United Natural Foods, Inc. (UNFI) Q1 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the United National Foods First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. And a question-and-answer session will follow the formal presentation. [Operator Instructions] I would now like to turn the conference over to your host, Halie O'Shea, Director of Investor Relations and Corporate Strategy. Thank you, Halie. Please go ahead.

Thank you, Chris. Good afternoon and thank you for joining us on UNFI's first 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, President 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, EBITDA 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 and good afternoon everybody. Before I discuss the industry and our first quarter, I want to take a moment to talk about the progress that we’ve made on our strategic initiatives. We are pleased with the integration efforts of the four companies we acquired since the start of 2016, and the integration in some cases, moving faster than we expected and I’m incredibly proud of our team involved with integrating these terrific companies into UNFI. From our information technology group, national operations team, finance group and new associates from Nor-Cal, Global Organic, Haddon House and Gourmet Guru they continue to look forward and believe in the value of UNFI as an integrated one company distributor of organic better for you fresh and specialty products. Our acquisitions pipeline remains attractive and we will continue to be prudent and take our time as we evaluate these opportunities. Our building out the store methodology of acquiring businesses that expand UNFI’s position in Fresh and into adjacent lines of products remains at the forefront of our strategy. Despite deflationary pressures that affect our produce and protein categories, we remain confident that our move towards the national platform serving the perimeter of our retailer stores will prove to be a differentiating and winning strategy for UNFI. And I’ll talk more about deflation during the quarter shortly. Looking at some of our under strategic initiatives, the sales reorganisation was completed at the start of our fiscal year. This brings our sales teams closer to our retail customers, helping us to better tailor our product and service offerings to meet their needs. Feedback from the sales force has been positive and based on our earlier read we are really encouraged. With the sales reorganisation, our sales reps are in the stores more leading to increased and more robust interaction with our customers. We no longer have retail customers being serviced by just Albert's and Produce or Tony’s and Speciality protein. Our full sales force is now selling across all of UNFI’s products and businesses and providing our customers with a single point of contact to create a more streamlined approach. During the last six months, we’ve had some terrific wins expanding our product offerings with retailers into fresh categories. And on an adjusted basis, UNFI’s net sales year-over-year grew approximately 13% reflecting our continued focus on our building out the store growth strategy. Additionally, throughout the balance of our fiscal year we will be rolling out approximately $100 million in annualised new customer contracts and expansions of current agreement with additional banners and product categories in current customers. The enhanced sales effort enables us to do more of what truly differentiates us at UNFI, and that is to offer our customers innovative, new and exciting fresh, speciality, ethnic and better for you products. On the supplier side, our UNFI next initiative is working very closely with new, exciting and fast growing smaller brands. UNFI next is positioned to enable these brands to have their products managed throughout the supply chain. We are developing brands - we were helping brands develop strategies, which move freight into UNFI’s distribution network and out into the retailers with merchandising category management and brokerage support across our customer base. Additionally, our own field day brand is now the eight largest brand in the natural channel and our Woodstock healthy snacks production facility is making fast growing private label better for you snacks for retailers nationwide. We believe our differentiated product offerings along with innovation and technology will provide long-term