United Natural Foods Inc (UNFI) 2013 Q4 法說會逐字稿

Greetings and welcome to the United Natural Foods fourth quarter and full year 2013 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Katie Turner of ICR. Thank you, Ms. Turner. You may begin.

Thank you, and good afternoon, everyone. By now, you should all have access to the fourth quarter and full year fiscal 2013 earnings press release issued this afternoon at approximately 4.05 PM Eastern time. If anyone still needs to review the release, please reference the Investor section of the Company's website, at www.UNFI.com. As a reminder, the webcast of the earnings call is also available on the Company's website. On the call today are Steve Spinner, President and Chief Executive Officer; Mark Shamber, Chief Financial Officer; and Sean Griffin, the Group President.

Before we begin, we'd like to remind everyone that comments made by management during today's call may contain forward-looking statements. These forward-looking statements discuss plans, expectations, estimates and projections that might involve significant risks and uncertainties. Actual results may differ materially from the results discussed in these forward-looking statements.

Additionally, in today's earnings press release and during the call, the Company 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 intended to be considered in isolation or in substitute for any measure prepared in accordance with GAAP. For a complete reconciliation of GAAP and non-GAAP financial measures, please refer to the Company's earnings release issued earlier and available, as we mentioned, on our investor website, under Investors. And with that, I'd now like to turn the call over to Steve Spinner.

Thanks, Katie. Good afternoon, everyone, and thanks for joining us today to discuss UNFI's financial results for the fourth quarter and the full year of fiscal 2013. We are really pleased to report another year of very strong top and bottom line growth. We finished the year on a strong note and achieved record sales of over $6 billion. Our growth underscores the consumer's growing appetite for our natural, organic and specialty products, as well as our focus on enhancing our efficiency and driving further operational excellence across our business.

For the full year, our sales grew nearly 16% compared to 2012 fiscal. And sales during the fourth quarter grew 22% on a year-over-year basis, reflecting an acceleration in demand which has continued throughout the first five weeks of fiscal 2014. UNFI's now a Fortune 500 Company, and we are now included in the S&P Mid-cap 400. Our operating income grew 20% year-over-year to $185 million, also a record, and our operating margins expanded by 10 basis points, to 3.1%. For the year, our net income increased 18.1% versus the prior year.

Looking at the fourth quarter in particular, 2013 demonstrated that our strategies for managing cost and gross margin were on the mark. Gross margin was up 11 basis points versus prior year and 53 basis points versus Q3 2013. The various initiatives focused on during fiscal 2013 are yielding benefits, specifically, with respect to inbound freight, the implementation of our inventory optimization technology, and the migration to a true national supply chain, inbound logistics, category management, and inventory planning platform. Operationally, we continued to be extremely diligent in managing our distribution network, with significant improvements made in the management of our fleet. All of our key indicators, including miles per gallon, cases per route and delivery service level, demonstrated continued improvement.

In the fourth quarter, our operating income increased approximately 31% over the prior year, and we improved our operating margins by 22 basis points to 3.42%, as we've benefited from these ongoing initiatives to enhance productivity and reduce operating expenses throughout the organization. We spent a lot of time talking about operating margin growth, and UNFI had its strongest EBIT margin growth year-over-year since August of 2006. So during the quarter, inflation was 2%, under 2%, which further accentuates the increased demand for our products.

Our core distribution business performed quite well during the year. Additionally, Albert's Organics grew approximately 25%, Woodstock Farms manufacturing grew 16%, and our Blue Marble brands business grew 14%, driven primarily by product launches and rebranding of several of our most popular brands. Field Day branded products, which are exclusive for the independent channel, is now a $14 million brand. And Blue Marble SKUs now represent UNFI's top 10 highest volume brands.

Industry dynamics remain very favorable, due to a growing number of consumers focusing on maintaining healthy lifestyles, with an increased interest in natural and organic products and food safety. I'd like to point to several interesting data points. Today, the natural organic industry is approximately $55 billion at wholesale. At current growth rates, the industry will be over $100 billion by 2020. Additionally, almost 80% of consumers are buying some organic products each year and almost every single household in North America bought at least one natural and organic product last year, with over 72% of parents recognizing the USDA organic seal. These are extremely compelling numbers which point to long-term growth at UNFI. Over the last several years, UNFI's growth, exclusive of acquisitions, has exceeded the growth of the industry.

UNFI is also positioned to capitalize on consumers' growing demand for transparency in food labeling. Recently, the FDA announced new requirements for gluten-free labeling that clarify what is required for food to be labeled as gluten-free. We were pleased about the new policy, which sets a uniform standard that will help individuals manage their gluten intake, in gluten-free products, our category which continues to grow at a very rapid rate. In addition, consumers are becoming increasingly interested in knowing if their food contains genetically modified seed, or GMOs, and we believe that over time there will be legislation requiring the labeling of GMOs. We are well ahead of this trend, as many of our products are certified not to contain GMOs; and our Blue Marble brands division, in particular, currently produces the widest variety of products available under the certified non-GMO label.

