United Natural Foods Inc (UNFI) 2017 Q2 法說會逐字稿

Greetings and welcome to the United Natural Foods second-quarter FY17 earnings conference call.

(Operator Instructions)

As a reminder, this conferences is being recorded. I would now like to turn the conference over to your host, Ms. Halie O'Shea, Director of Investor Relations and Corporate Strategy. Thank you, Ms. O'Shea, you may begin.

Good afternoon and thank you for joining us on UNFI's second-quarter FY17 earnings conference call. By now, you should have received a copy of the earnings release issued this afternoon. This press release and webcast of today's call are available under the investor section of the Company's website at www.UNFI.com. On the call today are Steve Spinner, Chairman and CEO; Sean Griffin, Chief Operating Officer; and Mike Zechmeister, Chief Financial Officer.

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

In addition, in today's earnings release and during the call, management will provide GAAP and non-GAAP financial measures. These non-GAAP financial measures include adjusted net sales, adjusted net income, adjusted earnings per diluted share, EBITDA, EBITDA as a percentage of net sales, debt to EBITDA, and free cash flow. For a reconciliation to the most directly comparable GAAP measures, please see our earnings release or visit our website. I'd now like to turn the call over to Steve Spinner.

Thank you, Halie. Good afternoon, everyone. Today I will provide a brief overview of our second-quarter FY17 and an update on our strategic initiatives. As we turn towards the back half of our year, our strategy remains strong, building out the store for UNFI and our constituents remains at the forefront of our strategic growth strategy, and it is taking shape as we move towards 2018. Additionally, the investments we've made in infrastructure, systems, and people have also begun to bear fruit, which I'll discuss in a moment.

We live in an interesting, challenging, and exciting retail food environment. Because of our strategy, commitment to execution and projects now coming to life, UNFI continues to be well positioned as the leader in the better-for-you and specialty foods merchandising and distribution industry for the long term.

I am pleased with our second-quarter execution. Through the hard work and contributions of all of our associates, we have made great progress on our strategic objectives. During the quarter we grew net income 12.3% and grew EBITDA 16.7%, compared with the prior-year second quarter. Additionally, we achieved free cash flow of nearly $91 million in a period where sales grew more than 11%, which is the result of strong asset management.

I'm also very pleased with our working capital management in the quarter. As an example, from a supply chain perspective, the technology we implemented several years ago is now driving strong improvements in more effectively managing our inventory days on hand, while driving up service levels to our customers.

During the quarter, our sales grew over 11%, with a very strong fill rate to our customers, while inventory only grew 6%. In addition, our broadline business, which is our core center store distribution business, performed quite well. Organic sales growth in our broadline business was up approximately 5%, and this was a quarter when our center store business had almost no deflation compared to a prior-year period where we had inflation of more than 2%, or a negative variance of approximately $50 million in the quarter.

We accomplished these financial results in spite of ongoing industry headwinds, as we and our retail partners continue to operate in a highly competitive and deflationary environment. In the face of these challenges, we are even more resolute in the importance of our building out the store strategy, and the need for a robust and differentiated product and service offering for our retail customers.

During the quarter, we continued to make great strides in selling existing customers a broader array of our products. Our one sales team across the US is working, and I'll touch on that more in a moment.

Our recent acquisitions have helped us further build out our products and services. We are able to better leverage these new and enhanced offerings with the strength of our national distribution network, our one sales team initiative, our work with UNFI Next, and our e-commerce platform, which delivered over $60 million of revenue during the quarter.

We continued to gain traction in the second quarter, as we further integrated our acquisitions. We are excited about the opportunities we have for growth and greater efficiencies ahead.

For instance, we are rolling out Haddon House product offerings across our legacy DCs and further deploying our new full-service model. We brought Haddon products to the metro Chicagoland area approximately 10 months ago. Within that time, we have seen a doubling of Haddon House sales in that market. Our recent acquisitions of Nor-Cal produce, Global Organic, and Gourmet Guru also provide an opportunity for us to expand our product offerings and gain additional learnings with new and existing retail partners in a broadened in-store service environment.

We are also seeing leverage from our one sales team initiative, which began in August at the start of our fiscal year. It was designed to create a more unified approach across our product and service offerings by creating a single point of contact to service our customers' needs.

This cross-functional initiative is enabling cross-selling opportunities, as our full sales force is now selling across all of UNFI's products and categories. And we appreciate the efforts of our sales team and are encouraged by the early results and learnings. We are now a one salesforce Company across the country, representing all of our diverse product offerings.