growth opportunities. We are encouraged by our on-going initiatives and our progress along our building out the store strategy, but we’d be remiss if we did not acknowledge the challenges facing our industry today. To start with, we see the industry growing at approximately 7% versus the single high digit, high single digit to low double digit levels we have seen historically. And this is happening for several reasons. The first is the law of larger numbers. We are no longer serving a retail niche, as many of our products are now mainstream. We also think lower levels of inflation or deflation are also having an impact on overall industry growth rates. In addition, same store sales have slowed at many of our retail customers as they have continued to operate in a highly competitive, consolidating and deflationary environment. What’s more, they are facing competition for more channels and food delivery options such as e-commerce and meal delivery kit. Also, we believe consumer-buying habits continue to evolve in a maturing consumer driven economy pressuring overall growth rates. And we are working closely with our retail customers as they navigate a tough environment and tailor our service offerings to meet their needs. We believe that in periods of headwinds and a challenging retail environment retailers will be looking to UNFI more than ever for differentiated products and infrastructure, which enables them to be competitive at the shelf, retail category management based on data by geographical region in an exemplary one company sales team committed to growth. Additionally, we believe retailers will deploy capital on store execution, store design, fresh product selection and resets to meet the needs of a changing consumer, but we are certainly not immune to the industry headwinds. We experienced meaningful deflation in the quarter when compared to the prior year. And the impact of deflation for us is quite difficult. We experienced 13 basis points of deflation in our first quarter, however when compared with the year ago period when we experienced inflation of 2.44% or 244 basis points the year-over-year change is significant with 250 basis points less inflation or pricing this quarter, we worked just as hard at the same cost but wih less revenue and gross profit to offset it. If the inflation in the first quarter had been in line with the year ago levels, which was comparable to our historical trend our net sales would have been more than $53 million higher. The impact was felt most severely in our Produce business, which had deflation of about 7% for the quarter and led to additional complications and challenges in integrating our newly acquired produce business. So to highlight why this is such a headwind, as an example and this is only as an example if a year ago our produce case was a $20 sale with deflation in the current year that same case was $18.60 today assuming 7% deflation. If our gross margin is the same on that case, at for example 20% we earned $4 in gross margin on that case a year ago, but only $3.72 today. However, our cost behind delivering that case remained the same. And we don’t believe the magnitude of the deflation or the lack of inflation is a long term issue, it may continue throughout the next several quarters. And we continue to view our produce and fresh acquisitions as highly strategic and important despite the deflationary pressures across many of these product categories and we remain vigilant towards building out the store. Our strategy is proven and we will continue to grow our national fresh platform. Given the deflationary challenges we are experiencing, we also must be vigilant in controlling cost in a difficult operating environment and maximizing gross margin and we have a structure and a plan in place to ensure that we are executing against both. So in summary, some of the industry challenges we experienced in fiscal 2016 have continued into this fiscal year but we remain confident in our full year outlook. We believe it incorporates the ongoing operating environment with heightened competition and little to no meaningful improvement in inflation. But at the same time it reflects our continued commitment to and confidence in our ongoing strategic initiatives as well as growth and opportunities with our retail partners. And now I’d turn the call over to Mike to provide some additional financial detail. Mike?