To capitalize on the opportunities of our expanding industry, one of our key initiatives is to ensure that we have the proper distribution infrastructure in place. And we've recently opened two new distribution centers that will help us further streamline our operations and improve our efficiencies while meeting the increasing demand for our products across the country. We opened a new facility in New Jersey for our Albert's Organic division which, as you know, is one of the country's largest distributors of organic produce and perishables. For the past several years, our Albert's business has posted strong sales and operating income growth, and the new facility will help us better service our customers and ensure that Albert's is able to continue to deliver strong growth going forward. We also consolidated four distribution locations in Aurora, Colorado into a new facility; and again, this will help us be more efficient, resulting in better service to our customers and the opportunity to achieve better leverage in our distribution costs.

Looking forward, we are in the process of building additional new facilities that will help create capacity for growth. In the back half of fiscal 2014, we expect to open a new facility in Wisconsin, our first in the state, which will serve as our primary distribution point for the Chicago market. We also plan to open two new centers in fiscal '15, with a new facility in the Hudson Valley, New York area, and another in Northern California.

In summary, we believe that building new distribution centers close to our customers will be necessary to meet the significant growth we predict over the next five years. And these distribution centers are also built in a manner that supports our sustainability objectives. We remain true to our stated objective of reducing our carbon footprint by 5% in five years, with over 10% per year sales growth, new LEED-certified buildings and solar panel arrays, reduced distribution miles, and lower energy use, which contribute to our sustainability goals.

Let's talk about customer mix for a couple minutes. During the fourth quarter and compared to the prior year fourth quarter, supernaturals remain consistent, representing 36% of our net sales in both periods, while supermarkets grew to 25% from 23%, and independents declined to 34% from 36%. But interestingly, all three channels are growing rapidly, with supermarkets leading the growth during the quarter with 30% growth over the fourth quarter in the prior year. And our independents are also growing quite nicely, with 16% growth over the fourth quarter of the prior year. UNFI continues to be deeply committed to this very important customer base.

Now supplier out-of-stocks, which we've spoken about quite a bit on the previous calls, continue to be a challenge for us. Throughout fiscal 2013, we focused on maintaining higher service levels despite greater supplier out-of-stocks, and this was accomplished through increase in our inventory at UNFI and moving freight on an expedited basis, as well as throughout our centers, to meet demand; and we do that, to a large degree, at our cost. During periods of high supplier out-of-stocks, UNFI loses the gross margin on these lost sales and reduced promotional activity. We believe that this issue will continue through the holiday season; however, there is some evidence that the numbers are improving. We will continue to be proactive and carry increased inventory levels to help us maintain the high level of service our customers expect from us.

In fiscal '13, we made really solid progress on our initiative to drive operational excellence. And for the year, our operating expenses as a percentage of sales decreased 69 basis points compared to the prior fiscal year. In fiscal 2014, we're confident that we will continue to leverage our higher sales volume and further improve our operating efficiencies. And to help us maximize our productivity and rationalize inventory purchases, we began rolling out a new inventory optimization system. IO is now fully deployed throughout the Western US and is on track to increase service levels, reduce inventory, and enhance our gross margin profile. And we intend to deploy IO in the remaining geographies toward the end of fiscal 2014.

We're confident that we will continue to grow our business organically by adding new customers and increasing our business with existing customers. To complement this growth, we also remain focused on identifying potential acquisition candidates. Historically, UNFI has been an acquisitive company and we have a history of successfully integrating newly acquired companies into our distribution network, and these companies have contributed to our top and bottom line results. We see a healthy pipeline of acquisition opportunities which expand UNFI's product and service offering to our existing base of customers. We have a strong balance sheet, which gives us the flexibility to make these strategic investments to expand UNFI's product and service portfolio.

Looking at CapEx, our capital expenditures during the full year were 1.1% of net sales, and were driven primarily by the construction of our new Denver facility. We expect CapEx will continue to ramp up as a percentage of sales as we build new capacity to support our growth, including the projects that I mentioned earlier in my remarks. For fiscal 2014, we expect CapEx to be approximately $80 million to $95 million, or 1.2% to 1.4% of sales, and Mark is going to provide some more detail on guidance in a moment.

To summarize, fiscal 2013 was a terrific year for UNFI and we are really excited about the prospects for our business in 2014. With almost 16% sales growth, 20% increase in operating profit, and earnings per share growth of 17.2%, I am really, really proud of our team's execution across our business and cultural strategies. And our fourth quarter results demonstrates that our disciplined approach towards managing expenses and gross margin were spot-on, as evidenced by our 53 basis point increase in sequential gross margin and continued efficiency in our operating expenses. And these results would not have taken place without an extremely dedicated, passionate, and driven workforce, which I am extremely proud of.

And now I'll turn the call over to Mark Shamber to discuss our financials for the period. Mark.

Thanks, Steve, and good afternoon, everyone. Net sales for the fourth quarter of fiscal 2013 were $1.64 billion, which represents growth of 22.2%, or approximately $299 million, over the prior year fourth quarter's net sales of $1.34 billion. In Q4, sales growth related to acquisitions accounted for approximately $15.8 million, or 1.2%. As a reminder, fiscal 2013 was a 53-week fiscal year, and that extra week occurred in our fourth quarter. Adjusted for the extra week, which represented approximately $119 million in net sales, fourth quarter sales growth was 13.4%, an increase of approximately 60 basis points sequentially. Inflation increased sequentially in the quarter for the first time in more than a year, coming in at 1.92%, a 16 basis point increase over Q3.

