United Natural Foods, Inc. (UNFI) Q1 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the United Natural Foods First Quarter 2015 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to introduce your host Katie Turner. Please go ahead.

Thank you, Kevin. Good morning everyone. By now, you should have all received a copy of the first quarter fiscal 2015 earnings press release issued this morning at approximately 7 AM Eastern Time. The earnings press release and webcast are available under the Investors section of the company’s website at www.unfi.com. On the call today are Steve Spinner, President and Chief Executive Officer; and Mark Shamber, Chief Financial Officer. Before we begin, we would like to remind everyone comments made by management during today’s call may contain forward-looking statements. These forward-looking statements discuss plans, expectations, estimates and projections that might involve significant risks and uncertainties. Actual results may differ materially from the results discussed in these forward-looking statements. In addition, in today’s earnings press release and during the call, management will provide both GAAP and non-GAAP financial measures. These non-GAAP financial measures include sales excluding acquisitions, operating expenses, operating income, net income, and earnings per diluted share. Presentation of these non-GAAP financial measures is not intended to be considered in isolation or as a substitute for any measure prepared in accordance with GAAP. For a complete reconciliation of GAAP to non-GAAP financial measures, please refer to the company’s earnings release. With that, I would like to turn the call over to Steve Spinner.

Good morning and thank you, Katie. Also joining us this morning here in Phoenix is Sean Griffin, UNFI’s Chief Operating Officer. The first quarter of 2015 continued to demonstrate strong demand for UNFI’s products and services. Net sales across all channels performed well, culminating in a 24.4% growth rate versus the first quarter 2014. Adjusting for acquisitions, our sales grew over 10%. And our organic growth in the first quarter of 2015 reflected a slow start to our fiscal year as mentioned during our last call discussing fiscal 2014. We also mentioned at that time that our sales during the second period of our first quarter 2015 had begun to accelerate. And I am pleased to report that the trend has continued and our sales have in fact remained quite strong during the back half of the first quarter and into holiday period. The first quarter 2015 sales increased almost $400 million versus the first quarter of fiscal 2014 and the company reached record sales of approximately $2 billion for the quarter. These results also reflect approximately $20 million in higher supplier out of stocks during the quarter. Operating income during the period increased nearly 22% versus the first quarter of fiscal 2014, reflecting our ongoing commitment to service, efficiency and revenue growth. Operating expenses, as a percentage of net sales, continued to decline during the first quarter of fiscal 2015, as we gained traction with our Thrive initiatives. Expense ratios were also positively impacted by the addition of Tony’s Fine Foods. Gross margin during the quarter, which Mark will discuss in detail, was negatively impacted by the addition of Tony’s Fine Foods. However, another significant driver of our gross margin decline during the period was continued high levels of supplier out of stocks, which were approximately 175 basis points worse than prior year, representing approximately $20 million in lost sales. And these issues occurred primarily across the chilled category with organic milk and milk byproducts driving most of the chilled increase. And the chilled category represented approximately 40% of our total increase in out of stocks during the quarter. Higher out of stocks during the quarter also resulted in higher inbound freight expense which negatively impacted our overall gross margin for the quarter. And during the quarter we announced that our Aux Mille facility in Quebec, would close and move into our facility in Montreal, Quebec, Canada. We believe this change will result in higher service levels in the market and significantly lower cost to serve the Canadian market in general. We're extremely committed to continue to build out our network in Canada as we strategically build market share and capacity. The market for UNFI products has changed dramatically over the last five years. Natural organic products were once viewed as unique and differentiated products for a narrow band of consumers and retailers. And today our products are demanded by consumers across North America which has led to the adoption of these items across every channel. This rapid adoption rate has led to new opportunities for UNFI as we operate the broadest network of companies specializing in natural organic and specialty products. Consumers continue to demonstrate a desire to seek a healthier know-your-ingredients lifestyle. This resulted in increased shelf-space across a growing number of retailers which ultimately drive demand to UNFI. During October, UNFI hosted an analyst day at our new facility in Hudson Valley, New York. We talked about our five-year strategy for building out the store, and the strategy is based on: one, continuing to expand our market share by selling more of the store to existing customers, by acquiring new customers and by select acquisitions that add products or geographical coverage. With the acquisition of Tony’s Fine Foods, UNFI offers retailers a wide array of organic produce, commodity organic groceries, natural supplements and personal care, proteins, specialty cheese, bakeries, deli and e-commerce. And two, continuing to build out our infrastructure through capacity expansion and our Thrive technology and business improvement projects. We believe that the building out the store strategy and our infrastructure improvements should drive 10% to 14% revenue growth, 10% to 16% EBIT growth, free cash of $30 million to $85 million per year and EPS expansion of 14% to 19% per year over the next five years. We have built a strong team with a proven track record of delivering exemplary results against these long-term strategies. Over the next several years, we expect to build out two new exciting channels. The first is our Gourmet & Ethnic Channel which will focus on merchandising specialty products to specialty based retailers. These products include Italian, Hispanic, [Kosher] Asian and other related ethnic products which are growing rapidly. This is a long-term opportunity to grow net sales by up to $5 billion which UNFI has yet to take advantage of. And our market share in this space is approximately 1.5%. We've established a new sales and procurement organization and look forward to expanding this important channel. Second is our e-commerce channel. As we build out capacity across the U.S., our goal is to offer retailers over 15,000 SKUs across gluten-free organic, personal care, supplements, lifestyle and other important lines. And given our proximity to the retailer and the consumer, our hope is to be the e-commerce solution for retailers and business-to-business e-commerce providers. Additionally, we hope to provide similar ecommerce services to manufacturers whose products are distributed throughout our network. Lastly, Tony’s Fine Foods turned in a very strong operating result during their first full quarter as part of the UNFI family, with over $200 million of net sales. We are actively planning a rollout of this platform and product mix to other markets by securing new customer contracts and expanding relationships with existing customers. All of UNFI’s new distribution centers have the capacity as well as the refrigerated systems needed to accommodate this existing strategic product mix. And now I will turn the call over to Mark.

