United Natural Foods Inc (UNFI) 2017 Q3 法說會逐字稿

Greetings, and welcome to the United Natural Foods Third Quarter Fiscal 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to Ms. Halie O'Shea, Director of Investor Relations and Corporate Strategy. Thank you, Ms. O'Shea. You may now begin.

Good afternoon, and thank you for joining us on UNFI's Third Quarter Fiscal 2017 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 Investors 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 operating income and adjusted earnings per diluted share, EBITDA, adjusted EBITDA, leverage and free cash flow. For a reconciliation to the most directly comparable GAAP measures, please see our earnings release or visit our website at www.unfi.com.

I'd now like to turn the call over to Steve Spinner.

Thank you, Halie. Good afternoon, everyone. Today, I'll provide some brief comments on our third quarter fiscal 2017 and an update on some of the initiatives we are excited about at UNFI.

As we turn toward the end of our fiscal year and think about fiscal 2018, there was a lot we are doing to move UNFI forward. We work in an industry that is constantly changing, and we need to evolve with it to meet the needs of our customers and suppliers. Our "building out the store" strategy continues to be our vision for UNFI's long-term growth, and the team executed well against these plans during the third quarter.

I'm extremely proud that we completed the integration of Haddon House and Gourmet Guru during the third quarter. We completed Haddon House in just 10 months. This would not have been possible without the hard work and dedication of our associates. Although integrations are never easy and this quarter was no exception, they were successful despite some short-term disruption during the quarter. And I'm going to speak more about the opportunities we're seeing as result of our recently acquired businesses in a few minutes.

During the third quarter, when compared to the prior year period, we were pleased that adjusted EBITDA grew 6.3%, and gross margin expanded 34 basis points to 15.46%, which is a credit to our team's focus on creating value through highly disciplined expense and pricing control. We generated free cash flow of nearly $49 million. We demonstrated strong working capital management. Working capital was up 2.5%. Inventory was up 5.8% even with net sales growth of more than 11%.

We accomplished this at a time when our industry is facing real challenges from deflation. Same-store sales in many of our retail customers were under pressure or negative during the quarter. Our retail customers are facing competitive pressure not only from other food retailers but also from many channels now carrying assortment of better-for-you products.

And UNFI is not immune. We continue to experience deflation, which was negative 17 basis points, excluding Haddon House, during the quarter. Deflation in produce was around 2%. This was an improvement from the second quarter, however, reflects a headwind compared to the year-ago period when we had inflation of 1.25%. And general lack of inflation also caused what we believe to be a short-term pressure on gross margin dollars, which Mike will speak more specifically to momentarily.

Although industry headwinds have not abated, we see some reasons for cautious optimism. Deflation has continued but has moderated. We believe UNFI is well positioned for growth as the broader industry backdrop improves over time.

Natural and organic remains a bright spot in the food retail industry. Consumer demand for natural and organic products remains strong. Sales of products with natural positioning were up 8% for the 52 weeks ended April 16, 2017, according to SPINS. This measure reflects an aggregate of products with natural positioning in retail channels, including conventional, mass, natural and specialty.

The industry continues to grow and UNFI is deploying its significant sales and supply chain resources to take share. Our highly skilled enterprise and regional teams are focused on customer category expansion across many exciting new buyers of better-for-you products.

E-commerce in particular is a channel where natural and organic is growing rapidly, and we believe we have extensive capabilities. In the third quarter, we extended our e-commerce platform to Northern California in our Gilroy, California distribution center. Our e-commerce sales were up more than 12% over the prior year comparable quarter, and we continue to have rapid growth with our largest customers in this business.

We work with both Internet retailers and with brick-and-mortar retailers that are looking to offer their customers greater variety or endless aisles of products and categories like gluten free, vegan, vegetarian, health and beauty supplements, baby food and specialty snacks. We provide fulfillment either on a direct-to-consumer basis or direct to store always on behalf of UNFI's business customers.

We have a strong pipeline of new business. We are getting a lot of base hits resulting from the migration of our sales force to a single sales team with associates representing and selling across all UNFI categories. This has helped accelerate our "building out the store" strategy moving forward.

We are gaining momentum with our initiative to build out a national fresh platform that includes bakery, deli and conventional produce, and with the Nor-Cal acquisition, we gained important knowledge and expertise in conventional produce, which has been an integral part of this effort. To continue this important initiative, we have recently restructured our produce business and is now led by Bill Schultz, who, until recently, served as the Chief Operating Officer of Haddon House and has over 20 years of perishable distribution experience.