On a year-over-year basis, the spread in the decline of inflation moderated to 109 basis points, as inflation in last year's fourth quarter was 3.01%. On a full-year basis, fiscal 2013 net sales increased by 15.8%, to $6.06 billion, or 13.6% excluding the impact of the extra week. Acquisitions contributed $53.8 million, or approximately 1% of our fiscal 2013 sales growth. Through the first five weeks of our first quarter of fiscal 2014, our sales growth has further accelerated, trending north of 14.5%, which is more than 100 basis point acceleration from our average for the fourth quarter, adjusting for the extra week.

For the fourth quarter of fiscal 2013, the Company reported net income of $32.1 million, or $0.65 per diluted share, an increase of approximately 27.6%, or $6.9 million, over the prior year's fourth quarter. Net income for the fourth quarter of fiscal 2012 was $25.1 million, or $0.51 per diluted share.

With respect to breaking down our growth by channel, I'll provide the results discussing actual growth and then adjusted for the extra week, as Steve has already covered the breakdown by channel as a percentage of our overall sales. For example, supernatural sales increased by 22.2% for the quarter, and 13.4% adjusting for the extra week. Supermarket sales growth was 29.5% in Q4, and 21.1% adjusting for the extra week. The independent channel grew at 15.8% in the fourth quarter, or 8% after adjusting for the 53rd week. And finally, food service sales were up 40.8% for the quarter, or 30.7% factoring in the extra week.

I'm pleased to report that our gross margin for the quarter showed an 11 basis point increase over the prior year's fourth quarter gross margin of 17.2%, coming in at 17.3%. Sequentially, as Steve's covered, this represented a 53 basis point improvement over the third quarters gross margin of 16.8%. The primary drivers of the gross margin expansion were improved performance by our supply chain group, specifically with respect to the inbound logistics and procurement teams. Additionally, the stronger growth by the conventional supermarkets in comparison to our supernatural channel was also a component. Finally, the lower year-over-year inflation headwind and the modest sequential uptick in inflation were contributing factors.

Our operating expenses for the quarter were 13.9% of net sales, compared to 14% for the same period last year. This represents an 11 basis point improvement over the prior year, as operating expenses as a percentage of net sales benefited from a variety of areas. In particular, I'd like to spend a few moments discussing our non-recurring expenses associated with the opening of our new facilities in Denver, Colorado, and our new Albert's Organics facility in Logan Township, New Jersey. We had expected that those expenses would total approximately $5 million to $5.5 million for the fiscal year, with about $2.5 million to $3 million of those expenses occurring in the fourth quarter. And in the quarter, our move and duplicate rent-related expenses amounted to approximately $2.2 million between the Denver and Albert's locations. However, upon further discussions with our auditors surrounding the accounting treatment of the Denver facility lease, we recognized a net benefit of $2.2 million during the quarter, or just under $0.03 per diluted share, associated with the non-cash deferred rent which was partially offset by interest expense from the related financing obligation.

For the quarter, fuel costs decreased by 4 basis points in comparison to the fourth quarter of fiscal 2012, as fuel represented 75 basis points of net sales in the quarter. Our diesel fuel costs in the fourth quarter increased by approximately 1.7% versus the same period in fiscal 2012, while the Department of Energy's national average was up approximately 1.4% over the prior year.

Share based compensation expense totaled $4.1 million in the quarter, compared to $2.4 million in the prior year's fourth quarter. This led to share based compensation expense representing 25 basis points of net sales in the quarter, compared to 18 basis points in the fourth quarter of fiscal 2012. The increase in this area was due to increased performance based long-term equity compensation.

Operating income for the fourth quarter was $56.1 million, a 31% increase over the prior year's operating income of $43 million. Our operating margin in Q4 was 3.4%, a 22 basis point improvement over the fourth quarter of fiscal 2012, when the operating margin was 3.2%. The benefit of the change in the Denver lease accounting was approximately 18 basis points for the quarter.

Interest expense in the quarter of $2 million was approximately 67% higher than the prior year quarter, and was about 23% higher sequentially due to the change in our treatment of the Denver lease. As we look towards the impact of this change on fiscal 2014, we would project interest expense to be approximately $2.5 million higher than in fiscal 2013, spread ratably over the course of the year.

Inventory was $702 million at quarter end, as our days inventory on hand averaged 52 days for the fourth quarter. This reflects a 2-day increase over last year's fourth quarter, when we were at 50 days. Our higher days on hand is being driven by intentional efforts by our procurement personnel to carry more inventory where appropriate, in an attempt to compensate for continued issues with supplier out-of-stocks in certain categories and maintain our service level.

As I mentioned earlier, we have seen a further acceleration in our sales growth through the first five weeks of the first quarter, more than 100 basis points. And as a result, we expect to continue to pursue these efforts into and through the upcoming holiday season. Additionally, with the implementation of inventory optimization in our Western region, we have seen our inventory carrying levels fluctuate, depending upon the supplier. Sequentially, inventory levels increased by about 3.5 days for the same reasons. DSO for the fourth quarter improved by about 1 day, to 21 days, over the prior year quarter and was up modestly over the third quarter.