Thanks, Steve and good morning everyone. Net sales for the first quarter of fiscal 2015 increased by 24.4%, as Steve mentioned, to just under $2 billion, coming at $1.99 billion, a $390 million increase over fiscal 2014’s first quarter net sales of $1.6 billion. Our two acquisitions which occurred in fiscal 2014 contributed approximately $228 million to our sales growth in the quarter or 14.2%, with Tony’s Fine Foods representing approximately $215 million of the growth while Trudeau contributed approximately $13 million as we lapped this acquisition in the month of September. Excluding these acquisitions, net sales increased by $163 million, or 10.2%. Inflation decreased modestly on a year-over-year basis to 1.94%, a decline of 10 basis points from the first quarter of fiscal 2014. However, this represented a sequential increase of 18 basis points over the fourth quarter of fiscal 2014. For the first quarter of fiscal 2015, the company reported net income of $33 million or $0.66 per diluted share, an increase of $5.3 million or 19% over prior year net income of $27.8 million, or $0.56 per diluted share. In the first quarter, sales to the supernatural channel increased by 16.5% over the prior year’s first quarter and supernatural represented 33% of sales for the quarter. Independent sales rose by 23.8% year over year and independents also represented approximately 33% of net sales. Our supermarket channel experienced growth of 30.6% over the prior year and now represents approximately 27% of net sales. Finally, food service grew by 60.4% over the prior year and now represents approximately 4% of net sales. Excluding the impact of the acquisitions, supernatural’s net sales growth was 11%, supermarket sales increased by 9.3%, independent net sales grew at 8.2% and food service’s net sales growth was at 23.3%. Gross margin for the quarter was 16% which represents a 92 basis point decline compared against the first quarter of fiscal 2014 which had a gross margin of 16.9%. The major driver to our lower gross margin in the first quarter of fiscal 2015 was the dilutive impact of Tony’s which represented more than 50 basis points of the gross margin decline for the quarter. Our gross margin was also negatively impacted on a year-over-year basis due to supplier out of stocks, increased inbound freight costs, shifting customer mix and the decline in the value of the Canadian dollar on our Canadian business. As an example specifically associated with increased inbound logistics costs, when we send a UNFI truck or a third party carrier to a supplier to pick up an inventory order, the freight costs associated with that inventory are higher if the suppliers do not have the order quantity available. As the costs associated with the truck picking up a product don’t change whether we receive 60% of the quantity ordered, or the complete ordered quantity. Operating expenses for the first quarter of fiscal 2015 represented 13.1% of sales, an 85 basis point improvement compared to 13.9% for the same period last year. Adjusting for the $0.6 million impact of the write-off of an intangible asset related to Aux Mille location in Canada, operating expenses improved by 88 basis points over the prior year. The quarter also included $1.4 million of start-up expenses associated with our Racine, Wisconsin and Hudson Valley, New York facilities, as well as our Auburn, California location which will serve as a West Coast hub for our select nutrition business. Fuel had a positive impact of 3 basis points on operating expenses in comparison to the first quarter of fiscal 2014 as fuel represented 70 basis points of distribution net sales in the first quarter of fiscal 2015. Fuel expenses were 5 basis points better than the fourth quarter of fiscal 2014 when fuel came [ph] in at 0.75% or 75 basis points of net sales. Nationally our diesel