During May, we had 2 UNFI food shows, 1 in Foxwoods, Connecticut and the other in Long Beach, California, and I can't remember any shows that we have that have been so well attended by both suppliers and retailers. The shows had more than 2,000 suppliers and over 3,000 retailers that attended. This clearly demonstrates UNFI's continued leadership role within the industry, attracting customers from every major retailer across the country. And we showcase fresh produce, cheeses from all over the world, proteins, exciting new products, floral, deli, prepared foods and so much more.

With initiatives like UNFI Next, we have superior capability at sourcing, supporting and incubating our new and emerging brands. Combining the efforts of our UNFI Next team with the sourcing capability of Gourmet Guru, we believe we have created an unparalleled platform of unique and emerging brands to offer our customers.

We are also moving forward with our new supplier services business. As part of our acquisition of Haddon House, we acquired this capability, further differentiating UNFI with our suppliers. It enables us to provide direct representation within our customer base with truly unique in-store sell-through programs.

During the third quarter, we completed the integration of Haddon's distribution center in Howell, New Jersey. This followed the conversion of Haddon's South Carolina facility onto UNFI's infrastructure and warehouse management system during the second quarter. The 2 distribution centers have now been fully integrated, and we see a significant opportunity to grow by adding each company's products to distribution centers throughout the country.

We have been very pleased with the expansion of our specialty and full-service capabilities into the Chicago metro area after moving Haddon product to our Racine distribution center. We are excited about these growth initiatives. However, as I mentioned, UNFI and the industry are facing numerous headwinds. As a result, we continue to look for greater efficiencies within our organization. And today, we announced an expansion of the restructuring we first spoke about on our second quarter fiscal 2017 call on March 8, 2017. It is primarily related to expenses for severance and other employee separation costs mostly related to the recently completed integration of several of the acquired businesses.

As a result of these actions, UNFI expects to incur restructuring charges of between $3 million and $4 million before taxes during the fourth quarter of fiscal 2017. And these charges are in addition to the $3.9 million in restructuring charges we incurred during our third quarter that we talked about during the last quarterly call. Mike will discuss our guidance and how we expect the restructuring and related savings to impact our outlook for the balance of the fiscal year and next year.

In summary, we believe our sourcing capabilities, our recent acquisitions, our reorganized sales force, our strong balance sheet and demonstrated leadership within better-for-you distribution will provide long-term growth and enable us to achieve our strategic objectives. "Building out the store" continues to be our winning formula as we take advantage of our significant North American infrastructure to expand into fresh, e-commerce and new customer channels.

And now I'll turn the call over to Mike to provide some additional financial detail. Mike?

Thanks, Steve, and good evening, everyone. Net sales for the third quarter of fiscal 2017, $2.37 billion, which represents growth of 11.1% or approximately $237 million over the third quarter of last year. Net sales finished below our expectations in the third quarter driven by broad-based retail softness, the rationalization of business in conjunction with our margin initiatives and lack of inflation.

Regarding our recent acquisitions, due to the progress we've made on integrating Global Organic, Nor-Cal Produce, Haddon House and Gourmet Guru, their financial results are no longer separable. That said, we estimate that the acquisitions contributed approximately 7 percentage points to net sales growth in the third quarter.

In the third quarter fiscal 2017, we experienced deflation of approximately 17 basis points, excluding the impact of the recently converted Haddon House warehouses. The result was a slight improvement versus the second quarter of this year, but the lack of historic levels of inflation continues to be a headwind to our net sales growth and to our margins.

From a channel perspective, supernatural net sales were up approximately 4.8% over last year's third quarter and represented 33.7% of total net sales, which was a 203 basis point reduction in net sales concentration versus the third quarter of fiscal 2016. Supermarket channel net sales increased 27.5% in third quarter versus third quarter last year and landed at 28.7% of total net sales. Supermarkets concentration was up 369 basis points versus third quarter last year.

The independent channel grew 7.3% in the third quarter versus last year and represented 26.9% of net sales in the quarter. Food service net sales were up 5.6% over the third quarter last year, and e-commerce, as Steve mentioned, increased approximately 12.3% versus last year. Neither food service nor e-commerce were significantly impacted by the recent acquisitions.

Gross margin for the quarter came in at 15.46%, a 34 basis point improvement over last year's third quarter. The increase was driven by acquisitions and margin improvement initiatives, partially offset by the lack of inflation and competitive pricing pressure.

I'm encouraged by the progress we are making on our margin initiatives. Due to the lack of historic levels of inflation, the results of our margin efforts are somewhat muted. Consider that our business model delivers 30 to 40 basis points of gross margin and EBITDA margin expansion each year from just 2% more inflation. The lack of that level inflation, particularly across the center of the store, has been a headwind in our results for the past 5 quarters.