Capital expenditures were $31.8 million, or 1.9% of net sales for the quarter, which is above our annual targeted spending. However, as we had previously mentioned, a greater portion of our capital expenditures were planned for the second half of the fiscal year, as we completed construction on the Denver and Albert's Organics buildings and we began construction and land purchases for our new facilities in Wisconsin and New York, respectively. For fiscal 2013, CapEx was $66.6 million, or 1.1% of net sales, which was a bit below our guidance. Weather delays in Wisconsin and a longer than expected process to locate a site in Northern California were the major components of the lower CapEx. These expenditures will still occur, but they have now been shifted into the next fiscal year and are captured in our fiscal 2014 capital expenditures guidance.

Outstanding commitments under our credit facility were $131 million at quarter end, with available liquidity of approximately $330 million, including cash and cash equivalents. Our leverage at the end of fiscal 2013 improved to approximately 0.6 times on a trailing 12-month basis. This improvement was due to the decline in inventory on an absolute dollar basis and our increased profitability. For the fourth quarter, we generated about $49 million in free cash, although we finished the year in a negative free cash flow position, due to our investment in inventory, as I mentioned previously. As is typically the case, leverage will increase in the first half of fiscal 2014 as we further invest in inventory for the upcoming holiday season.

As discussed in the press release, we have provided our financial outlook for fiscal 2014 ending August 2, 2014, which will be a 52-week year. For fiscal 2014, we expect net sales in the range of approximately $6.65 billion to $6.78 billion, an increase of approximately 9.7% to 11.8% over fiscal 2013. Adjusted for the impact of the 53rd week in fiscal 2013, net sales are expected to increase by 11.8% to 14%. GAAP earnings per diluted share for fiscal 2014 in the range are expected to be -- sorry, are expected to be in the range of approximately $2.40 to $2.50 per share, an increase of approximately 10.1% to 14.7% over fiscal 2013 GAAP earning per diluted share of $2.18. Excluding the impact of the 53rd week in fiscal 2013, which is approximately $0.04, this represents growth of 12.1% to 16.8%.

Included in our fiscal 2014 earnings guidance is approximately $2.5 million to $3 million of non-recurring expenses associated with the planned opening of our new Wisconsin facility, which is expected to begin receiving product early in the fourth quarter of fiscal 2014, and duplicate rent and building costs associated with the vacated Denver facilities that we exited in fiscal 2013 that have not yet terminated. Finally, we expect our capital expenditures to be in the range of $80 million to $95 million, or approximately 1.2% to 1.4% of expected fiscal 2014 net sales, excluding our plans for financing our new facilities in Wisconsin and New York.

At this point, I'll turn the call back over to the operator, Doug, to begin the question-and-answer session.

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session.

(Operator Instructions)

Our first question comes from the line of Sean Naughton from Piper Jaffray. Please proceed with your question.

Hello. Thanks for taking the question, and congrats on a strong top line in the quarter. Just in terms of the acceleration that you continue to see here to start the new fiscal year, is it a continuation of similar trends that you were seeing in the fourth quarter, or is there something that is really driving that, one of the particular channels, at this point in time?

Yes. Hello, Sean. No, this is -- it's really a continuation of an increase in demand that we saw towards the fourth quarter of last year, and it has continued nicely through the beginning of this year. I wouldn't say that it's directed at any one particular channel. The acceleration is across all three of the channels that we report against.

Okay. That's great to hear. And then secondly, and I know you've touched on this a number of times, but just thinking about the out-of-stocks and understanding how that impacts your gross margin, how would you -- and I know that in Q1 here, that that was called out as a little bit of an impact in your last year. How much would you say that that impacted your ability to maintain or expand margins in 2013? And then what gives you some of the confidence that this may normalize post holiday?

I mean, if you think about what happens when -- we're always going to have a certain amount of supplier out-of-stocks, just the nature of the beast. What happens is when it accelerates beyond historical levels, I mean, the biggest loss is the lost gross margin on the sales that we lose because we don't have the inventory. But there's also a fair amount of promotional gross margin that we lose related to those lost sales, as well as freight revenue and a whole slew of other things that just don't take place when we don't have the inventory. I think we quantified the amount at some point during the last year. We had said that the out-of-stocks were about 100 basis points worse year-over-year in our third or fourth quarter of last year.

Yes. We vary, depending on where they've been. But when we talked about the third quarter, we referenced that we lost about $17 million in sales in the third quarter. And when we had the first quarter earnings call back in late November, early December of 2012, I think we had referenced about $25 million in lost sales there. We didn't break it out in Q2, but we did break it out in those two quarters.

Okay. That's helpful.

It is important to note that we have seen some improvement over the last month or so. I think that we're probably prepared for a rocky road through the holidays, but we're still optimistic that we'll get it back to more historic levels in January, February.

That's great. And then just a quick clarification, Mark, maybe on Q4. If you remove the impact of the accounting treatment for the Denver facility, would you say the margin expansion would be closer to about 5 basis points? Is that the correct way to read it?

On the operating margin?

Yes, that's correct.

Yes.

Okay. Thank you very much.

Actually, well, before we take the next question, the one thing I would add, Sean, is that the benefit would have been spread over the other quarters. As much as it's all concentrated in one quarter, that benefit still would have been reflected during the course of the year, just wouldn't have been in one quarter. Okay, operator.

Thank you. Our next question comes from the line of Andrew Wolf from BB&T Capital Markets. Please proceed with your question.

Okay. So as a follow-up on the accounting, so the first -- Q1 through Q3, your auditor said they wanted that reversed out. Is that how we should look at it?