fuel cost in the first quarter of fiscal 2015 decreased by approximately 0.4% from the prior year’s first quarter while the national average price decreased to 375 a gallon, a decline of 4.1%, compared to 392 a gallon in the first quarter of fiscal 2014 per the Department of Energy. Share-based compensation expense during the first quarter of fiscal 2015 totaled $6 billion or 30 basis points as a percentage of net sales, compared to $5.5 million or 34 basis points in the prior year period. Operating income increased by 21.6% or $10.4 million to $58.4 million in the first quarter of fiscal 2015. Operating income as a percentage of sales was 2.9% in the first quarter, a decline of 7 basis points over the prior year first quarter operating income of 3%. Operating income declined by 4 basis points over the prior year’s quarter as adjusted for the impact of the intangible write off in fiscal 2015. Other net expense was approximately $0.6 million during the quarter and primarily reflects a non-cash charge related to the impact of the continued decline of the Canadian dollar on our Canadian business. Our inventory days on hand averaged 49 days for the first quarter of fiscal 2015, an improvement of 3 days from the first quarter of fiscal 2014 when we averaged 52 days. The primary driver of the year-over-year improvement was inclusion of Tony’s for a full quarter as Tony’s inventory turns are much faster than UNFI’s broadline business due to the heavier perishable concentration. Within our broadline business, we have selectively been carrying higher inventory levels in an effort to compensate the continued issues with supplier out of stocks for certain categories that Steve touched upon in his commentary. DSO for the first quarter of fiscal 2015 was consistent with the prior year coming in at 21 days. Capital expenditures were $27.4 million or 1.4% of net sales for the three months just ended. The largest components of our CapEx incurred during the quarter were associated with new facilities, specifically our Twin Cities facility located in Prescott, Wisconsin which is ultimately expected to be a leaseback as well as our new facilities in Gilroy, California and Hudson Valley, New York. Outstanding commitments under our credit facility were approximately $400 million at quarter end with available liquidity of approximately $206 million, including cash and cash equivalents. Our leverage increased approximately 2 times on a trailing 12 month basis as a result of higher debt level due to the combination of our acquisition of Tony’s Fine Foods and our normal seasonal investment in inventory for the holidays. In today’s press release, we reaffirmed our guidance for the fiscal year ending on August 1, 2015 which was originally provided back on September 17. For fiscal 2015, we expect net sales in the range of approximately $8.13 billion to $8.38 billion, an increase of approximately 19.7% to 23.7% over fiscal 2014. GAAP earnings per diluted share for fiscal 2015 are expected to be in the range of approximately $2.88 to $3.01 per share, an increase of approximately 14.3% to 19.4% over fiscal 2014 GAAP earnings per diluted share of $2.52. Additionally, our capital expenditures guidance of fiscal 2015 of approximately to $130 million to $140 million, net of the planned sale leaseback of the company's new Twin Cities area distribution facility in Prescott, Wisconsin, remains the same as the other guidance surrounding our expected tax rate for fiscal 2015 of 39.25% to 39.75%. At this point, I will turn the call back over to the operator for the question and answer session. We would ask that people limit themselves to one question and a follow up before re-entering the queue as we ran out of time before we got through the initial queue last quarter and we already have north of 10 people in the queue right now. Operator?