We're also excited about UNFI Next, our program for finding and on-boarding new and emerging brands. It is a great opportunity for UNFI to work with newer brands and support them as they grow. This enables us to build and expand our pipeline of fast-growing and exciting brands that we offer our retail customers.

The enhanced offering also fits well with our online efforts, whether we are working with a large e-commerce retailer or helping a bricks-and-mortar food retailer with its online initiatives. We believe this is an attractive opportunity, as we are able to help our retail customers by offering an endless aisle of products across many different product categories. And we continue to invest in our national e-commerce platform across the US.

While we were encouraged by these initiatives, we also have to acknowledge the ongoing challenges facing our industry. Our customers are facing a difficult retail environment due to deflation and increased competition.

We view deflation as cyclical. Inflation will come back at some point, but while it's here, it's leading to some very real challenges for us and our retail customers. Many of our broadline customer contracts are on a cost plus basis, so when we have less inflation or deflation, the gross profit dollars we generate per case is lower.

In the second quarter, we experienced about 30 basis points of deflation, which is down about 245 basis points from approximately 2.15% in the year-ago second quarter. And we face the greatest deflation in produce.

Although we ship more produce cases in the quarter, pricing and therefore gross profit per case was lower pressuring our earnings in our produce business. During the quarter, produce deflation continued to escalate versus our first quarter by several hundred basis points.

In the face of these industry headwinds, we also look internally for greater efficiency. And as part of these efforts, UNFI is announcing a restructuring program primarily related to severance and other employee separation costs in conjunction with the opening of a shared services center, previously announced acquisitions, as well as other workforce reductions. These initiatives are part of the Company's ongoing efforts to improve internal operations, generate cost savings, and enhance the customer's experience from suppliers to retailers.

As part of the restructuring program, we expect to incur charges of between $3.5 million and $4 million before taxes, and Mike will discuss our guidance and how we expect the restructuring to impact our outlook for the balance of the fiscal year.

We believe our outlook incorporates the ongoing industry challenges, including heightened competition and little to no meaningful improvement in inflation. But at the same time, it reflects our continued commitment to and confidence in our strategic initiatives, strength in our new customer pipeline, and growth opportunities with our retail partners.

In summary, we believe our differentiated product offerings, our recent acquisitions, our reorganized sales force, and our strong balance sheet will provide long-term growth opportunities and enable us to achieve our strategic objectives, while providing a differentiated and unique service platform for our customers. Now I'll turn the call over to Mike to provide some additional financial detail. Mike.

Thanks, Steve, and good evening. Net sales for the second quarter of FY17 were $2.29 billion, which represents growth of 11.6%, or approximately $238 million over the second quarter last year. Regarding the impact of recent acquisitions on our financial results, keep in mind that as the Company has made progress integrating the acquisitions of global organic, Nor-Cal, Haddon House, and Gourmet Guru into existing operations, the financial results are no longer completely separable.

As Steve mentioned, in the second quarter of FY17, we experienced deflation of approximately 30 basis points, which was a slight reduction to where we finished in Q1 of this year and a significant reduction to the 2.15% of inflation that we experienced in Q2 of last fiscal year. Our Q2 deflation this year was comprised of modest inflation across the center of the store categories, combined with deflation in the perimeter categories, such as produce, protein, and cheese.

From a channel perspective, super naturals net sales were up approximately 3.5% over last year's second quarter and represented 34.2% of total net sales, which was a 270-basis-point reduction in net sales concentration versus second quarter of FY16. Supermarket channel net sales increased 26.2% in the second quarter versus Q2 last year and landed at 29.1% of total net sales. Supermarkets concentration was up 336 basis points versus 25.8% in second quarter of last year.

The independent channel grew 9.6% in the second quarter versus last year, and represented 26.4% of total net sales in the quarter. Finally, food service net sales were up 5.1% over second quarter last year, and e-commerce increased approximately 15.4% versus last year. Neither food service nor e-commerce were significantly impacted by recent acquisitions.

Gross margin for the quarter came in at 15.09%, a 56-basis-point improvement over last year's second quarter. The increase was driven by acquisitions and margin improvement initiatives, and partially offset by continued competitive pricing pressure.

In recent quarters, we have experienced reduced vender promotion support, which has been a headwind to our gross margin. In the second quarter we saw a sequential improvement in vendor promotion support versus Q1. And while the support we saw in Q2 was not back to historic levels, it was not a headwind versus Q2 last year.