Thanks, Steve, and good afternoon, everyone. Net sales for the first quarter of fiscal 2017 were $2.28 billion, up 9.7% from approximately $202 million over the first quarter of last year. Excluding the year-over-year impact of the previously disclosed customer distribution contract termination, our adjusted net sales growth for Q1 was up 12.9%. We estimate acquisitions contributed approximately 8 percentage points to net sales growth this quarter, excluding the impact of our global organic business, which was fully integrated into our Albert’s business in Q4 of fiscal 2016. Keep in mind that as the fiscal year unfolds and our recent acquisitions become more integrated into our core business, our ability to separate their financial impact will diminish commensurately. As Steve mentioned, we experienced modest deflation of 13 basis points in Q1 versus Q1 of last fiscal year. This represents first quarter of deflation for UNFI in atleast seven years. The Q1 deflation was comprised modest inflation in our centerless [ph] store categories combined with deflation in the perimeter categories such as produce, meat and cheese. The Q1 deflation represents 16 basis points of sequential decline versus fourth quarter of fiscal 2016 and as Steve mentioned a 257 basis point decline versus Q1 of last fiscal year. From a channel perspective, supernatural's net sales were up 4.6% over the prior year’s first quarter. The supernatural channel represented 32.8% of our total UNFI net sales in Q1, which is a 159 basis point reduction in net sales concentration versus the first quarter of fiscal 2016. Supermarket channel net sales increased 13.5% in Q1 versus first quarter of last year and landed at 28.6% of total UNFI net sales, up 0.9 percentage points from 27.7% in the first quarter of fiscal 2016. Excluding the customer contract termination supermarkets grew 26.3% in Q1 versus first quarter of last year due in large part to our recent acquisitions. The independent channel grew 10% in the first quarter versus Q1 of last year and represented 27.3% of total UNFI net sales. Food service sales were up 8.1% in first quarter compared to Q1 of last year and e-commerce net sales continued strong growth increasing approximately 22.4% over the prior year’s first quarter. Gross margin for the quarter came in at 15.32%, a 20 basis point increase over last year’s first quarter. The increase versus the prior year’s comparable quarter was driven by our acquired companies, which tend to generate higher gross margins by providing more value added services has been the majority of our new business. Despite the year-over-year improvement in Q1, gross margin continued to experience headwinds from moderated supply of promotional activity, competitive pricing pressure and a reduction in fuel surcharges in the quarter. Our operating expenses for the quarter were 12.98% of net sales, a 46 basis point increase compared to the first quarter of fiscal 2016. It is driven primarily by increased expenses from acquired businesses. In Q1, we also had increased expense related to depreciation, amortization and accruals for incentives, which was largely offset by the improved operating leverage resulting from the increased net sales. For the first quarter, total fuel costs decreased 11 basis points as a percent of net sales compared to the first quarter of fiscal 2016, and represented 43 basis points of distribution net sales. The Department of Energy's national average price per gallon for diesel in Q1 was down approximately 5.5% or $0.14 per gallon compared to the first quarter of last year. Sequentially, total fuel cost in Q1 were down 2 basis points as a percent of sales versus Q4 of last fiscal year, sequentially the market price for diesel increased $0.02 per gallon versus Q4 in fiscal 2016. In Q1, our diesel fuel cost per gallon benefited relative to market prices from fixed price contracts that cover a portion of our diesel fuel needs. Share-based compensation expense represented 29 basis points of net sales in Q1, which was flat versus the first quarter of fiscal 2016. On a dollar basis, share based comp expense was up $0.7 to $6.7 million compared to $6 million in Q1 of last year. Operating income for the first quarter was $53.3 million, a decrease of $0.6 million or 1% from the same period last year. Our operating margin in Q1 was 2.34%, a 26 basis point decline over the first quarter of fiscal 2016. EBITDA for the first quarter of fiscal 2017 was $74.6 million an increase of 5.6% from $70.6 million in the same period last year. Interest expense in Q1 of $4.5 million was approximately 21% higher than Q1 of last year, due primarily to additional debt resulting from the recent acquisitions. In September of 2016, we reduced the interest rate on our term loan by approximately 75 basis points. The term loan had an outstanding balance of approximately $130 million. This helped reduce the average rate on outstanding debt to 3.08% [ph] in Q1, a reduction of 33 basis points versus the first quarter of last year. In addition, our percentage of fixed rate debt increased to 55% in Q1 versus 38% in Q1 of last year as a result of a $150 million of new, pay fixed rate and received floating rate swaps have entered into in June of 2016. For the first quarter of fiscal 2017, the company reported net income of $29.2 million or $0.58 per diluted share, a decrease of approximately $0.9 million over the prior years first quarter. Total working capital at the end of Q1 was $1.0 billion, up 0.9% versus first quarter of last year, a net sales growth of 9.7%. Our Q1 inventory days on hand improved versus last years first quarter driven by system improvements that helped us better forecast our command. In Q1 we remained disciplined with our capital expenditure decisions landing at approximately $9.2 million CapEx spending or 0.4% of net sales. This compares to the same rate of 0.4% of net sales in the first quarter of fiscal 2016. Outstanding lender commitments under our credit facility were $887 million at quarter end, with available liquidity of approximately $435.5 million, including $13.5 million in cash and cash equivalents. Our debt-to-EBITDA leverage at the end of first quarter was 1.99 times versus 2.04 times at the end of fourth quarter fiscal 2016. We had negative free cash flow of $16.5 million in the quarter compared to negative free cash flow of $2 million in the year ago first quarter. This Q1 result was favourable versus our expectations as we plan to build inventory versus prior quarter in preparation for additional sales over the holidays. As we evaluate our outlook on the balance of the fiscal year and factor in newly signed business and margin enhancement initiatives we are reaffirming the fiscal 2017 guidance that we provided on September 12, 2016 which included net sales increase of approximately 11.3% to 13.3% over fiscal 2016 and GAAP earnings per diluted share in a range of approximately $2.53 to $2.63. At this point, I’ll turn the call over to the operator to begin the question and answer session.