[Operator Instructions] Our first question today comes from Karen Short from Deutsche Bank.

Thanks for taking my questions. A quick question, in general. In terms of the organic growth rate it was obviously very strong but it looks like it was kind of at the lower end of your range of guidance. I guess the first question I have is that a fair statement or how do you view your organic growth rate? And then I have a follow-up.

Hey Karen. We did talk about a slowdown that we experienced at the end of last quarter and into the first period or so of the first quarter. However we did see that pickup quite nicely through P2 and P3 of our first quarter. So yes. that's right. We were a little light on the sales towards at the end of last quarter and into the beginning of the first quarter but we've seen it come back nicely.

And I would just add, Karen, and Steve touched on in his commentary about the impact of the out of stocks coming to almost $20 million, that would be about 1.25% on a year-over-year basis that’s factoring into that as well. So one aspect of it is that as long as we continue to have higher out of stocks in some of those perishable categories, we are going to continue to see the sales growth impact of that.

Okay and would you say – is it fair to say that the demand kind of picked up and the cadence of the sales trends was – I mean correlated with gas prices. So I guess any color there, and then some color just in terms of sales trends into the second quarter given that gas and diesel prices continue to come down?

Yes, I don’t know that we have any data that would support the fact that sales began to pick up a little bit when gas prices came down. So I am not sure that we would have any good commentary there.

And Karen, just one thing I want to interject raised diesel, that the one thing that I’d want folks to know is that, while regular gasoline prices for unleaded have come down significantly, the decline from diesel since the May timeframe is still less than 10%. It’s only in the 7% to 8% range as of this week. So --

Yeah, the numbers are definitely not as compelling on diesel but it would affect the customer demand obviously – and then just following on that, any color on the sales trends into the second quarter?

I think the sales trends continue from kind of where – the accelerated rate that we’ve kind of been talking to during your question. So I wouldn’t say that it’s accelerated beyond that but we are certainly pleased with where it is.

Thank you. Our next question today is coming from Rupesh Parikh from Oppenheimer.

So I just also wanted to touch on the sales trends. Is there a way to maybe quantify the magnitude of acceleration we’ve seen from maybe the first five weeks or so of the quarter?

That’s something that we normally don’t provide any color about where it was. I mean we give directionally but we wouldn’t want to go that route because in any given week things can fluctuate based off of the pattern or anything that happen for whether a week [ph], weather does usually impact us over the course of a quarter but it can make impact from day to day or week to week. So I think we’d stay away from that but if you look at what we said, back in September we said that we’ve seen a deceleration of 100 to 150 basis points of where we were coming out of the fourth quarter. So you can make some inferences based on that.

We also – indirectly answer the question just by confirming guidance for the year.

And then with the Tony’s acquisition, I mean clearly very upbeat commentary that you guys provided in the press release. So far – I guess two parts to Tony’s. I mean, one, what type of comp growth did you see this quarter for Tony’s and then also at this point, have there been any significant [ph] prices that you’ve seen?

We’re not going to get into the comp growth of Tony’s but it’s just been knock on wood, a wonderful acquisition. It’s a great cultural fit, terrific leadership there. I think the customer base in the markets in which we share, are excited about having both companies. We’ve got – actually have an exciting new program rolling out right now actually, which is based on bundling customers’ purchases between all of our companies to give those customers that participate in all of our brands, a significant advantage and we are in the process of signing customers up to that as we speak. So it’s been a very very good well accepted acquisition on both UNFI, Tony’s as well as the customer, from where we see it today.

Thank you. Our next question today is coming from Sean Naughton from Piper Jaffray.

So I guess just based on your Q1 performance you were a little bit ahead of the external expectations but didn’t flow through kind of the earnings upside of the full year with the raise. Just curious how the first quarter maybe was relative to your expectations and has anything changed on the outlook moving forward? And then just as a follow up question is, just if you can clarify what you think the inflation expectations are going to be for the balance of the year?

Sean, we generally do not adjust the guidance upward or downward based off of what turns out Q1, it’s still too early in the year, there are [indiscernible] second half – I mean if trends were to remain favourable and we got to the second quarter, we would adjust accordingly from that standpoint. On the second component with regards to our – the last point you asked about – with regards to inflation, I think our outlook is dissimilar to what we stated in September and at the analyst day where we’re seeing a modest uptick but we are still going to hover around that 2% range, maybe close to 2 and 2.25%, on the high end 2.5% over the next six months but most of the price increases that would have come for the holiday period have already come through and reflected in what we saw in the October results and that’s not very far north of 2%. So I would say that there is probably some modest upside in inflation but there is nothing that indicates that we are going to get north of 2.25%, 2.5% from that standpoint.

And just one more follow up on – some of the impacts I think you had in Q2 last year, I think there was some on the polar vortex or the cold weather that happened last year. Maybe you could just elaborate on what those impacts were and maybe some of the steps that you have taken to help mitigate some of those things this year to avoid some of those increased costs that we saw in Q2 last year?