Yes, it's -- I could probably take up 15 minutes of the call trying to explain exactly just went on.

Is it close enough for horseshoes, was that what happened?

so basically, we reversed some of it out. Some of it is now below the line in interest expense, or it led to increased interest expense. And that's, when we were talking about the fiscal 2014, we'll still have the total amount of expense per year going forward, but a portion of it will be above the line in operating expenses and a portion will be below the line in interest expense. But there's no net change in the amount of money that we're expensing or incurring.

And just under $0.03 in EPS.

Yes, just under $0.03 for the quarter.

Oh, there was $0.03 charged this quarter?

Benefit.

Benefit.

Benefit. Okay. And that's the offset. But what was the net for the year? Because you did bring up your interest expense. There was some net cost to the move, right?

Yes. I mean, I don't have it. I know the increase on the interest expense was $600,000. I don't know what the net rent expense for Denver was, off the top, Andy. I'll have to follow up with you.

I'm just trying to figure out the negative swing. And you called out next year a couple million, $2.2 million or something.

Yes, it will be about $2.5 million next year. It's a shift next year. It'll move from operating expenses to interest expense.

But that's all reflected in our guidance.

Right.

Okay. All right. So on the operating line, the margins, as adjusted, at a 5 basis points expansion, that's how we should think of modeling and so forth.

Yes.

It's all going through interest expense now, and some rent expense we're not going to see. And what about this duplicate rent you're paying, could you tell us what that is? Because that's just dead rent on an empty warehouse?

We talked about, we moved from three buildings or four buildings in Denver to a new location. Not all of those leases end at the same time. So we're going to be paying rent expense, CAM charges, have minimal electricity and water for those buildings until the leases end. Some of them end as soon as six months, some of them don't end for another two-and-a-half years.

But again, it's important to note, we're very particular here in that we call them out just to give you the data, but all of these things are reflected in our guidance.

I know. I just want to know. When a company's paying rent for an empty building, it's real money, but it's also not part of your ongoing earnings because it's going to go away at some point. Is that a couple million? Can you give us a sense of what it is?

It's about -- it's anywhere from $1.4 million to $1.8 million for next year.

Okay. And a bigger picture question, hopefully for Steve. There's so much consolidation going on in supermarkets, whether it's Super Value being sold to private equity, Harris Teeter to strategic, Fresh and Easy and Piggly Wiggly in the last couple days, strategic, and one private equity. Is this an opportunity for -- I'm sure each one's different. But when you look at it as a whole, is this an opportunity, because things are being shaken out, or is it more like these assets are changing and they've got to sort of settle into their new ownership structure and maybe plans that might have been happening are on hold? Can you give us a sense of how you're viewing the current consolidation and how it might affect UNFI?

I think the answer, the short answer, is yes to all of the above. But I think generally it creates an opportunity for us, because there's enough empirical data that says that we know how to do this. And certainly a lot of the supermarket customers that have made the switch over the last couple years are seeing the benefit of that in their increased consumption in organic and natural, and you're certainly seeing it in our overall supermarket sales growth. And for the most part, we have relationships with most of these customers. And so I think generally, we look at it as an opportunity. It's certainly not a negative.

That's it for me. Thank you. Congratulations on wrapping up a good year.

Our next question comes from the line of Scott Mushkin from Wolfe Research. Please proceed with your question.

Hello, guys. Thanks for taking my questions. And I'm probably going to beat this dead horse, because I'm confused, which is not unusual, necessarily. So if we're looking at the -- basically you're shifting into, what is it, an operating lease into a capital lease, or something like that, Mark? Is that what happened here with the treatment, or it's not that?

It's basically going from a sales lease back to a financed building that we, from an accounting standpoint, are perceived to still own.

Okay. So as --

It goes up on the books on the non-cash side.

So as we compare next year to this year on a yearly basis, you trued up in the fourth quarter, but basically the margin look for the year is going to be the same. In other words, the expenses will look the same next year as you've made this correction, is that correct?

Yes. The only thing that would be different, and Andy was partially right with what he was saying, is that a portion of the expense -- and this is rough numbers. But let's say that 40% of the expense, 40% to 45% of the expense, is going to be captured in operating expenses, where 55% to 60% of the expense will now be in interest expense. So the full number still hits in our expenses, but they're now split based on the way this is treated.

And this was all made up in the fourth quarter, but for the year, as we look at year-over-year numbers, it's going to be apples-to-apples as we go forward.

Yes.

Okay. Second question, on the line of guidance. You guys had a ton of one-time charges this year. I'm just trying to get a feel, as we look through the couple million, $2.5 million you talked about and then the dead rent expense, my impression always was as we go forward, '14 is a little easier with some of these one-time expenses versus '13. Is that not true?

That is correct.

That is true.

Again, we typically don't break out the non-recurring for the new buildings. But having said that, as much as we provide the figures, those numbers are down $2.5 million to $3 million on a year-over-year basis.

They're down $2.5 million to $3 million.

Yes.

Okay.

We guided $5 million to $5.5 million in fiscal '13. We're guiding $2.5 million to $3 million in fiscal '14.

Okay. So then this leads to not my third -- but not my final question. If I go to the mid-point of your guidance, unless I'm doing something wrong, your guidance implies margins to be down a little bit.