Operating expenses for the quarter were 12.72% of net sales, a 69 basis point increase compared to the third quarter of last fiscal year. The year-over-year increase was driven by higher expenses for acquired businesses, which have higher cost to serve their customers and the associated integration costs in the quarter.

Operating expenses for the third quarter fiscal 2017 also included $3.9 million of restructuring expenses as well as an increase in health care, depreciation, amortization and stock-based compensation expense, which were largely offset by leverage and savings from margin initiatives in the quarter.

Fuel costs for Q3 of fiscal 2017 increased 5 basis points as a percent of distribution net sales compared to the third quarter of fiscal 2016 and represented 42 basis points of distribution net sales. Our diesel fuel cost per gallon increased approximately 8.6% compared to the third quarter of last year, and our increase was less than the Department of Energy's national average price per gallon for diesel in Q3, which increased 23.6% or $0.49 a gallon over the third quarter of last year. Compared to the second quarter of this fiscal year, our diesel fuel costs were down 1% or $0.02 a gallon, and for the same period, the Department of Energy's national average price per gallon for diesel was up 2.5%. Our favorable position on diesel fuel cost per gallon versus the reported national average is primarily the result of unfavorable fuel locks in previous comparable quarters, which have expired in Q2 of this fiscal year.

Share-based compensation expense represented 20 basis points of net sales in Q3 compared to 15 basis points in the third quarter of last year. On a dollar share basis, share-based compensation expense was up $1.5 million to $4.7 million compared to $3.2 million in the same period last year. Compared to Q2 of this fiscal year, share-based compensation was 12 basis points as a percentage of net sales.

Operating income for the third quarter was $64.9 million, a decrease of $1.6 million from the same period last year. And adjusting for the restructuring expenses incurred in the third quarter of fiscal 2017, operating income increased 2.9% to $68.9 million compared to adjusted operating income in Q3 of last year, which excluded acquisition charges.

Interest expense in Q3 was $4.2 million, which was $0.2 million lower than Q3 of last year due to a 72 basis point reduction in the average interest rate and offset by approximately $60 million more debt versus Q3 of last year. The Q3 average interest rate reduction is due to the previously disclosed debt refinancing and rate locks that were completed over the past 5 quarters.

For the third quarter of fiscal 2017, the company reported net income of $36.6 million, a decrease of approximately $1.7 million over the third quarter of last year. Earnings per share was $0.72 per diluted share in Q3 compared to $0.76 per diluted share in Q3 of last fiscal year. Adjusting for the impact of restructuring charges recognized in the third quarter of fiscal 2017 and the acquisition cost in the prior period, adjusted earnings per diluted share was $0.77, which was flat to a year ago.

EBITDA for the third quarter was $86.4 million, an increase of $2.7 million (sic) [2.7%] from $84.1 million in the same period last year. And adjusted EBITDA was $90.4 million during the third quarter, up $6.3 million -- I'm sorry, 6.3% versus Q3 last year.

Total working capital at the end of Q3 was $984 million, up 2.5% versus Q3 of last year compared to our net sales growth of 11.1% over the same period. The working capital favorability was due to targeted initiatives that improved days of inventory outstanding and days payable outstanding in Q3 versus last year.

In the third quarter, our capital expenditures landed at approximately $17.3 million or 0.7% of net sales, an increase from 0.4% of net sales in the third quarter last year. We generated free cash flow of $48.9 million in the third quarter of fiscal 2017 compared to $72.4 million a year ago.

And at the end of third quarter, our debt-to-EBITDA leverage, excluding operating leases, was 1.51x, which equals our lowest leverage over the past 3 years. Sequentially, leverage was down 0.31x from 1.82x at the end of second quarter.

Outstanding letters of -- lender commitments under our credit facility were $883 million, excluding reserves at the end of the third quarter, with available liquidity of approximately $565 million, including cash and cash equivalents.

Earlier today, we announced an expansion to the restructuring initiative announced last quarter. With this expansion, we expect to incur additional restructuring charges of between $3 million and $4 million before taxes during the fourth quarter of fiscal 2017. These charges are primarily related to severance and other employee separation costs in connection with recently completed integration actions on several of our acquired businesses. These actions are expected to result in annualized savings of between $8 million and $9 million before taxes in addition to the savings we expect to generate from restructuring initiatives we announced in last quarter.

So in aggregate, the restructuring program will now result in pretax charges of between $6.9 million and $7.9 million in fiscal '17, and we anticipate annualized savings from the combined initiatives to be in the range of $15 million to $17 million on a pretax basis with approximately $4.5 million to $5 million of that savings expected to incur in fiscal 2017. The remaining savings will be included in our fiscal '18 guidance that we expect to deliver in September.