Yes, last second quarter was brutal from a weather perspective and as you know we moved a lot of products across the country by rail and unfortunately a lot of that product got – dry [ph] products that caught up in Chicago in the middle of the polar vortex and had some implications to service as well as had – we dumped a lot of products. So we’ve obviously spent a lot of time on that this summer in planning for how to work around weather implications and we’ve done that. And basically what will happen is we will use alternative routes during the winter to bypass markets where we worry about the weather, whether it’s by truck via the south, whether it’s by rail on alternate directions. So our hope is that, we’re not going to let that happen again.

Our next question today is coming from Mark Wiltamuth from Jefferies.

Hi, I just wanted to see if you had any updates on securing key customers for anchor customers for spreading Tony’s out to the other regions?

No updates. Certainly if we had any material win and we would announce it, otherwise we will just quietly plough along and take on some business wins in markets, in Hudson Valley, Racine et cetera.

And as you look at moving more into the perimeter and pushing into perishables do you think you need to do more acquisitions in that area in these other verticals?

I don’t think we need to. I think there is plenty of opportunity for us to not have to do M&A. However it’s a pretty fragmented market and so I think that there will be some follow on M&A opportunities that come our way, that would ultimately get folded up underneath Tony’s and we will be opportunistic and look at those. The beauty of having had the foresight to build the capacity is that gives us a tremendous amount of flexibility in terms of acquiring small regional companies that specialize in this product and having the ability to fold them into our much bigger much more efficient distribution centers.

Our next question today is coming from Vincent Sinisi from Morgan Stanley.

Wanted to ask about the Tony’s products going to your DCs when those of us who were at your analyst day about a month or so ago, we saw in the Hudson Valley DC, the room that Tony’s products would be going in, can you guys just give us a sense for I guess – first for that facilities specifically, is there now Tony’s product there and how should we think about the timeframe for more of a full rollout of Tony’s products?

We do not have any products, specific products of Tony’s there yet. We are still in the process of moving products and customers from our Dayville and Chesterfield facility phasing it into Hudson Valley, that’s our first priority. We will begin to put Tony’s product into Hudson Valley as we secure agreements with customers who will pull that products. Again I don’t think that anyone customer win is going to be material and so I think it’s just going to be slow and steady as she goes. Sean, do you have anything to add?

Other than – again folks that have an opportunity to tour Hudson Valley, Hudson Valley is indicative of Denver’s capacity, Racine’s capacity, we will also include Twin Cities DC and we believe that we can essentially have somewhere between 3500 to 4000 SKUs of Tony’s assortment. So we really have to find the anchor customers so that we can assure that we get the inventory turns and the buy side to supply chain is efficient.

The economic model for an existing UNFI customer to add those products to the current list of items that they take from UNFI is very compelling because what drives our profitability is scale and the delivery. And so if we are already going to the retailer multiple times a week, the cost of adding new categories of products is very low. And so we believe and I think a lot of the customers believe that it’s very compelling, we just have to phase it in carefully and buy their time.

And just as a follow up question, regarding the ethnic and gourmet opportunity, I know obviously right now very low percent, half of market share of that, that 5 billion or so opportunity. Can you give us more kind of a qualitative sense in terms of products that you currently have available, kind of where you have that now and where you foresee that going?

So we have a wide array of the products already available, it’s just – we don’t have it widely available across all of our networks. And so what we have chosen to do is to focus our efforts on very specific urban markets where we know that there is very high demand for the product, and we know there is a large amount of what we call specialty retailers which has not been a targeted customer that we focused on. So really it’s more a factor of building out a sales force who calls specifically on the specialty retailer that is going to build our share in that category. And if you are familiar with New York, there is bodegas on every corner and given the growth of specialty and higher end natural organic, those small stores are carrying a large amount of those products, yet we never had a sales force specifically designed to call on them, and that’s what we’ve created.

Our next question today is coming from Scott Mushkin from Wolfe Research.

Just wanted to understand the speed up in growth and I think your answer – Steve, to Karen’s question is that things have sped up post the slowdown we just saw but they haven’t sped up further. Is that – am I paraphrasing what you said right?

That’s right. That’s right. I mean we are not talking about hundreds of basis points here. We are still comfortable with where we are for the year in terms of our overall guidance, and obviously very pleased with the fact that the sales accelerated from what we could call slowdown towards the end of the last fiscal and into the beginning of this month.

So then a follow up to that, I mean there has been a lot of building going on in the space. How much – when you guys say things sped up, are you taking that into account or is some of the speed up related to the fact that a lot of stores are being built and you are benefitting from that?