I think it depends on how you choose to pick the numbers, Andy -- I'm sorry, Scott. The only way -- I think if you were to take the high end of sales and the low end of the guidance, that's the only scenario in which we have any margin dilution. And even then, that's a basis point. When you take the numbers, I think that it translates into anywhere from a half dozen basis points of expansion to, in certain scenarios, as much as a little bit above the high end of our guidance.

Okay. That's good clarity. We'll have to run through our model again. So I appreciate that. And then -- this is my fourth. And my fifth one, I promise, I'll be done and I'll yield the floor. CapEx, Steve, you made a comment that it's $80 million to $95 million, about 1.3% of sales, but then it was going to continue to ramp up as a percentage of sales. Just wanted to make sure I heard that right.

I didn't make that remark. I didn't mean to communicate that it was going to ramp up as a percentage of sales beyond that.

Okay. So it's not going to ramp up as a percentage of sales. Just wanted to clarify for the record there. Okay. Then the final thing, and this is really to Steve. Clearly, the Company's running really well and you guys are doing a wonderful job, so it's not really meant to be a criticism at all. But the big negative UNFI's had through its history is the idea that they really weren't able to get any free cash flow, that they grew so fast, it forced them to build facilities, they couldn't really leverage as much as they would like the current facilities, and free cash flow really never showed up. What's your thought, as we move forward, on that criticism?

I mean, I think the -- I understand the criticism, and everybody's got their point of view. I just don't happen to share that one. I mean, the reality is if you look at our top line sales growth, we could be short-sighted and say, well, we'll push for $100 million in free cash next year. We won't build any buildings and we won't invest in inventory. And our service level will fall, our buildings will be way over capacity, and two years from now, we won't be in a good place. So I think my job is to look long term and to think less about quarter to quarter. And as a result of that, I need to make sure that we're building the buildings to satisfy the demands that are put upon the Company by our customers, and that means building new buildings. And unfortunately, every one of the buildings is $50 million. Now, it doesn't mean that free cash isn't important to us, because it is. And we demonstrated that we could deliver pretty strong free cash in 2010 and'11, fell off a little bit in '12, and it will certainly fall off a little bit in '13 and '14, as we continue to build these buildings.

And just to expand on that, Scott, I mean, one of the reasons I referenced the inventory levels is that if we were short-sighted, we could have finished the quarter, finished the year at say, the mid-point of our target ranges, which is 48, 49 days. And a day of inventory for us right now is about $14 million. So if we took out 3 to 3.5 days worth of inventory, instead of generating $49 million of free cash in the fourth quarter, we would have generated $100 million and we would have had $30 million of free cash. But with the ongoing supplier issues that we've had, we probably would have negatively impacted sales growth into the first quarter and potentially had to move product around, like we did in the first quarter of last year. So we understand it, but you've got to think about the best interest of the business long term.

And just one other comment. Return on invested capital is an important metric for us. It's something that the senior leadership -- actually, everybody who is on an annual incentive plan, one of the metrics is return on invested capital. So while it's not quite the same, looking at the balance sheet and the components of the balance sheet is very important to us.

Great. Thank you for the thorough answer, and I'll yield. Thanks.

Our next question comes from the line of Karen Short from Deutsche Bank. Please proceed with your question.

Hello, there. Just following on Scott's question, back to your response as it relates to margin expansion in fiscal '14, I guess my question is, what are you using as a base earnings in fiscal '13 when you make the comment that you expect margin expansion in fiscal '14? Because I guess I would look at your base earnings as $2.22 this year, not the $2.20. And I actually do show maybe there could be some margin contraction implied in your guidance for fiscal '14. So any color there?

I think, when we look at it on the adjusted basis, we think we're at roughly $2.20. So I'm not -- we were backing out roughly $0.03 for the three items in the first quarter, and so the way rounding comes out, it ends up being about $0.02-plus. From that standpoint, when I ran the guidance with where we have projected that we would come out, I mean, depending on -- again, depending on the puts and takes as to where you put the sales versus where you put the EPS versus those sales, I see only in the scenario where I have the high -- the low end of sales and the low end -- sorry, the high end of sales and the low end of guidance do I actually have dilution, and the other scenarios I see us having varying levels of expansion.

Okay. So when we think about your model and your long-term goals, should we still assume that that 10 to 15 basis point expansion in operating margins is what you're striving for on an annual basis?

Yes, I mean, I would say that it's 9 to 12. We would adjust -- I think the 10 to 15 was what we had put out about four years ago, and a couple years ago we adjusted it to 9 to 12. But yes, that's still what we're targeting.

Okay. And then in terms of the CapEx in fiscal '14, so is it fair to say that's just a one-year situation and then you do think you'd revert back to the 1%?

I think it's --

-- all things being equal.

I think it's going to be a '14 and '15 phenomenon. Because we've got one building coming online in '14, two buildings coming online in '15. Now we haven't determined how we're ultimately going to finance those buildings, but I think it's reasonable to think that our CapEx is going to be similar '14 to '15 and then hopefully come back down.

Okay. And then what are your thoughts on inflation expectations for next year? Obviously, Hain made some comments on where their inflation was this last quarter, and it seems like you saw some acceleration sequentially, so that's consistent. But what are you thinking for next year?

The inflation was up sequentially, but very small.