We also reported on the sale of our investment in Kicking Horse Coffee, a Canadian roaster and marketer of organic and fair trade coffee. The sale closed after the completion of our third quarter on May 24. As a result of that sale, we expect to recognize a gain of $6.1 million before taxes in our fourth quarter results. With an original investment of approximately $3.1 million, the gain is a successful outcome against our strategy of cultivating our minority investments in high-potential brands.

As indicated in our press release, we are revising certain components of our guidance for fiscal '17 that was provided on December 7, 2016, and updated on March 8, 2017, based on our performance to date and our outlook for the balance of the fiscal year, including the impact of expenses associated with the restructuring program and proceeds from the sale of our investment in Kicking Horse Coffee. For our fiscal year ending July 29, we anticipate net sales in the range of $9.29 billion to $9.34 billion, up 9.7% to 10.3% over fiscal 2016 compared to our previous guidance of $9.38 billion to $9.46 billion. The guidance range for GAAP earnings per diluted share and adjusted earnings per diluted share is unchanged from the range given on March 8 with adjusted EPS, excluding the gain on sale -- a gain on the sale of the company's interest in Kicking Horse Coffee and the additional restructuring charges described previously. We continue to anticipate capital expenditures for fiscal 2017 in the range of 0.5% to 0.6% of net sales and free cash flow of $150 million to $175 million. And finally, we now expect our tax rate for fiscal 2017 to be in the range of 39.3% to 39.6% compared to the previous guidance 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?

(Operator Instructions) Our first question is from John Heinbockel of Guggenheim Securities.

So Steve, with the combined sales organization, I imagine that would show up first in existing account penetration as opposed to new accounts. Is that right? Are we beginning to see that yet? And when does produce go into Hudson Valley and Denver?

So John, the first part is that we have obviously completely -- completed the integration of the One Sales Team, and so we're now a couple quarters into fully functioning in that way. And so really the intent was a couple of things, first and foremost, to really get a lot of base hits, smaller base hits where we're taking advantage of opportunities within our independent customer base, our regional chain customer base, and we certainly are starting to see that. A little bit difficult to see it through the clouds of kind of deflation and the related headwinds, but we're starting to see a lot of base hits, which is really what we anticipated. At the same time, we put together what we feel is a really strong national sales force or enterprise sales force that is going after kind of alternative channels, channels that we've never really been in before, a much more narrow focus on e-commerce. And those things are all taking place outside of the One Sales Team structure.

John, this is Sean. And to add to Steve's comments, I think you're right to think about it in terms of penetration sort of first as a result of the One Sales Team effort across categorization, et cetera. And there is a tremendous amount of activity in that regard. But we're also seeing wins. As it relates to the produce question, keep in mind that we are in produce distribution in our Bridgeport, Pennsylvania distribution center with Albert's. So we are penetrating into that market today.

Really, I think it's really a question of we're pretty national on our produce today. There was a couple of pockets where we don't have coverage, but we're much more focused on rolling conventional out around the country. And that's a much more competitive area that we wouldn't want to get into discussing where it's being deployed and how.

All right. And then secondly, I think you would -- you guys have said you want to get Haddon House integrated and then you would be ramping up M&A again. So you've done that. Are we now poised to see that pick up -- activity pick up again? And what does the pipeline look like?

Yes. I mean, John, we've worked hard over the last year as you know. Four acquisitions is very hard work for a lot of people. Integrating Haddon in 10 months, we had a lot of people that did a heroic job to get that done. And so I think we're going to continue to let the integrations continue, let the One Sales Team have more and more success in getting deployed. Obviously, if there was an acquisition that made a lot of sense, we wouldn't walk away from it. But I think our focus right now is to continue to see the united sales force take hold. And once we feel comfortable that we're good to go and people had a chance to breathe, then we'll go back at it. As you know, we've got a really strong balance sheet, and we're protecting that balance sheet so that we can start getting back onto the M&A campaign as soon as the time is right.

The next question is from Rupesh Parikh of Oppenheimer.

So maybe to start out, Steve, with your commentary in the press release about the broad-based food retail softness. Clearly, we've seen challenges with all the specialty retailers last several quarters, so just want to get a sense of where you guys saw incremental pressure this quarter maybe versus your expectations.