No, no, it’s definitely – when we look at kind of same store comps, that’s what we kind of view it as an acceleration.

Our next question today is coming from Meredith Adler from Barclays.

I wanted to go back to something you mentioned about giving a benefit to your customers if they buy products of multiple one of your companies. Could you talk a little bit more – maybe about how things work now and how you would do that and how does it impact sales, or commissions, or how does it work together?

Sure. So in the markets in which we have overlap with Tony’s which is primarily the western part of the country. An Alberts rep covered a retailer, a Tony’s rep covered a retailer, UNFI rep covered a retailer, Select Nutrition rep covered a retailer, they play outside Tony’s and they play it very well together, being that they are with the same company. But we call on the customer as a separate organizations under the UNFI umbrella and up until now we haven’t aggregated the customer volume in order to essentially provide more economic value to the customer as a result of buying from more UNFI companies. And so what we are doing in the west is we are bundling the total sales that a customer buys from all of our brands into one number, we are providing the customer with the gross target which ultimately gives the customer incentive to buy more all of the UNFI brands. And so we think it’s a very compelling experiment in order to build business across all of our companies. And we will see how it goes, it kicks off later this month.

So that means that they don’t get a discount unless they hit the growth target, you are not just lowering the money you receive simply by aggregating, they have to achieve more?

Yes, they have to earn it. So they have to drive more purchases through any of our brands in order to achieve a targeted number which obviously is a growth number. So they don’t get a discount today, they have to earn it.

That makes a lot of sense. I have a sort of unrelated question but I know you have talked about the newest facilities having been built with the idea that you put Tony’s product in there. But you obviously have a lot of customers where you have established business, in other parts of the country with older distributor centers. Is it in your mind that some time in the future you would retrofit those facilities to be able to handle more of the Tony’s products or it’s just too difficult?

Well, I think if you think about where we are building the buildings, I mean the buildings are going into the very strong urban markets, Chicago, New York, San Francisco, and those are the markets that have the greatest demand for those products. As we move a volume from older DCs into the newer DCs, that will create some opportunity for us to retrofit where it makes sense. And that’s a relatively modest cost of doing. But the reality, Meredith, is if you think about Hudson Valley, New York, we are pulling volume out of Chesterfield, New Hampshire and Dayville, Connecticut. And so it may not make sense for us to retrofit those facilities because they are just not playing into markets that have a high degree of demand for natural protein and speciality cheese. So I think the long winded answer is I think we are pretty comfortable with where we built the DCs in order to satisfy the demand for those products. But moving the volume out of existing DCs will give us the ability to retrofit if we need to.

And since we still have some time, I am going to ask one more question. Do you get any pushbacks from existing customers, when you talk about them buying Tony’s products or even for that matter, getting them to buy from more of your businesses? Is there anything in particular, do they have a very close established relationships with other providers or is it just going to take time of selling process?

I mean, I think there is an emotional answer and there is an intellectual answer, right? So the intellectual answer is that if it’s economically appealing, then most of the customers are going to make a smart decision that it makes sense for them to add those product categories into their current UNFI program. So if we have quality product that’s differentiated that meets or is better than what they currently have and they can get it on the UNFI system and it’s cheaper better faster than they are going to do it, and I think we are pretty confident of that. I think on the smaller stores, I think we will get a little bit of – I already have 40%, 50% of my purchases into the UNFI system, do I really want to go to 75% or 80%, and that’s more emotional decision. But I think we are pretty confident that the economics – the products and services are going to be very compelling for the majority of our customer base to add the products.

Our next question today is coming from Robby Ohmes from Bank of America.

Hi this is Marie [ph] for Robby. Wanted to dig into the sales growth acceleration that you were seeing in the supermarket and independent channels. And I was wondering if you could provide any color about how much of this is driven by new customers or existing customers, and you’re building up store strategy, and are there areas of the store that you are seeing increased demand for additional products?

Yes, Marie [ph], I think – as Steve mentioned in one of the earlier questions that were asked, we typically don’t highlight new business that we have taken on board unless it was material and historically we use a threshold of $100 million for that. I think it’s fair to say that it’s a combination of the growth from a comp standpoint and obviously as there has been some new store openings we get the benefit of that in those channels. Having said that in the first quarter ex the impact of Tony’s into those two channels we believe that the supermarket channels are a little bit of a deceleration on a quarter over quarter basis, so from the fourth quarter to the first quarter. The independents were relatively flat but the supermarkets were little bit softer.