Yes.

I think first half of the year, Karen, it's maybe 2.25%, give or take 10, 15 basis points either way. But I wouldn't expect anything north of, say, 2.5% through the first half of the fiscal year. And it gets a little dicey predicting more than five or six months out for us.

But if there's anything you can do to get it up over 3%, we'd appreciate it.

People just have to keep demanding the product, right? I guess the last thing was just, is there anything going on with the $1 million in other? It just seemed a little higher than normal.

Yes, really what that is is we have our Canadian division, and at the end of every quarter, every period, actually, we have to revalue the assets on the Canadian books. And so the Canadian dollar, with the strength of the US dollar as is talked about cutting back on QE and the taper, the Canadian dollar has weakened, and as a result, that's all revaluation of the Canadian net assets, which is a non-cash expense.

Got it. Thanks. I'll get back in the queue.

Just one other comment, back to Scott's question. And that is on return on invested capital. UNFI's return on invested capital fiscal '13 versus fiscal '12 was actually up 66 basis points which, from our perspective, was a very strong performance.

Do you have those actual numbers handy?

Yes. As you and I have talked, and I've had with other conversations, the way we model it, we came in at about 9.38% for the year, and the prior year we were at about 8.72%. But everyone has a different way in which they perform the calculation. So I think in your model, Karen, you have us at a north of 10% number because of what you put in versus don't put in. But from our model standpoint, we had it going up by about 66 basis points.

Okay. That's helpful. Thanks.

You're welcome.

Our next question comes from the line of Scott Van Winkle from Canaccord Genuity. Please proceed with your question.

Hello. Thanks. First, on gross margin. In the commentary, you talked about the shift towards supermarket having a positive impact on gross margin, I think, relative to supernaturals. Did I get that right? And then second, I was thinking that the decline as a percentage of sales going to independents would have been more than an offset.

Again, the way I had said it, yes, it's the fact that the supermarket business, on an average, not any individual customer, but on an average, it causes -- it's a contributor in the sense that it's less dilution. The much bigger drivers were the procurement team and the inbound logistics and how we performed on those. But we didn't get -- by virtue of supermarkets growing faster than supernatural for the quarter, we got less pressure than we've experienced for the last few quarters.

Okay.

It's not that it so much helped it expand, but by virtue of the growth, it didn't pressure it as much as it had in prior quarters.

And in that gross margin, particularly the sequential improvement, is there any seasonality? Obviously, you have scenarios like a vitamin mix or independent mix at some times that has a positive impact on gross margin. Was there any seasonality towards that 50-plus basis point sequential improvement?

No, there wasn't. I think that we've talked about this for quite a few quarters, and I think that we are starting to hit our stride as it relates to becoming one company on a national supply chain, logistics, inventory planning, inventory optimization. And so I think a lot of the improvement that we got was related to those things proving themselves out in the quarter.

Okay. Great. And then is there anything with that extra week, I guess intuitively, or shouldn't be, but is there anything in that extra week that has an impact on the operating expense, either positively or negatively?

No.

No. Because we're on an accrual basis, Scott, we would accrue for the extra rent and the extra electricity, any of the trucks running, the lease expense for that extra week, all of that gets factored in. So there's maybe a little bit of leverage that you gain for items that you don't buy regularly, but that's really about it.

Great. And lastly, on the acceleration you've seen since the end of July, you mentioned it was broad-based, I think, Steve, across channels. Is there anything specific UNFI that you would see acceleration maybe more than some of the public retailers that we would see, Whole Foods or Natural Grocers, happening in your branded product? Is there anything you're seeing with branded versus private label? I'm just -- obviously, I'm trying to see if I can extrapolate that on to the rest of the group.

I don't think so. I think it's -- I think the demand is growing across all the channels, as I said earlier. I think that we're starting to see some significant growth from some of the supermarket customers that we brought on in the last couple of years. And that could be based on the fact that they now have a really strong mix of the products that they need to have. But I wouldn't point to any one particular set of SKUs or channels.

Okay. And one other question, if I would, and maybe you gave the numbers and I can add this up. But if you were to take all of the captive brands to UNFI today, what percentage of your sales would that be?

You're talking about the brands that we own or control?

Correct.

4%.

Thank you.

Our next question comes from the line of Greg Badishkanian from Citigroup. Please proceed with your question. Your line is live.

Great. Thanks. And just wanted to follow up on Scott's question, in terms of the accelerated growth. Is there -- would you say that the industry is growing, or are you picking up maybe incrementally new customers or new business that the industry wouldn't be seeing?

Well, I mean, Greg, we haven't seen the published industry growth numbers. We see them directionally. We think it's probably around 10%. And obviously, we're growing considerably faster than the industry. I think, selfishly, I think we're just doing a good job, merchandising the products, providing retail category management. I think our field salespeople are doing a good job, and that's pushing the demand up. I can't comment about what some of our competitors are doing, because I don't see their numbers.

That's helpful. That's very helpful. And then also, have you noticed any changes in the industry the last few months in terms of the competitive landscape, whether it's pricing or discounting or anything, or has it been pretty consistent?

No, it's been -- I think it's been pretty consistent. I haven't seen real change.

All right. Good. Nice job. Thank you.

Our next question comes from the line of Jason DeRise from UBS. Please proceed with your question.