Our operating expenses for the quarter were 13.07% of net sales, a 58-basis-point increase compared to second quarter of last fiscal year. The year-over-year increase was primarily driven by increased expenses from acquired businesses which have higher cost to serve their customers. Additionally, we incurred additional expense related to depreciation and amortization and stock-based compensation. Offsetting the impact of these year-over-year increases was a $3 million nonrecurring acquisition, severance, and other transition-related costs recorded in second quarter of last fiscal year.

Fuel costs for Q2 of FY17 decreased 5 basis points as a percent of distribution net sales compared to the second quarter of FY16, and represented 42 basis points of distribution net sales. The Department of Energy's national average price per gallon for diesel in Q2 increased 9%, or $0.20 a gallon, compared to the second quarter of last year.

In contrast, our diesel fuel cost per gallon decreased approximately 9.2% when compared to the second quarter last year. Our decrease was primarily due to unfavorable fuel price locks in Q2 of last fiscal year.

Sequentially, the Department of Energy's national average price per gallon for diesel if in Q2 of FY017 was up 4.5% versus Q1 of this fiscal year. However, our total fuel costs in second quarter were down 1 basis point as a percent of distribution net sales, primarily due to the unfavorable fuel price locks in the first quarter of the fiscal year.

Share-based compensation expense represented 32 basis points of net sales in Q2 compared to 17 basis points in the second quarter of last year. On a dollar basis, share-based compensation expense was up $3.9 million to $7.4 million compared to the same period last year. Operating income for the second quarter was $46.3 million, an increase of $4.6 million from the same period last year.

EBITDA for the second quarter was $67.5 million, and as Steve mentioned, an increase of 16.7% from the $57.8 million in the same period last year. EBITDA margin was 2.95% of net sales, up 13 basis points from Q2 last year.

Interest expense in Q2 of $4.4 million was $800,000 higher than Q2 of last year, due to additional debt resulting from our recent acquisitions. The Q2 average interest rate of 3.07% on outstanding debt was 21 basis points lower than Q2 last year.

For the second quarter of FY17, the Company reported net income of $25.5 million, an increase of approximately $2.8 million over second quarter of last year. EPS was $0.50 per diluted share in Q2, an increase of 11.5% over Q2 last fiscal year.

Total working capital at the end of Q2 was $1 billion, up 4.2% versus Q2 of last year, compared to net sales growth of 11.6% over the same period. The working capital favorability was due to targeted initiatives that improved days of inventory outstanding, days sales outstanding, and days payables outstanding. In the second quarter, our capital expenditures landed at approximately $13.5 million, or 0.6% of net sales, which was equal to 0.6% of net sales in the second quarter of last year.

We had free cash flow of $90.7 million in the second quarter of FY17 compared to $106.2 million in the year-ago period. Our Q2 free cash flow represented our second highest quarter in Company history, only trailing last year's second-quarter results. As a result of our Q2 free cash flow, we are raising our guidance for the year and I'll provide more detail around that in a few minutes.

Our debt to EBITDA leverage at the end of second quarter was 1.82 times. Leverage is down from 1.99 times at the end of first quarter of FY17, driven primarily by the working capital improvements.

Outstanding lender commitments under our credit facility were $850 million, excluding reserves at the end of the quarter, with available liquidity of approximately $449 million, including cash and cash equivalents. Our available liquidity increased 60%, or $168 million, versus the second quarter of last year.

Before we discuss guidance, I'd like to provide more color on the restructuring program we announced today. In the second half of FY17, UNFI expects to record restructuring charges of between $3.5 million and $4.0 million before taxes, primarily related to expenses for severance and other employee separation costs.

In connection with the initiative, the Company estimates the elimination or relocation of approximately 265 positions under a plan that will be largely completed in Q3 of FY17, with certain shared service-related transitions extending into the second quarter of FY18. We believe these actions will result in overall expense reductions in the coming year and allow the Company to operate more efficiently and effectively.

As discussed in today's press release, we are updating the FY17 guidance that we provided on December 7 of 2016, based on our performance to date and our outlook for the balance of the fiscal year, including the impact of the restructuring program. For our fiscal year end July 29, 2017, the Company expects net sales in the range of $9.38 billion to $9.46 billion, an increase of 10.7% to 11.7% over FY16.

