about how you would deploy that and taking on debt going forward?

Well, number one, I would say that we don't have a target of 2% to 2.5%. I think we are comfortable with 2% to 2.5%, but it's certainly not a target.

I think that's in a range that we prefer not to exceed versus that's a target range.

But to answer your question, I think that we are most comfortable having a lot of flexibility with our balance sheet, whether it be for M&A, to invest in inventory. We feel that that's the most efficient use of our financial strength at this point. Now, at some point in the future, if we didn't find good M&A candidates, we would have to consider other options, whether it be a dividend or a stock buyback, but we are just not prepared to do that yet.

And in terms of the M&A, is that still focused in Canada? Is that the place you would be looking to see the most opportunity?

Well, I mean, we made a couple of acquisitions in Canada over the last year; two, in particular. They were relatively small. And we will continue to do that, and I think we are starting to see some modest activity here in the US on the specialty side, which would make sense for us. But certainly, nothing that is imminent.

Okay, great. Thanks for taking the questions.

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

Hi, thanks. Most of my questions have been answered, but Steve, you mentioned a field sales training effort, and I apologize I'm not quoting you correctly. Is this something new and something focused on independents that is trying to grow that base?

Yes, Scott. You know, in the past we hired regionally, so as somebody retired, or left or demand increased, we left it up to the regions to determine when they would hire and how they would hire. And we did a lot of work, and we basically came to the conclusion that one of the ways to grow our independents is to add more value to them. And the only way or the best way to add more value to them is to let them see their UNFI territory manager more frequently, because historically, we had a lot of scenarios where territory managers were only getting to the retailers maybe once a month. So our view was if we hire a national class, train them nationally and then deploy them regionally with the goal of getting our trained territory managers to be in the retailers more frequently, that we would see a lift. And so we went to the college campuses and we hired graduating kids with degrees in Food Science and Nutrition, and we put out a new class I guess about four or five months ago. I think we put 15 or 16 of them out in the first class, and we are going to do it again this summer. It's been incredibly successful, so it is certainly something we are going to continue.

Thanks. And then on the strike, post-strike, obviously, you have your staff back and things are running smoothly. Was there any customer disruption that would be noted during the strike period that has been corrected since?

You know, yes, there was some disruptions, certainly, because in the first couple of days, we were not running at capacity. Fortunately, we had communicated out to them, they knew it, but certainly, a lot of the customers were nervous and they probably had a week of being put in a situation where service was not what they were used to. We certainly did not lose any customers during the time period. I'm sure we had some scenarios where customers started buying from a competitor just to ensure if there was a complete melt down that they would be able to get product. But from everything that we can see, we are fully back to normal. (multiple speakers). Yes, customers that were there are there today.

Got you. Thank you.

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

Hey, it's Jason DeRise at UBS. It wouldn't be a conference call with you guys if I didn't ask about expectations for inventory days going forward, and if you felt the free cash flow would be up or down for this year, so that's what I'm asking.

Well, one thing's for sure is that the past couple of years, we have tinkered around with our inventory in an effort to get it reduced. And what we learned through that process is we just don't have the technology that gives it the ability to lower the inventory without destroying the service bubble. So that will never happen again. However, we are deploying our new inventory optimization technology this year, and the driver of putting in a technology is to increase our service level and get our inventory days down. Inventory optimization gives us the ability from any single geography within the United States to buy product, to manage inventory using an algorithm, a very complicated algorithm that looks at demand forecasting so that we don't have to blindly build inventory to cover service expectations. That we can use some basis whether it be an algorithm, as I said earlier, or past three years' trend, and that technology will be installed within the next 12 months.

Right, and it's going into -- in our western region this fiscal year and will probably move into the eastern region in fiscal '14.

Okay, and through better forecasting technology, the inventory will better align with what the sales mend is, but it still needs to be in the 50 day range or the effects will be -- (multiple speakers).

No, no, no. We -- our expectation is once we have it deployed, we will be much more prepared to get our inventory down. We certainly believe that the inventory today is the factor of a lack of technology, a lack of demand planning. More than it is, we have to have 50 days of inventory. Now, the model itself is slow moving inventory; it's never going to be in the 30 day range. But we do feel that there is quite a bit of room for us to move towards over the next couple of years.

But I don't think you are going to see us point specific targets out, Jason, until we've got it up and running for a bit and ensure that the parameters that we are setting are based on what we need and not trying to hit a target for a reduction in inventory, and we certainly have hit that target.

And we turn it on supplier by supplier, so it will take awhile.