Yes. I mean, I can't really comment on our expectations, but obviously, Rupesh, you know as well as anyone that when you look at general same-store sales and year-over-year, quarter-over-quarter, many of the retailers across most of the channels are facing some real headwinds in terms of growth. And as part of that, we've seen certainly a fair number of store closings as retailers are coming together. And so in the near term, that's been a real headwind for us. But deflation will -- inflation will return. That'll make it a little bit better. We'll get some stability in kind of overall unit growth. And so like I said in my comments, I'm cautiously optimistic, but I mean, everybody's seeing the same data that we are. And we just got to work our way through it.

Great. And I guess, Steve, on the comment about closing, so as you look at going forward, how much visibility do you have into store closings from your retailers? And do you expect them to accelerate going forward?

We see it when you see it. We don't really have any clarity into it. I think that -- again, I'm optimistic, and so I think that we've seen -- I think the worst of it's behind us. And whenever you get inflation returning, that just kind of -- it seems like it's the tide that lifts all ships. And that's -- we feel good that we're going to start seeing more and more of that.

The next question is from Eric Larson of Buckingham Research Group.

Could you give us a quick update? I think that you had spoken about onboarding. I think it was about $100 million worth of new customers. I believe it was this year. Is that going according to plan? Is it a little bit behind? I mean, how would you characterize kind of your new customer build through the third quarter?

Eric, this is Sean. Thanks for the question. Actually, we're tracking on that $100 million in customer wins that we previously announced. However, in the context of Steve's comments, the overall landscape, the terrain at retail is sort of masking that activity in terms of it printing. So the teams are doing a great job. The outcome from the region structure is working. We certainly would like to see that continue. We believe it will, but the overall landscape is -- it just continues to be a challenge for us.

And looking out to 2018, you guys continue to generate a lot of free cash this year. Your leverage ratio is down, and it's very attractive. You're not levered hardly at all at this point. Can you talk about your CapEx needs for 2018? Obviously, revenues have been a little softer than you had expected. So are your capital expenditure needs going to accelerate at all in the next year? Or will they remain kind of the net 0.5% of sales range going forward for at least another year?

Eric, this is Mike. We haven't provided any guidance for fiscal '18 specifically. What we have said in the past is that with the kind of growth that we would expect, that our CapEx would land around 1% of sales over the longer term. But as you know, CapEx can be very chunky because if you build a new warehouse, you're talking about $30 million to $80 million potentially, depending on the size and capability of the warehouse. And so that can add a lot onto a year when you do that. We haven't talked about the need to build any new warehouses in the near future. It's possible we could have some expansion, but we'll give you more color on that when we provide guidance in fiscal '18.

Okay. And then just one final question. I believe -- and you kind of gave a rough number of sort of 7% -- 7 percentage points of your 11.7% growth in the quarter top line came from acquisitions. And again, I know that, that's a difficult number to come by. But that 4.7% actually looks like an acceleration from Q2. Can you discuss that briefly, if that is accurate or not? And what might be the drivers of that?

Yes. Eric, Mike again. The -- so first of all, just to clarify, the growth in the quarter was 11.1%, and we do estimate 7 percentage points coming from acquisitions, which would put the core growth at 4.1%. And that is a little bit better than we've seen here recently, and I think it -- even with the retail landscape as it is and with some of the initiatives on margins that we've done, we're feeling -- we've signed up new customers, as Sean talked about. We're tracking against that $100 million, and that core growth number is getting better for us.

Okay. Yes, sorry, I misquoted the total quarterly growth rate.

The next question is from Andrew Wolf of Loop Capital Markets.

So kind of following on, on Eric's thought. So was the cadence in the quarter what you -- was it also improving? And could you tie that into why you're trimming the guidance? Is it on the inflation side? Or is it on -- is there something going on with customer rationalization? Is that what you're alluding to?

You're talking about the -- you're talking about why did we trim the sales guidance in Q4?

Yes, I'm just sort of -- I mean, you got 4.1%. I guess, is that an improvement but still below what you expected, and so you're just sort of -- it's better but not what you thought it would be even better than that? Is that the -- I'm just trying to get a sense for why you trimmed the sales guidance.

Yes, I think that there -- let me answer it 2 ways, and I would let Sean and Mike comment. So one is, certainly, we tend to be cautious. Two, we see the trend that we saw in Q3. We had hoped it would be a little bit better than it was. And so we guide to what we see. We feel great about the discipline in our pricing, in our margin control, in our expense control, our overall sales growth, a little bit harder to track right now. And so I think we take the trend. We look at the trend and apply a certain amount of reality to it, and that's why we revised to what we did.