The Company expects GAAP earnings per diluted share for 2017 in the range of approximately $2.49 to $2.54 compared to FY16 GAAP earnings per share of $2.50. Adjusting for costs related to the aforementioned restructuring plan of between $3.5 million and $4 million, adjusted earnings per diluted share for FY17 is estimated to be in the range of $2.53 to $2.58, compared to the FY16 adjusted earnings per diluted share of $2.59.

Capital expenditures for FY17 are expected to be approximately 0.5% to 0.6% of estimated FY17 net sales. We expect free cash flow to be in the range of $150 million to $175 million. And finally, the Company expects FY17 tax rate to be in the range of 39.7% to 40.1%. At this point, I'll turn the call over to the operator to begin the question-and-answer session. Operator.

Thank you. At this time we will be conducting a question-and-answer session.

(Operator Instructions)

Our first question comes from John Heinbockel of Guggenheim Securities. Please proceed with your question.

Good evening. It's Steve Forbes on for John today.

Hey, Steve.

So given the -- you think back to last call when you called out the $100 million in new customer contracts and just the general optimism right as it relates to the sales team initiative, the one sales team initiative. Is there a specific driver of the updated top-line guide? I know it's modest, but is it particular categories of lower inflation? Maybe you can update us on your inflation outlook. Any color would be helpful.

Yes, I wish we could be more optimistic on the effect of the deflation, which obviously is a big headwind in our top-line growth. But, Steve, like I said in the comments, we feel really good about not only the pipeline for new customers, which is going to come on in the back half of the year, but the work that our one sales team is doing is uncovering lots of really interesting opportunities for us. But unfortunately, we're at a time right now where just the magnitude of the deflation across broadline and primarily in produce is having a fairly meaningful impact in our top line.

Steve, this is Mike. You asked a little bit about forward-looking. It's awfully difficult to forecast where deflation or inflation is going, but we would say the outlook for the remainder of the year would be in the range of minus 0.5% to plus 0.5%, which is down about 25 basis points from where we were thinking last quarter.

And then just a quick follow-up on the restructuring program. I'm not sure how much color you want to provide, but maybe what's really happening or what are you moving around, if you can comment? And if not, maybe just as we think about the benefits of it flowing through, is it fair to think that they should come relatively quickly in the first half of 2018 or is it a longer tailwind, the recognition of the benefits?

It's primarily in the migration to a national sales shared services center that we announced a couple weeks ago, as well as we integrate some of the acquisitions into our systems. I would say that's the majority of where the restructuring is coming from, so severance related. As far as where we see the benefit, whether it's in 2017 or 2018, I'm going to defer to Mike to give you some color on that.

So the expense that we announced today, the $3.5 million to $4 million, is largely offset in the fiscal year, which means the primary benefits will come in FY18.

Thank you.

Our next question comes from Eric Larson of Buckingham Research. Please proceed with your question.

Yes, good afternoon, everyone. Just to push back a little bit on the deflationary front. Obviously produce is something that when you get inflation, it rectifies relatively quickly because it's a short cycle crop, and we're continuing to see this continue on throughout the industry.

So I'm assuming this is really from a competitive industry point of view of all the retailers trying to more competitive on produce. And if that is the case, Steve, where do we sit with that cycling through the entire system? Are we in the third inning of it in fifth inning, or later innings?

Well, Eric, the issue that we have, and it is cyclical, this obviously is not going to last forever, is that the produce deflation got worse in the second quarter than it was in the first. And so in the produce world as the product deflates, we still incur the same amount of cost to get the product from the DCs into the retailers, yet we have considerably less gross margin to cover the cost. And so it is a short-term issue and misery loves Company; everybody's got the same problem.

As far as when it's going to cycle through, your guess is as good as mine. The only thing I would say is I have a high degree of confidence that it's not going to be forever. It will turn. We're just not sure when.

Okay. And then just one other quick follow-up question. Your organic growth rate in the quarter of 5%, which you termed, Steve, broadline, it sounds like our performance food group days. Would you just help -- and that's actually with deflation included in that, that's actually a pretty solid -- that's a pretty solid organic growth rate. So when you talk about broadline, would you just give us what you put into all of that broadline distribution, and then the percent of sales that you call broadline?

So broadline is our primary center store distribution business. It doesn't include our produce. It doesn't include our Tony's business or our fresh business. It doesn't include our produce business. It's the vast majority of what we do.

Do we disclose the total? I don't think we disclosed the total, but it's the vast majority of our Company.