Hello. It's Jason DeRise. So obviously, there was the change in the accounting for the quarter, but if we just put that aside, you did better than the guidance. What changed during the period operationally that surprised you?

I think a lot of it was just the sales strength was much better than we had projected. The operations teams continued to deliver from an expense standpoint. We've continue to achieve improvement on the leverage side; but with the additional sales volume, we're able to gain that much more leverage.

And in terms of which categories or customer groups? I know you've been talking about the recent acceleration has been broad-based. Would you say it was that independents maybe did a little bit better than you were originally expecting?

For the quarter to date, we really don't break that out, particularly because we have one customer that represents entire channel for us and they're publicly held. We generally stick to just the overall trend and we don't go into it sales by channel for the quarter to date.

I guess I meant for the quarter that happened.

For the past quarter? I mean, I think that the supermarkets, when we look at where they were third quarter versus fourth quarter, I think that even after adjusting for the extra week, the supermarket growth saw a noticeable uptick from 3Q to 4Q.

Okay. And in terms of the -- just wrapping up the full year of fiscal '13, when you clean up your EBIT margin, I know you're referencing in the press release 10 basis points. I just want to make sure I'm thinking about that right. That is like fully cleaned up for the accounting change that really should have been in place for the whole year? It adjusts for the strike. It adjusts for -- that's a clean number. Or would you say that that still needs to be adjusted further?

What I would say is on a GAAP to GAAP basis, it's 10 basis points expansion. So fiscal 2012 on a GAAP basis was just under 3% and fiscal 2013 on a GAAP basis was just under 3.1%. If you were to do it on a non-GAAP basis, I would say that we had a modest -- I think it would be 3 or 4 basis points dilution. But we would be at 3.1% both years.

And the fourth quarter?

In the fourth quarter, it would be 5 -- 4 or 5 basis points expansion, non-GAAP to -- the fourth quarter last year didn't have any adjustments, so GAAP to GAAP it's 22 basis points, non-GAAP to GAAP, it was 4 or 5 basis points expansion for the fourth quarter.

All right. I'm probably going to follow up with you after this call, just to make sure I get all these bits and pieces right.

Sure.

And I guess the last thing I wanted to ask, are there any -- in the guidance, is there any contemplation of any big wins coming up in terms of new customers on-boarded?

There is not.

Okay. Thank you.

And Operator, we probably have time for just one last question, as we're just about at time.

Okay. Our last question comes from the line of Stephen Grambling from Goldman Sachs. Please proceed with your question.

Good afternoon. Thanks for taking my question. You helped quantify some of the out-of-stocks and noted that you expect them to improve, but if you can just provide a little bit more detail on some of the drivers there. Is it specific categories? Is this something that there's just something longer term that's happening with the suppliers that's giving them issues with getting the appropriate product? Thank you.

Sure, Stephen. It's driven by, first and foremost, by the fact that we have a lot of suppliers that are growing 20%, 30%, 40% and they just cannot keep up with that kind of demand. In many situations, suppliers roll out new products. They allocate lines to produce it with a forecast that says, hey, we're going to get 15% consumption on the line, and they get 40%. Well, if you only had one line, you only have one line, and it just takes time to catch up. So I think that's the biggest single driver, and the plus of that scenario is that we will ultimately catch up.

Where it gets a little bit more complicated is where you're dealing with commodities, quinoa, products that may grow once a year, specifically to organic products that grow once a year, where there's just a limited amount of capacity around the world to produce the product. So those out-of-stocks will probably be a little bit longer than the others. But we feel very confident that it's going to plague us for some period of time and has already, that the industry will adapt and we'll get through it and we'll produce the product, just under the notion that everybody wants to sell more.

That's helpful. Two very quick follow-ups on that. The first would be, you mentioned that on the customer side you've been seeing -- there was some discussion about some consolidation, but on the supplier side, are you starting to see some consolidation that can maybe help alleviate some of that as you get some bigger players? And then the other follow-up is just on the commodities, where you do see some limitations in terms of the supply, are you starting to see some inflation or pockets of inflation in those categories? Thanks again.

Let me answer the first one first. Interestingly, no, we haven't seen the inflation come. I guess it will, at some point, but we certainly haven't seen it yet. As far as the manufacturers consolidation, I think what you have to keep in mind is that the majority of these suppliers are still very, very small, relative to what you would typically think of as a conventional manufacturer. And I'm talking about suppliers who are sub-$50 million in size. And so there hasn't been a lot of manufacturer consolidation, relatively speaking. I guess there could.

I guess you're talking about the Procter & Gambles of the world acquire some of the smaller organic brands. And in theory, that should be able to help control some of the out-of-stocks. It's possible. We haven't seen it. A large percentage of the manufacturers that play in our space have products that are co-packed. In other words, they're made by third parties, which gives them a little bit less control over the capacity. So we haven't seen it. I guess it could happen. But in the end, I think we're ultimately somewhat optimistic that the supplier out-of-stocks will alleviate over time.

Great. Thanks so much for the color and good luck in the upcoming year.

Thank you.

Thanks.

I'd like to hand the call back over to management for closing comments.

I want to thank you once again for joining us this afternoon. UNFI's fiscal 2013 was a terrific year. We're now focused on 2014 and look forward to discussing our Q1 results later this year. Thanks for your continued interest in UNFI and eat organic.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.