Thank you. At this time, I'll be conducting a question-and-answer session. [Operator Instructions] And our first question comes from John Heinbockel with Guggenheim Securities. Please go ahead.

Hey guys, Steven Forbes on for John today.

Yes, hi Steve.

Given the deflationary and more competitive environment you noted in your prepared remarks, has the trend moved in your favor as it relates to customers converting to a direct distribution model, given that they are tied up with a difficult operating environment? And with that are you seeing less margin pressure associated with contract renewal?

In answer to your first question we haven’t seen any change on the direct. I would say on the contrary going back to some of the opening comments that I made, I think we are seeing more retailers focused on improving the in-store experience, re-sets, re-designs and they are deploying their capital into getting consumers into the stores and buying in the stores as opposed to further building out their captive distribution network. And number two, I think it’s important that people keep in mind that you know captive is only a phenomena that affects less than 30% of our business. So our independent channel our super natural channel is not affected by that. But Sean, I think you were going to say something.

No, no. Okay.

I think was there a second part to that question, Steve.

And just as a follow up as it relates to the sales force reward, again I know you touched on it, but maybe to clarify the $100 million you mentioned was that a direct result of [indiscernible] wins associated with the re-org or was that something else?

Yes hi, Steve this is Sean. I wouldn’t say that – I wouldn’t characterize it as you know one way or the other as these many of these opportunities have been developed over a long sales cycle. However, I would say that we are encouraged in the early innings as we have just moved to the structure here in our first quarter around some of the independent natural and independent supermarket opportunities as well as expansion and existing customers with new categories that we believe is certainly a result of more and increased frequency of customer visits and more customer proactive work in the regions, closer to the customer, but the bulk of the $100 million is coming from new customer wins and significant expansions of existing customer relations.

Thank you.

And our next question comes from the line of Chris Mandeville from Jefferies. Please go ahead.

Hi, thanks for taking my question. Just really quickly and a point of clarification. You had mentioned that global organics was not in that 8% or so from M&A, is that correct?

Yes, that’s correct, Chris. You know that’s a really difficult number for us to get at because that business was fully integrated. As you know they occupied warehousing space adjacent in the same building as what we had, so upon acquisition we brought them in which makes it impossible really to segregate exactly what the contribution was from that business in the quarter and we won’t be able to do that going forward unfortunately either.

No, that’s fair, just is it possible to disclose the sales that were acquired at the point of the yield?

No, we didn’t provide that at the time of the deal.

Okay, I guess moving on, I’m curious seeing how obviously it is a hyper competitive market at both the wholesale and retail level for that matter. Can you help us understand a little bit Steve what you are seeing as it relates to the phase of growth for natural organics or even maybe separately fresh for that matter given the deflationary pressures? What’s going on with pricing from where you stand? Is it just promotion or we’re actually seeing some shelf price reductions in certain categories like produce?

Yes, so I really can’t comment on pricing at the retail level. You know obviously you can’t possibly escape the challenges that retailers regardless of whether they are hard goods, clothing, food, everybody is facing the same challenges in getting consumers into the stores. And you know unfortunately there’s not really one answer and certainly you can point to the pressure associated with deflation in meat and produce, but that will be temporary. But you know we can have a long discussion around are the changing dynamics and the way the consumers buy whether it’s millennial driven, whether millennial is getting married late, whether it’s a lot of student debt, whether it’s their living in home, whether they are going to stay in the cities as opposed to buying a house and moving out to the suburbs. So I think right now it’s just we’ve got a lot of noise but given that we have such a significant infrastructure and our retailers would rely so heavily upon us or data access supply chain we feel we are better positioned than anybody to find a way to manoeuvre it through this tough operating environment.

Okay, and then you have mentioned in the past that I believe fresh is around 15% of your sales, any update on where that stands now and how fast we should maybe expect that going forward? Was that 100 million that you’d mentioned earlier largely within the fresh category?