Okay. Thanks, Steve. Thanks, everyone.

Our next question comes from Steven Tanal of Goldman Sachs. Please proceed with your question.

Hey, good afternoon, guys. Thanks for taking my question.

Sure.

Sure.

Just I wondered if we could just on produce deflation, and maybe broadline, Steve, you mentioned that there was deflation there too. Would you be willing to quantify what you're seeing by category, specifically produce and then maybe broadlines too?

No, we're not going to get into the detail of the categories. I think the consolidated number is what we're comfortable sharing.

Steve, I'd just clarify there too. You made the comment that the center of the store was deflationary, but actually the center-of-the-store categories were inflationary. We had modest inflation there. It was just more than offset by the higher level of deflation across the perimeter categories of protein.

It was 30 basis points of inflation in --

30 is the deflation.

30 is the deflation, yes, right. Got it.

Got it, okay, that's helpful. Thinking about gross margin, really nice number, obviously and good job there. I was wondering if you could give us a flavor for what's acquisitions versus the improvement initiatives you framed versus the competitive pressure, at least relative maybe to one another as we think about the model here.

The lion's share of the margin -- a lot of the margin improvement was related to the acquisitions. We did have some modest improvement in our core broadline business as well.

The margin initiatives also played a role in achieving that number. Whereas if you go back to last quarter, we said that the acquisitions contributed more on their own in terms of the margin enhancement.

Yes, I'd also like to add that as you know, we reorganized our P&L leadership into three regions within UNFI. And I would say that as it relates to margin and business decisions and a level of accountability, our region presidents are really doing a wonderful job and I think it's beginning to print.

Got it, okay. And then just last one for me just on fuel. Are you guys still locked at this point or what's the outlook there? Are you locked favorable versus spot or how are you thinking about that going into the third quarter?

Historically, and as I alluded to, we've had fuel locks that were quite a bit above market, which created this headwind on fuel. That headwind is now largely behind us. We still do have some fuel price locks, but they're much closer to current market, which doesn't pose a tailwind or a headwind at this point.

Got it. Okay. Thanks.

Thank you.

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

Hey, guys. Thanks for taking my questions. So I was wondering, -- obviously you're doing the restructuring, but as you think about your retail partners, seeing the challenges that they are and the prep that you guys are looking to if they -- we saw one of them actually close some stores. If we have further slowdowns in store growth, but even maybe some net closures, how do you think about your business in that context and what else you guys may need to do or may not need to do if the current trends continue?

Yes, Scott. So I think what we got right, I think we've talked about this before, is the whole notion that we needed to reorganize the Company into one sales force. We also recognized that in order to continue to grow strategically, we were going to need to get to be a much bigger player in perishable, because perishable was going to grow at a much faster rate than center store.

And so we built the infrastructure. We built the refrigerated DCs with multi-temperature and the fleet and the food safety, and then we reorganized the sales force so that our sales force sells across produce and fresh and vitamins and supplements and personal care and center store and specialty.

And so now, we really are in a terrific position to sell more to our existing customers, which is the most efficient way and most profitable way for us to grow. And we can use the new sales force to enter new customers, not necessarily large customers, but smaller regional customers to sell them categories of products that we were never able to sell them before. And so the long answer is that our building out the store platform is what's going to enable us to continue to grow the business, despite these headwinds that our retailers, our suppliers, and us are facing.

So just a couple -- want to follow up with that, but also ask -- I have two more things here, and one's more of a follow-up. If you look at the deflation, I know you guys talked about that and we've done some research around what's going on in organic. But organics look like they could actually be deflationary for some time.

The thought process is we look at the planting in the US, so many people have gone over to organic, because obviously the farmers haven't been doing well, that it may put downward pressure on products for a while, as all this -- as all these deals come on. I'm wondering if you guys have a thought process if we're going to see a narrowing of the gap between organic and traditional products and what that might do to your business as we move forward. And do you agree with it? I have one more.

I probably need to think about that, Scott. My gut reaction is that growth is good and that if the price point between organic is closer to the price of conventional, it's going to bring more people into the space. It's going to make the product more affordable. And in the end, that's going to be a stimulus for growth for us. So that would be my first reaction, but I'd really need to spend a little bit more time thinking about. Certainly as it relates to the complexities of the inputs, the products that are required on the production side in order to make that happen.