Our next question today is coming from Kelly Bania from BMO Capital Markets.

Just first, a quick housekeeping question. I am assuming the start-up costs and the Tony’s acquisition costs were probably embedded in your guidance. But just curious on the asset write-off that you incurred this quarter, looks to be about a penny to the quarter, was that part of your guidance or was that –

We did not have that originally factored in, we went through some internal review and made a decision that, that was over the course of time the best decision from an operational basis and so we did have that roughly $600,000 charge in the first quarter, and we will have due to severance and some other related restructuring costs, we will probably have somewhere between $800,000 and $1 billion in the second quarter as well.

And that was also not contemplated –

I wasn’t. I mean from a GAAP standpoint it is factoring, so I am not touching the range as well but to Sean’s earlier question we normally wouldn’t adjust after Q1.

And then just a couple questions on your Thrive initiatives. I guess first on, on inventory optimization I believe that was completed this quarter on the East Coast, just curious if there were any sayings [indiscernible] impacted the gross margin this quarter or maybe we start to see it over the next couple quarters? Just any comments you have on inventory optimization and then just a bigger question on WMS, I believe at your analyst day you spoke about $5 million cost savings. Can you just help us understand what exactly you mean by that, is that a per warehouse cost, but where exactly are the savings coming from and how should we think about those savings as you accelerate the implementation of that over the next few years?

Good morning. This is Sean. With respect to the IO rollout we did complete the east region recently, in the last 60 days. We expect that inventory optimization would drive a similar result in the east as it did for us in the west but we are in the early innings of IO for the east regions. So we’ve got some upside ahead of us in terms of gross margin. As it relates to WM, and the productivity savings – the productivity saving were 5% number and it was related to a DC to DC rollout of WM, so when we think about completing a number of WM migrations from our older system to the new plus the new DCs which are all stood up on the WM system, we are anticipating 5% improvement in productivity in each of these DCs.

Those numbers are obviously factored into our guidance.

So that 5% equates to that $5 million, is that the right way to think about it?

I don’t know where the $5 million came from, that might be out of context.

Yes, in terms of productivity numbers driving 2.8 number but let’s just speak of it in terms of productivity increases of 5%.

Kelly I think I can try to call up to you offline after the call to try to work through that, to make sure at the analyst day where you were referencing and try to create the place for you.

Our next question today is coming from Andrew Wolf from BB&T Capital Markets.

On the sales, Mark, when you talked about out of stocks being worth I guess 1.2% of it and to sales, is that – what was that trending at before, if we want to look sequentially and sort of adjust for that?

Well I think Andy, I mean part of the reason we highlighted it, I think we went down – of course a couple of years ago when we said at that point in time it was like $25 million. I mean we obviously from an industry standpoint have a normal fluctuation of supplier out of stocks and so where we were basing the numbers is some of the – I don’t call, acceleration but some of the increased out of stocks in the supplier side that we saw in the first quarter, so we were a little conservative to make sure that we generally state that impact but we are taking off that we were for the third, fourth quarter kind of average and where we are trending to the first – where we trended or where we came in for the first quarter and that’s where we are getting roughly the $20 million which would be that incremental one to one in a quarter percent. So that’s how we get to it, does that help?

That’s an all above normal number.

Yes.

And then when you look at the customer segments, and like you said with supermarkets slowing relative to the other two, is it fair to think that, that there were some re-acceleration in that sector or was the early quarter slowing and re-acceleration sort of across the segments?

I would say that what we saw at the beginning of the quarter versus what we saw when things re-accelerated, it was across all the channels. So we have not channel specific that supernatural, independents or supermarkets, were the one driving the slowdown and their return led to the re-acceleration, I would say that we saw softness across all the channels in the first quarter. We did see a little bit more in the supermarket, in the first quarter only because of the issue with the customer up in the northeast but with regard to work stoppage but other than that, it was across all the channels.

I like to switch to Tony’s with couple questions. Could you give us what the EPS accretion was?

I mean Andy, from a standpoint we’ve never historically broken out any of the divisions or any of the acquisitions from an accretion standpoint below the sales line. So I don’t think we are going to break with that precedent. We did see some general ranges as it relates to the analyst day and what we thought for the full year and I would say that Tony’s came in a bit above on the top line of our expectations so they probably exceeded a little bit where we had projected. But we are not necessarily going to get into the specifics because some of the synergies that we start to get may be on the UNFI side or may be on the Tony’s side. So some of that $0.09 to $0.17 on an annual basis for fiscal ’15 reflects synergies – one part of the business versus another.