Yes. And I'll just add a little more color there, too. Just as you do the math on our acquisitions, as we've entered into Q4, we've lapped completely the Global acquisition. We did that in Q3. We lapped the Nor-Cal acquisition in Q3. And then a couple of weeks into Q4, we also lapped Haddon House. And so it's just Gourmet Guru that impacts the full quarter and just a couple of weeks of Haddon House in terms of year-over-year, which is why, if you do the math on the net sales for the quarter, it's quite a bit lower than our year-to-date net sales growth. And it's really has to do with the lapping of those acquisitions, but embedded in there is a good core growth number.

Okay. You sort of anticipated my -- so that gets to the cadence. I think the guidance implies the core growth number is a little higher than what you just -- a little too -- a little more than a little higher than what you just reported [in Form 1] . Is that how you -- what it looks like?

Well, yes, we've got -- like I said, we've got Gourmet Guru, is a full quarter with -- where it wasn't in last year. We got Haddon for a couple of weeks, and then (inaudible) the rest is the core growth, which includes the onboarding of the new customers that we've talked about and an acceleration in the HABA business from Whole Foods as well that [wasn't in].

The last follow-on on your core growth. You guys have a look into how much of that is same-store sales at all your customers by maybe tracking same-line sales versus penetration? And if you do, do you have a sense of how that -- could you share with us a lot of people would like to know how the retailers -- what you're seeing with the same-store sales.

Yes. I mean, we do track it, but obviously, we would never comment on any particular retail's -- retailer's same-store comps. I mean, you see the same data we do.

I was actually asking in aggregate, so you wouldn't be giving away anything.

Yes. I mean, I think it's pretty hard to comment on that in aggregate, Andy, but we'll keep in mind the one thing that we do get the benefit out of is, certainly, as retailers open up new stores, we get the benefit of the new stores and also, of course, the category expansions, which, again, may create distortion as it relates to same-store.

Yes.

Absolutely. And if I could sneak one last in. So last quarter, you said you had a $50 million drag from low inflation, I think, in the broadline business. In this quarter, you can interpolate, it's less than that, but it's still a big number. As we think about the earnings impact of that, is it as simple as saying, here's our gross margin estimate on what those sales would have been and all those gross profit dollars would have otherwise in a normal inflation environment have flowed through to (inaudible).

Yes, that would be a safe exercise to go through. And then I would also layer on another thing that happens when we have inflation relative to when we don't, which is all our opportunity to take on a little extra inventory of products before their -- the price goes up and enhance our margin that way, too.

The next question is from Scott Mushkin of Wolfe Research.

This is actually Mike Otway in for Scott. Steve, I guess, I want to start with a longer-term question on sales and perhaps margin. You referenced out the kind of building of the store strategy as your vision for long-term growth. Is there a way to help frame the size of that opportunity just kind of contextually and then kind of balancing that with that strategy in the context of the challenges that you see from your kind of retail partners?

Yes. I mean, obviously, we've got the work done internally around the size of the fresh category. And what we do is we take what we think is our market share on natural and organic, and we apply it to the total size of the price in fresh. And it's a pretty significant number, so we feel really confident that the fresh strategy is a good one. And if we can achieve the same market penetration in fresh that we already have in natural, it's going to be a home run for us. But we're not in a point where we would disclose that number. As we continue to roll out and deploy fresh across the country, we build the infrastructure. We integrate the acquisitions. And so I think as we get a little bit more mature in the process, get through some of the deflationary pressure not only in produce but some of the proteins, make it much easier for us to kind of depict how well we're doing across that strategy. But I have a high degree of confidence that it is the right one, and we are far more advanced than anybody in the industry as it relates to infrastructure and process and sales force than anyone else to get it done and get it done in a big way.

I appreciate that. And then I guess on the margin side, kind of outside of acquisitions and let's say, for argument's sake or discussions sake that neutral inflation or deflation. How do you guys think about the operating margin structure of the business? I know you talked about you've got some cost savings next year, and this is long term. But you also called out some pricing pressure on the gross margin side. Ex some of these things that you can't control, do you see the business leading to operating margin expansion kind of on a year-over-year basis as you work internally to drive efficiencies?

Yes. Mike, again, we haven't provided guidance specifically for fiscal '18 with respect to margins, gross margins or EBITDA margins. But what we have said is that over the longer term that we would expect EBITDA margins to remain relatively consistent, and that is comprised of some gross -- again, in the context of your question, which is neutral on inflation, gross margin pressure that we offset with operating expense improvement.

The next question is from Stephen Tanal with Goldman Sachs.

Just a follow-up on the organic growth comments before and sort of where you're tracking. I guess, to the extent that, in the third quarter, you had a 4.1-ish kind of a growth rate was, as you said, a little bit softer than you had hoped. Could you (inaudible) which lines of business are sort of underperforming and which are maybe outperforming as you think about the different cohorts?