Alright, then my final one is a follow-up from the first one. You guys have obviously been very inquisitive and it's helped your business quite a bit weather the storm. Is that something that needs to be turned on even more as we look over the next year or two, and maybe even think about bigger mergers as the industry changes so rapidly? Thank you for taking my questions.

We did four in about a year, and so we're going to take a little bit of a breather. We're in the midst of integrating Haddon House; we're just about complete. And that's heavy lifting. And so, we've gotten pretty good at finding the right acquisitions, paying a fair price, and integrating them. And so, we're going to continue to do that. We're just going to do in a timeline that works. We just need to take a little bit of a breather.

Now on the other hand, as you know the way some acquisitions work, you either participate or you don't, and if you don't, you lose it forever. But I don't see that as being an issue for us right now, because for many of the companies, we're the acquirer of choice. And so, M&A will continue to play a major role in our long-term growth.

Scott, I'd just like to add that from an integration perspective, giving the team some kudos here, that we will complete the integration of the second Haddon House distribution center in Howell, New Jersey here coming up this weekend, which effectively puts us inside of 10 months to integrate this business here. Which, from a unified perspective is really quite an accomplishment.

That's great. Alright, guys, thanks so much. See you Friday.

Okay, thanks.

Thanks, Scott.

Our next question comes from Rupesh Parikh of Oppenheimer. Please proceed with your question.

Thanks for taking my question. So I wanted to start first with a housekeeping question. Is there any more color you can provide in terms of those savings associated with the restructuring program?

Yes, Rupesh, this is Mike. What we said there, we've got $3.5 million to $4 million that we're expecting in this year. And as I indicated, we expect to offset those costs in the fiscal year, and certainly, the annualized impact will be greater than the partial year that we're in. So the realized savings on an annual basis will fall primarily into FY18.

Okay, great. And Steve, maybe a question for you. As we all look at the environment out there, clearly the retailers continue to struggle, and you continue to hear more and more, everyone focus on their fresh side of their business. So I was just curious, as you guys look at everything that you've done, [receivers] with the acquisitions, are you getting more interest from -- clearly the acquisitions were aimed for, I think, the independent channel. But do you think your model now can help you win more business, or new players in conventional or even the mass channel?

Oh yes, without a doubt, Rupesh. We -- some of the fresh wins that we've had are in nice, multi-unit chains. And so a big part of our strategy is to put that fresh product into all the channels of our business, whether it be conventional or multi-unit independent or independent because it works well in every one of the channels.

Okay, great, and then one more question for me. At the Cagney conference this year, there was a number of the larger CPG players were talking about more and more about natural organic. And this year, there seemed to be more of a focus of introducing new natural, organic product line versus just reformulating existing product line.

I was just curious, are you guys starting to carry more and more products or are some of these new products from larger CPG players?

Yes, where it makes sense, sure. We have obviously, extensive programs with all of the CPG companies. I would tell you that we spend a lot more time thinking about UNFI Next and the resources that we put into finding the new and emerging suppliers with really differentiated products, because those are typically the products that make a big difference to our retailers and those are the products that the retailers need for their own sense of differentiation.

Whereas on the CPG side, if we're going to carry it, so is everybody else.

Okay, great, thank you.

And with respect to Next, there's a greater emphasis on local and regional brands versus national.

Okay, great. Thank you.

Our next question comes from Chuck Cerankosky of Northcoast Research. Please proceed with your question.

Good evening, everyone. When you look at this deflationary environment, I heard what you said a few minutes ago about acquisitions, but does this put pressure on some product categories in companies where the deflation is most focused, giving you some windows here to make some acquisitions?

Yes, without a doubt, deflation would have an impact on certain types of sellers. So my guess is that they -- most of them would probably elect to wait until inflation returns.

Okay, I was thinking it might be putting pressure on their ability to stay in the game, and they'd look for it somewhere else. You're suggesting they have the wherewithal to wait.

Yes, that's true. I think the challenge for us is we typically don't like to acquire turnarounds or companies that are financially troubled. We'd rather pay a fair price for a company that's doing well than a very inexpensive price for a company that's not doing well. The exception to that might be a company that's recently struggling, that's small, that we can close and put into one of our existing distribution centers. But generally, we would acquire the healthy company first.

Alright, thank you very much.

Our next question comes from Zach Fadem of Wells Fargo. Please proceed with your question.

Good afternoon, a couple questions. First, to follow up a little bit on the topic of CPG. With some of the larger companies moving away from direct-to-store distribution, can you talk us through just potential impacts to your business with respect to industry pricing, as well as any potential opportunities to expand your service offerings there?