Yes. I mean, I don’t know, we’d actually didn’t do that calculation. My guess it’s probably hovering around the same. But obviously deflation just causes unbelievable havoc in the calculation of our fresh numbers specifically in the protein category and in produce where we had 7% deflation in the quarter which is, that’s pretty hard to make up.

Okay. And then, last one from me. I suppose I would have to ask, but in terms of the 20 basis points of gross margin improvement, was that largely all related to M&A?

Yes. That’s absolutely, right, Chris, the increase certainly fully attributable to the acquisitions.

Even more so?

Yes, even more so.

Thank you very much.

And our next question comes from the line of Scott Mushkin with Wolfe Research. Please go ahead sir. Mr. Mushkin, your line is live.

Sorry about that guys. Cell phone. If anyone has iPhone 6 Plus, they are probably having the same defect happening that I’m having, so the screen doesn’t want to work. So thanks for taking my questions. And I just wanted to poke on kind of the sales growth outlook for the rest of the year. Obviously, some of your bigger customers are having some challenges, I mean, if you guys started bringing more conservatism as I know Natural Grocers talked about maybe reducing their store growth, Whole Foods is trimming a little bit. How do you guys think about guidance in relation to sales growth knowing that some of your retail partners are really struggling at this stage?

Well, I mean, I think we talked about it a little bit, Scott, we have to – we just have to go out and we have to bring more business into verified network whether its through acquisitions, whether its customer expansion, whether its single sales force, whether it’s a new contract and I think that we’ve had a fair amount of success doing that. I don’t believe we think that the dynamics within our existing customer base are going to get considerably better throughout the remainder of the fiscal year, but like I said in my comments, I think that we believe that retailers will rely more heavily upon us to use our supply chain, use our construction to get product into the markets more readily, because most distinctive items in to the market more readily, to help retailers reset and redesign and that’s I think the only thing that we can rely on to give us some confidence we can [Indiscernible].

Scott, I’ll add to Steve’s comments say, in reaffirming our guidance and we certainly look at the run rate that we’ve got, the inflation or deflation as it is that we’re experiencing. We’ve adjusted our thinking going forward as a result of that and still felt like reaffirming guidance was the right place for us.

So, as a follow-up. Thanks guys for that. So, as a follow-up, Amazon fresh has rolled into several more geographies where some of your customers are pretty big. Have you guys looked at that impact and how it builds over time and any insight there would be great? And then I have one last one and I’ll yield.

So, we wouldn’t comment on how one retailer impact another but we do have fairly significant relationship with Amazon that we feel pretty good about. And our role is to get healthy, better for you products into as many retailers hands as we possibly can. And as Amazon grows we hope that we can grow with them.

That’s good. That’s opened up the Pandora's box there. So you distribute to Amazon natural organic products?

We do.

Okay. Then my final question is how do we get out of this type climate or this tough climate? I ask this of every company like, okay we know it’s tough, how do we get out of it? When does it end? It seems to be just getting tougher and tougher? And then thank you.

I mean, I can always speak for us, clearly there’s going be more consolidation, right. Because in an environment where margins are tough, pricing is tough, you have to get bigger, you have to consolidate, you have to take out costs. Now, we I think are very fortunate that we already have a pretty significant network. We have a pretty significant sophisticated supply chain and so historically we’d always said, we have to take out more costs than the decline in the gross margin. So I think we haven’t been able to do that over the last year or so, given the speed of which the dynamic has changed, but I think we are incredibly focused on making sure we get cost down in the system making sure we can continue to consolidate. And so, we think we’re in a pretty good spot despite the fact that in this particular quarter and really from the last year or so the industry has been in the tough place as it relates to the what’s happening retail inflation. But we can win our way through it. We don’t look at the business quarter to quarter as you know. But we think we have the right strategy in place, building out the store and certainly going to get us to a national platform of fresh. I think we did more successful that most in our M&A strategy, and that’s going to continue to continues. And we have a great balance sheet.

Thanks guys.