Yes. I mean, obviously, the biggest negative influence in the quarter was produce, and that's just very, very high rate of deflation not only in the quarter but all year. I mean, I forget what the produce deflation was in Q2, but I would -- it was double digits, right? So that was a big number. And so produce has kind of been a big driver all year long.

Drag.

A big drag all year long. And so I think we're starting to see some of that come back. But other than the produce, I think it's just -- it's pretty much across the board. We're not seeing it in any one particular area.

Got it. Okay, that's helpful. And just on the second part of that, the deflation outlook. I mean, I think you mentioned that the headwinds you saw in 3Q have more or less continued. I know it's far from perfect, but we saw PPI for the broad finished consumer foods actually turn inflationary in April. And I guess, we've seen some relationship for your -- for you guys for your margins. But any thoughts there? Is that really not worth looking at? Or do you think that you actually might turn to inflation pretty soon here at least on the -- on your costs on that side of things?

Yes. We were pretty close to 0 obviously in the quarter. And I can tell you, if you look within the quarter, things -- month by month, things got a little bit better as we went forward. And in fact, we talked about produce, but we did see inflation in produce in the last month of our quarter. So it doesn't give you any insight -- any clear insight into where we're headed, but it does certainly seem to be improving.

The next question is from Chuck Cerankosky of Northcoast Research.

We're hearing a little bit about the convenience store channel trying to include more fresh products, better quality fresh products. Is that channel an opportunity for United, especially given their order size?

Yes. That's a tough one, Chris -- Chuck, I'm sorry. The SKU offering is pretty limited, and so in that channel, we tend to work on a cross-stock basis where we're not delivering direct to the stores. We're delivering to other distribution centers and having somebody else actually bring it out to the stores. But we can help with product selection. We can help with product sourcing. We can help with supply chain and making sure the products are moved around the country in the most efficient way that it possibly can. But the SKUs are pretty limited.

The next question is from Chris Mandeville with Jefferies.

I guess, just starting off, can you elaborate a little bit on the business rationalization, where you're seeing, at what channels and how that maybe has impacted the margins in the quarter and what to expect going forward?

Sure.

Chris, this is Sean. Again, just to reacquaint, we migrated to a tri-region -- 3-region structure with presidents and teams leading not only sales but margin, service, meaning expense right on through to the P&L. So rationalization is an outcome of that. To the extent that the business feels that, for example, that our contribution perhaps or subsidy on price is not driving the kind of momentum or growth that we're looking for, then we'll do something with respect to price. And we may or may not continue with that opportunity, so that could be a negative impact in terms of sales but a positive impact in terms of gross margin. So that is an appropriate outcome, one that, frankly, we've embraced as it relates to the results in the regions. Secondarily, just as an example, we have channels, to your question around channels, where our cost to serve, maybe food service as an example, generally against the sort of the mean or the averages of our supply chain delivery size and economics generally has a lower drop size. And so it's important that we get an appropriate price against that higher cost to serve. So we're seeing that. And those 2 sort of are part of what we would characterize as a rationalization outcome.

Okay. And Mike, just to kind of follow up on that, looking to Q4 on the gross margin itself, trying to balance lapping the majority of M&A with the potential for continued improvement inflation. How should we be thinking about the gross margin in Q4? I would think that the vast majority of what expansion you've seen has been related to M&A. So is it more likely than not that we'll see maybe flattish gross margins? Or could they potentially even be down?

Well, I think your comparison is a better comparison to Q3, is -- first of all, and then we do have a little bit of acquisition impact on Q4. But obviously, we don't give a gross margin guidance on a quarterly basis.

Okay. And then I guess just the last one for me. Steve, is there any update on the Tony's expansion with the meat and cheeses. Just trying to understand what's left to bring that nationally. And is there an additional need for infrastructure spend that's required to get that national? Or do you still just need an anchor customer? And I suppose, when thinking about just simply maybe the need to get an anchor customer, what's prohibiting you from further penetrating some of your existing accounts where I would think you'd be able to provide them with more favorable economics versus some of these mom and pops?

Yes. I mean, we -- I think we are successfully moving the product categories across the country and have done so. We have some, not all but some, close to all in several of the DCs around the country. And if you recall at our Albert's facilities, those facilities do not only carry produce, but they also carry a pretty full line of proteins and specialty cheese as well. And so again, I wouldn't get into the specifics of which DCs have which products because we view that as a competitive advantage for us. We feel good about the timing of how these products are rolling out across the country and the customers that we're getting into bed with. I think it's taking a little bit longer than I had hoped, but again, some of that is clouded by deflation across proteins, general softness within the retailers but long term, feel really good about where we are.