Your Tony’s guidance, was it first – a little hard to understand because you were factoring potential business losses, it looks like, is that out of the question now or could we still see some of that?

We have been again knock on wood, pleasantly surprised by the customers’ acceptance of the acquisition and so we feel pretty good about where we are in those markets. It’s still only been 3 months, so it’s little premature I think to answer that question. But we are optimistic.

Our next question today is coming from Scott Van Winkle from Canaccord Genuity.

Hey guys, it’s Mark Sigal for Scott. I was just wondering with regard to Tony’s and the ethnic initiatives that you have going, without trying to pin down any specifics on timing, are there any milestones that you are watching for – or that we can watch for in terms of when we should expect Tony’s products in new facilities – in the facility in eastward with anchor customers? And then on the ethnic side, is the milestone built out of the sales force there, or perhaps some initial sales, how are you thinking about that?

So let me answer the gourmet ethnic first, and that is that, we already have the organizations established, we’ve already hired the sales force. And so we are actively building our business primarily in the New York city market as we speak and that will expand to other markets as the product becomes available. And so we are pretty well established on that front. On the Tony’s side, we are still working our way through the acquisition, understanding the items and the item requirements, and the procurement requirements and storage requirements, we know where we are going to put our first Tony’s product selection and that’s going to be going into the Denver market. We have not talked about timing at this point nor where do we want to commit to that yet. But Denver will be the first location which makes sense because it’s geographically it’s contiguous to their existing, the current territory.

Our next question today is coming from Joe Edelstein from Stephens Inc.

As the diesel prices have come down, is there a fuel surcharge here that you are going to need to give up on a go forward basis, and maybe just clarify if you had some benefit from that in your first quarter here?

So to answer the question, we do have a fuel surcharge, it generally works in roughly 25 that increments. So it fluctuates up and down over the course of time as diesel prices move. And so we do adjust that as prices come down, we would adjust that as prices come down just as we do when it increases. As it relates to the first quarter, or as it relates to any benefit, we said it highlights to folks is that the fuel surcharge only gets us anywhere from an 80 to 90% recovery of the increase in diesel prices, so that as prices drop we only get a 10% to 20% benefit of whatever that change is. So I would tell you that for the first quarter we would be lucky if it was between half a basis point to basis point, and that’s maybe on the high side, depending where the prices move month by month every quarter. So there is a modest benefit when we reduce the fuel surcharge and the prices come down but it’s not anything meaningful.

How quickly do you adjust that, it’s just the leg –

It’s generally done on a roughly four week basis.

If I could ask another question, I was curious about your usage of intermodal during the quarter, just how fast did that grow and does that growth rate expect to change, for the second quarter as you think about just some alternative routes that you have mentioned as maybe some weather concerns?

Yes, we have continued to grow out our intermodal capacity which has obviously been increasing quite significantly over the last couple of years. Just because it’s a very efficient and economical way to move freight primarily from the west to the east. Obviously during the winter, that will fall off as we move more product away from rail through the center of the country and back to truck to avoid obviously potential weather. Sean?

Yeah, one other point that’s important to talk about is that in a stable supply environment where we plan rail, which can add 4 to 6 days of in-transit time, there are times that, that becomes an issue, a problem for us in terms of fillings and service level to our customers in which case we may move loads that were planned for rail to a higher cost over the road in order to support fill rates. So it’s kind of a fluid situation but at the end of the day we continue to find the most attractive way to move freight at the lowest cost at the higher fill rate.

Yeah, one additional comment I will make on freight which I think is important is what happens in a high supplier out of stock environment which we have been in, is if you think about the freight to move that product, if we negotiate as we pick up – while we manage the freight for almost half of everything that goes into our distribution centes, and so if we contract for a full truckload of freight to be picked up from a supplier which is say 45,000 pounds and we send that truck to the manufacturing point and there is only28,000 pounds but we’ve already committed to pay a 40,000 pound rate, so we are paying for that full truck whether there is 18 pallets, or 12 pallets, and so that was part of the gross margin issue that we had during the quarter that we will obviously change some of our practices to prevent that from happening in the future. End of Q&A

Thank you. We’ve reached the end of the question and answer session. I would like to turn the floor back over to management for any further or closing comments.

Thank you again for joining us this morning. And we hope that you have a terrific holiday and new year.

Thank you. That just concludes today’s teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation today.