And our next question comes from the Rupesh Parikh from Oppenheimer. Please proceed with your question.

Thanks for taking question. I want to ask a question on the gross margin. We again saw the headwinds related to moderated supplier promotional activity, the competitive pricing and reduce the surcharges. Do any of these pressures go away as the year progresses? And I was surprise that the last year, you also had pressures related to that moderated promotional supplier activities. I thought maybe you’d have less challenges as you lap those pressures last year?

Yes, Rupesh, we’ve still got headwinds there. We still got headwinds, in kind of I think those are listed in order of magnitude, so we’re feeling the pressure from reduce supplier promotional activity. You’re correct in your assumption that a year ago we also face that same headwind and as we lap that headwind from last year we’re still feeling it and its still definitely a headwind that we’re facing as well as the competitiveness. Reduced fuel surcharge is there, that’s impact to a lesser extent, but that’s also on the list.

I just like to just add one comment to Mike point, that beyond just the promotional environment from a discounting perspective, as an example where you’re going to buy and buy again is the current lack of inflation in this quarter versus same quarter last year, that inhibit our ability to buy against inflation, which from UNFI perspective is a win on cross margin line. So we did not have that in this quarter.

Okay, great. And for the full year what’s your updated forecast for inflation or deflation?

Yes. We didn’t put in but what we’re thinking is in the range of 25 basis points of deflation to 75 basis points of inflation. So, that range is for the remainder of the fiscal year.

Okay. And my final question, as we look at your full year’s sales guidance, clearly deflation is a bigger headwind, it sounds like competitive challenges. Our lease is as maybe where you guys thought in September. What’s the off? Is it mainly more contract wins that’s helping you maintain that full year sales guidance?

Well, I think there is nothing we can do about the inflation. It is what it is. It’s kind of unparallel than it size, but we got to deal with it. And so I think both Mike and I comment it in our comments that there are couple of things we can do. We be extremely disciplined in our cost control we can initiate several projects that give us the ability to further control our gross margin. We can make sure that the value added programs that we have in place with our customers that they are truly adding value and that it’s okay, customers are paying for them. And so I think to some degree, the tough economic climate puts us in a position where we just have to turnover every rock and that’s what we are doing, both in terms of cost and margin and new customer opportunity. And we feel pretty good about 100 million or so annualized that we talked about. We think the M&A pipeline is good. And so again we don’t look at the business quarter to quarter, we look at the business over the course of years and we still see that there are tremendous opportunities ahead for us.

Yes. I would just like to add as well, you know, with respect to the change in our structure and regionalizing the sales organization under sort of ahead of household, account manager rolling up to the President. We know that in the first quarter our sales teams have really gotten after, so that’s number one and I think that some of the opportunities ahead of us are as a result of that. And then secondly, we don’t talk about this enough is that we’re providing excellent service and that we’ll take a look at a year over year perspective our fill rates was up over 70 basis points from last year from an execution perspective out of our distribution centers are on time delivery and other metrics are in improving and really, frankly I think industry class. So service had still today has a lot to do with the relationships that you can retain and win with the retailer.

Okay, great. Thank you for all the color.

Now our next question comes from the line of Robby Ohmes with Bank of America Merrill Lynch. Please go ahead.

Hi. This is Reshawn [ph] for Robby Ohmes. Thanks for taking my question. I have a couple -- I have some questions on the cost side. Has the cost to serve in the acquired businesses, is that track with your expectations and then as you sort of integrate the business as more, have you identified areas where you can lower the cost to serve and any additional color would be great?

Yes. This is Mike. The performance of the acquisitions with respect to cost to serve is consistent with our expectations, and I would also add that an aggregate we’re exceeding our expectations in terms of contributions across the acquisitions and certainly our synergy opportunities, we expect to have synergy opportunities entered into these and as we integrate them in aggregate we’re pleased with where that’s heading.

Got it. And then I wanted to follow-up on Amazon, is that being captured in eCommerce and other? And then when did you launch on Amazon?