The next question is from Kelly Bania of BMO Capital Markets.

Apologize if I missed this, but the GAAP earnings guidance is unchanged. But the adjusted earnings guidance, can you just clarify, is that also unchanged? And is the $4.5 million to $5 million in cost savings, I believe that's new in this fiscal year. Can you just clarify that?

Yes. EPS guidance is unchanged. What we did was we took the guidance from -- that we announced last quarter and we added to it. And so when we talk about $4.5 million to $5 million of impact on fiscal '17, if you recall back the last quarter, we said $3.5 million to $4 million of restructuring expense but that expense would be offset in the fiscal year. So we didn't break out the savings by quarter, but we did end up with $3.9 million of expense. So you could expect that in the back half of the year that we have a similar amount of savings related to that. And so then we come back with the new restructuring here, which we just talked about at $3 million to $4 million, and there's some savings in fiscal '17 associated with that. So you combine what we did last time with what we did this time, and that's how you get to that savings for fiscal '17.

Okay. I thought the Q3 restructuring, the majority of those savings were going to be seen in fiscal '18.

Well, it's about half and half.

Okay. So I guess, the bigger picture question I just wanted to ask is, is there anything that you're -- you feel like you're seeing in the business today? You make the comments about the broad-based softness, the rationalization. It sounds like you -- inflation may be starting to turn and is cyclical. But is there anything that you feel like you're seeing that makes you change how you would view your kind of long-term algorithm in terms of sales and EBITDA? And any change to that view, I guess?

No, I don't think so.

The next question is from Zach Fadem of Wells Fargo.

So now that some of the recent acquisitions are year-end, and I'm particularly curious about the deals you've done in produce and fresh, would you say you've been successful, thus far, cross selling these businesses with your existing customers as you work to build out the store? And as we think about future M&A, I know there's no hurry. But what kind of deals would be most attractive to you today?

Yes. I mean, we've learned a lot obviously by going through 4 acquisitions in the last year or so, and I think we certainly feel as though acquisitions in the protein categories, natural proteins, in particular, deli, specialty cheese, imports, those are the product categories that I feel like we will spend a lot of time from an M&A perspective. I think on the produce side, at this point, we have a fairly built out produce model, and we understand what it takes to compete in each one of the geographies. So it's unlikely that, that web will continue to play a very strong role in our future M&A growth. But there's some ancillary categories that we'll look at over time, but we're very committed to being bigger and better in fresh.

Okay. And can you update us on how you're thinking about the overall industry growth rates going forward for perishables versus nonperishables? And when you think about your business -- and first of all, what's the current mix today? And what do you think is the right mix between the 2 for your business over the long term?

Well, I mean, we don't have anywhere near the kind of share in fresh that we enjoy in center store, natural and organic, and we haven't provided that disclosure. But clearly, we're very focused on getting the share in fresh to be close to what our share in natural is. When you look at the growth rate across fresh categories, I mean, don't hold me to this because I know I just looked at it recently, and it's a little bit different by product category, whether it be in deli or in fresh protein, fresh cheese and fresh produce. But I believe in the natural channel, not the conventional channel but in the natural channel, the protein categories are growing faster than the rate of the growth of the industry overall.

The next question is from Bill Kirk of RBC Capital Markets.

My question's on the UNFI Next program. And I guess, related to it, is there any update on progress and maybe what impact it could have on number of SKUs in your portfolio or maybe number of inventory days on the balance sheet?

Yes. This is Sean, Bill. With respect to the last part of the question, I wouldn't be able to respond to the impact on inventory and the balance sheet. But I would say that the next program is working. We've expanded geographically so that we've got great supplier development resources across our network, sourcing new and exciting brands, incubating these brands and really collaborating with our sales organization regionally and geographically to make sure that we're connected to the retailers. I mean, we're spending a lot of time on Next, and we think we've got a lot of runway ahead of us.

Okay. And then maybe going back to the acquisition contribution, just for a point of clarification. The 7 points to top line in the quarter, does that include all 4 acquisitions? And the reason I ask because I think in 1Q, when you gave the number, it only was 3 of the acquisitions that were in that contribution number, so I just want to make sure it's all 4.

Yes. It's a good question. Previously, we had excluded Global because that was the business that we integrated almost immediately. But now that we've gotten to the point where we've lost complete visibility on them, we put that back in. So 7 percentage points does include all 4 acquisitions.

At this point, I would like to turn the conference back over to management for closing remarks.

Thank you all for joining us today on our call this afternoon. We look forward to speaking with you on our fourth quarter call in September. Have a terrific summer.

Thank you, ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.