Yes, we, through the Haddon House acquisition and the Gourmet Guru acquisition, now have a significant in-store field sales and merchandising team. And so, we're -- as the largest distributor in the country, we're going to the vast majority of the retailers already. And so for those suppliers or those manufacturers that want to have a DSD in-store merchandising program, I can't think of anybody better to do that than UNFI.

Okay, and on the competitive landscape, just relative to the conventional grocery distributors out there, has there been any change in the competitive environment as far as their ability to offer more natural and organic products versus in the past? Are they going after the local opportunity? And are you seeing anything from them in terms of pricing when you're out bidding for new contracts?

Not really. You've got to keep in mind that the models are so completely different. The conventional model is predicated on delivering a full truck of conventional products with some natural and organic into a conventional retailer. And obviously, the price dynamics to do that are much different than the price dynamic of delivering three pallets to a store.

When you look at UNFI's infrastructure, our infrastructure is built around providing a great deal of service, whether it's category management, retail category management, in-store service. And these are all things that, generally speaking, the conventional speakers just don't have. Their programs are typically a drop-and-go [drayage] type of situation, which is very different than ours.

But we certainly do lose SKUs as they become faster moving, to the conventional distributors. No different than when we lose SKUs to a captive distribution network.

Okay, and lastly, any update on your efforts to pursue customers in the mass and super-store channels? Would you say that's still a focus?

We'd love to. We unfortunately don't have anything to talk about.

Got it. Okay, thanks a lot, guys.

Our next question comes from Karen Short of Barclays. Please proceed with your question.

Hi, it's actually Ryan Gilligan on for Karen. Just starting with two quick housekeeping questions. Can you talk about what is driving the lower CapEx guidance? And then also, what are the tax benefits, if any, that you're expecting from the new shared services center?

Sure, Ryan. On the CapEx, if you recall back to last year, our CapEx spend as a percent of net sales was 0.49%. As we've been going through this year, we've got discipline on our CapEx spend. We put scrutiny in there. We're definitely interested in high return projects, no question about it, but the guidance that we gave is a reflection of where we've been so far year to date on CapEx, which is more similar to where we were last year. But also mindful of the spends that we've got here coming in the second half.

Got it, and then and on any tax benefits you might get from the new shared services center?

Yes, we're not getting into that level of detail. What I'll tell you about the shared service center is we are excited about it. We think it's going to have a great benefit to us, both on the effectiveness side and on the efficiency side. The project's got great return.

While it's somewhat of a new frontier for UNFI, it's obviously not in the broader business world. There's quite a bit of precedent out there about how to get this done and get it done right. And so we're excited to be on that journey, and getting started now.

Got it, that's helpful. And then, on e-commerce, it's obviously an area of opportunity. Can you talk about how you can accelerate revenue growth there and in a more meaningful way, given that you can't sell direct to consumer, since that could strain your relationship with your retail customers?

Yes, actually you're right in that we can't sell direct to consumers as UNFI. One of our fastest growing platforms is to sell direct to consumer on behalf of our retailers. So essentially becoming the endless aisle for a retail partner, where they're looking to expand their product offering to their consumers. We're doing that today. It's just the consumer doesn't know that we exist. We're just doing the back-of-the-house with [filming].

We have a network of e-commerce fulfillment centers across the country. We're adding to it so that we can get it to our customers in the most efficient and cost-effective manner. So we're investing in the e-commerce platform. And we certainly spend a lot of time with some of the larger e-commerce providers to ensure that we have -- we're giving them access to all of the fresh and vitamins and supplements and center-store, gluten-free, organic, et cetera, as we possibly can. It's an area that we're giving a great deal of focus to.

That's helpful, thanks.

Our next question comes from Kelly Bania of BMO Capital Markets. Please proceed with your question.

Thanks for taking my questions. Wanted to ask also about the mass channel opportunity. As you look to expand that, are you finding any structural challenges with that channel, with mass or drug, be it cost prohibitiveness? Or is there just a lack of interest? Any color you can provide on that opportunity?

There's actually no structural barrier whatsoever. It's taken us some time to figure out how they go to market, what they want to see from UNFI. But I -- think about this: we're buying in the largest bracket across the country in the vast majority of all of the products that mass and drug need to have in their stores. And so, from a logistics and supply chain perspective, we can get it either directly to their store or to their distribution centers more efficiently than they can do it themselves, to a large degree.