Is there getting to be a point, and maybe this is ten years down the road, but is there a point where you would put in minimum drop sizes for some of the independents and things like that to help streamline your --

Actually, we have that today. We have them -- (multiple speakers).

It's very small, right? There is not much of a hurdle, as I understood it, but maybe that's not right -- (multiple speakers).

Well, the thing is it's a relatively small minimum drop requirement, but our average drop size is not the issue, because we have a very, very large average drop size. I would say that the bigger issue on average drop is more in the supermarkets than it is in the independents.

Okay, and can I ask one other question just on the demand side. I guess you gave some of the stats from SPINS about the adoption rate of natural organic specialty and so on. In the past, you guys have talked about the crossover shoppers. So I don't know if there is anything that you have done seeing -- for those people that have always been consumers, if they are consuming more or if most of this growth is the new customers into the category?

You know, that's good question. I haven't seen the latest data on -- they usually do a survey, which looks at if you are an organic shopper, are you buying more? And if you are buying more, how much more are you buying? So I don't know the answer to that question, but we should know that. We will check that out.

Okay, cool. I will ask in the future then. Thank you.

Thank you.

And Operator, this is probably the last question.

Our final question comes from the line of Sean Naughton with Piper Jaffray. Please go ahead.

Yes, thanks for taking the questions. Steve, just first for you, I think you mentioned something about private label in your prepared remarks as a mild headwind. Just if you could clarify those remarks, maybe I heard them incorrectly, and then maybe talk about the growth in that category relative to national brand. And secondly, Mark, maybe you could just give us an update on how you are building, or how you are thinking about plans for fuel moving forward over the next couple of quarters.

Sure. Actually, Sean, it was in my comments that the private label was referenced. To the second part of that question, probably won't talk about their growth because we don't highlight as to whose brands they are and what rate they are growing; if the companies choose to do that, we leave that to them. But what presents a little bit of a headwind from our perspective on the private label standpoint is that, A, we are only able to sell it to that particular customer who is buying it from us. But it also typically doesn't have any opportunity to buy into promotions because the product is not promoted, so a lot of what we do when promotions are is we will buy additional volumes in that promotion and carry that inventory. Once promotional period ends and have an opportunity to make additional margin, that completely disappears in a scenario where there is a private label because their product is never promoted, never goes off invoice.

And then to your second question with regards to fuel, I mean, we have been relatively range bound from a pricing standpoint. If I was to go back probably at this point almost the last 24 months, we have been anywhere from $3.70 to $4.10, $4.20 a gallon for diesel. And I think as we sit here today, we are almost right in the middle of that in the high- $3.90s. From our standpoint, there is no real significant changes in the assumptions for the back half. We would expect to see pricing rise depending on what weather conditions are in the northeast, but see prices rise through March and then have them come off into April and May before they start to rise again starting around Memorial Day.

Okay, that's helpful.

Range bound-wise, we are probably still in the expectations of still in that $3.70 to $4.20 a gallon.

But it sounds like the private label, essentially, picked up a little bit as a percentage of the mix in the quarter.

Yes, yes. We have seen an increase in some of the customers whose private labels, they are selling more of it, yes.

Okay, and then just lastly, on the back haul -- on the impact, the lower back haul income, is that something we should suspect to continue moving forward or is those -- or have most of those issues been ironed out or very difficult to forecast at this point in time? Just curious what the potential impact could be on that line item moving forward.

I would think that -- our expectations that supplier out of stock levels are back into historical ranges, that we would stop seeing the negative impact on the back haul income side because we're not having to move product around multiple times. So there is no expectation that that will resurface into the back half of fiscal '13 and hopefully not into the holiday season in the first half of fiscal '14. But I think Steve, in his comments, in saying that we moved the product around in order to ensure the service level for the customer. To the extent that there are service level issues with suppliers going forward, we will experience a repeat of that because we will incur what costs we need to in order to get the product to the customers. But we don't anticipate anything in the back half of the fiscal year.

Okay. Thank you for taking the questions.

Thank you. At this time, I would like to turn the conference back to Management for any closing remarks.

Thank you for joining us this morning. We continue to be bullish about growth in our industry as consumers migrate towards a healthier lifestyle. We look forward to reporting our third-quarter results in the next several months. Thanks again, and have a great day.

Ladies and gentlemen, this concludes our conference for today. If you would like to listen to a replay of today's conference, you may do so by dialing 1-800-406-7325 or 1-303-590-3030 and entering the access code of 460-2426 followed by the pound sign. Thank you for your participation; you may now disconnect.