And so I think it's just a matter of us understanding the model and convincing them that it makes sense to do it. But we're, again, like e-commerce, we're spending a lot of time and effort to make that a priority.

I would say that the cycle to close in mass and drug is a longer runway. So we're learning our way through that.

Thanks, that's helpful. And then, also just wanted to ask, your biggest customer is accelerating their efforts towards category management. And I was just wondering if there's any impact that would have on you, positive, negative, neutral or otherwise?

Yes, so I wouldn't comment on any individual customer, but Mike can tell you that our customers generally that go through a category-management review process, a plan-o-gram review process, that is extremely beneficial to both suppliers and to the distributor. It just focuses a greater attention on having the right SKUs in the right place in the right ZIP code, 52 weeks a year. So our general experience with all -- with our customers who go through that is that it's beneficial to both the distributor and the supplier.

Thanks, and then just if I can squeeze in one more last housekeeping one. On the gross margin, you mentioned some of the margin improvement initiatives. Can you just elaborate on what those are, if you expect those to continue in the next couple quarter? And is there anything we should be thinking about in terms of fuel surcharges with respect to gross margin?

I will, Kelly, I'll handle, this is Sean, the first half of the question and then kick it Mike on fuel. As I previously mentioned in our reorganizing our business into three regions under the leadership of region presidents with P&L responsibility what -- we have seen many benefits. The level of accountability that is brought to the business, the decision making around investing in either price and/or service are reaping rewards.

So from a sustainability perspective, we certainly do believe it is sustainable. One of the things that we have spent a lot of time in getting to is pivoting the incentive for our sales organization from top-line sales only to gross margin dollar improvement on a year-over-year basis.

So we've got a turned-on sales organization that understands the benefit of selling gross margin, and frankly, they are now aligned to the financials of our company's performance. So it's working. It's early, but it certainly is working.

Yes, Kelly, I'd add to what Sean's saying there too, everything, there's a variety of initiatives and they really span across cost control and then transactional relational initiatives with both customers and suppliers.

Another part of your question was on fuel surcharge going forward, and of course, that is directly tied to our forecast of where diesel fuel would be for the remainder of the year. And we're not forecasting any significant changes from current market as we look at the remainder of the year.

Thanks.

Our next question comes from Marissa Sullivan of Bank of America Merrill Lynch.

Thanks for taking my question. On Haddon House, you mentioned that you've expanded into other DCs. Can you just give us an update on how many DCs currently carry the products and what -- how many are left for the rollout?

Yes, we talked about that, and that's a competitive question, and so we're not going to disclose which DCs have it and which ones don't. But we're really happy with the results that we've seen from the integration thus far.

But would you expect that to continue to be a driver to sales growth going forward? If there's more runway than there is --

Oh, absolutely, absolutely. We're still in the early innings.

Got it, and then I just had a quick housekeeping question for you. The 26.2% sales growth in the supermarket channel, can you confirm that that excludes the impact of customer losses and acquisitions?

Marissa, this is Mike. We have now lapped the previously disclosed customer contract termination; that happened in the middle of our first quarter. So second quarter was a clean quarter, no contract termination impact on the growth there. And of course, that large 26.2% growth number was driven by acquisitions primarily.

Got it, and are you disclosing the growth ex acquisitions?

Yes, we'd love to be able to do that, but as we've talked about, as we move through the year here, we're getting more and more integrated in terms of the acquisitions that we've done and the cross-pollination of selling and products in warehouse make it impossible for us to get an accurate picture of what the acquisition impact is.

So as think more broadly about it, just to provide a little bit of color, I don't think it's much different in Q2 than what we characterized in Q1 of this year, which was an 8% contribution from acquisitions.

Got it, and then just lastly, on that 5% organic growth, does that -- or 8% contribution from acquisitions, does that include Global Organic and the produce or is it -- does that exclude it?

Similar to the way we talked about it in Q1, when we purchased global, we integrated them fully right away. So the ability to separate those financial results became impossible relatively quickly. So as I characterized Q2 being a comparable to Q1, that Q1 number excluded the impact of global, so would the 8% number.

Perfect, thank you so much.

That 8%, of course, applies to net sales.

Great, thanks.

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

Thank you for joining us on our call this afternoon. We are having an investor presentation at EXPO this coming Friday. If you're interested, please contact Halie O'Shea. We hope to see you later this week at the Natural Products Expo. Have a great day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.