We’ve had a growing relationship with them for a long time and I don’t think we’ve given any disclosure around where it’s actually tracks within the own channel. But I would go back here to your earlier question about M&A performance, it is important to note that during the quarter, it is fully integrate global into our Sarasota business. We also fully integrated and transitioned to account from there of legacy fee system into our Albert’s ERP system and those two things require incredible heavy lifting that during a period of 7% inflation makes it even more complicated.

And just following up on the data, the Amazon is in our eCommerce business which rolls into our other.

Got it. Thank you so much. This has been really helpful.

Now our next question comes from the line of Zach Fadem with Wells Fargo. Please go ahead.

Hey, guys. Can you quickly clarify the 100 million? Is that purely new customer wins or does that also include the expansion of existing customers?

It’s both.

Okay. It’s both. So would that imply organic sales growth of about 1% just the 100 million over last year? And then secondly, as we think about just your long term outlook from mid to high single digit sales growth and then excluding M&A I’m curious how you think about the impact from new customer wins versus building share of wallet with existing customers and how you expect that to play out this year versus long term?

Yes. On the first part of the question, I think directionally you’re probably about right.

Okay.

I’m not sure I have understand that second part there.

When you think about your long term growth, I’m curious how you think about just the mix of winning new customers versus your opportunity to build out the store within your existing customer, selling more perishables perimeter items and what not like basically talk about the opportunity there?

Vast majority of our year-on-year budgeted growth comes from increasing our sales to current customer, because we don’t budget customers that we haven’t won and we don’t know we’re going to win. And so our new contract is material to contract were tend to be very lumpy, because you’ll take it on significant piece [Indiscernible]. And so I think generally speaking use of the large wins that’s one-off and vast majority of the business expansion of contract by selling more of what we offer to most retailers.

Okay. Thanks. That makes sense. And I just want to follow up on an earlier comment about grocery industry consolidation and the impact on your business. Is there a standard protocol for what happens to your contracts and the event that two customers combined or maybe you have a contract and someone else has a contract and the two customers combined? I know this has bee issue in the past, I’m just hopeful you can just walk me through how this typically plays out?

Yes. I mean, look we let use Ahold, Delhaize. We have a contract with both. We have a long history of both. And so I think it’s a great opportunity for UNFI’s [Indiscernible] supply chain to further and enhance that relationship. Now what you can’t control when two retailers come together is number of stores that they close, right, because that certainly going to happen as retailers come together, that’s part of the consolidation is to extract cost savings. And so there is no black and while answer to it. Fortunately we have great relationship with most of the retailers and at the end of the day like Sean said, I think service level and quality has been close to the consumers to what’s going to helping that decision.

And I would say that if you think about the construct of a win-win, sometimes you will negotiate sooner rather than wait for expiring contract so to come up in our peak, so each relationship has its own unique characteristics, but it certainly win-win is what obviously interest of both parts. Yes, there’s plenty of retailers that consolidate and leave the supply decision in the hands of banners themselves. So its not new rule that’s every time there’s a consolidation that it’s going to be winner.

Got it. Thanks. That’s really helpful. Appreciate the time guys.

Now our next question comes from the line of Vincent Sinisi with Morgan Stanley. Please go ahead, sir.

Hey, great. Thanks very much guys for taking my question. Just want to ask about the product mix a little bit. I know that some of the commentary you said in the past you said that in order to win some business certainly on a contract by contract basis you might go into some more of the conventional types of products. Just wondering if you can give us an update as a percent of mix today where that is, how that progress is going and then where you think that might go over time?

Yes. I mean, the vast majority of our product today is to be natural, some better for you ingredient. We don’t see ourselves as a conventional distributor carrying conventional type product that should not something that we never articulate at being a strategic direction for us. We think that strategy for us still remains higher growth categories like fresh, like specialty cheese, like produce and like those products that have a better for you ingredient base. The conventional world is pretty competitive, it’s not a whole lot differentiated and contracting, so I think we would much prefer to spend our energy building out the store in categories that still have a lot of legs. The only proviso to that would be in the context of produce where we believe that our pure organic offering through our Albert's organic business has put us at a disadvantage as retailers have expanded beyond organic on the natural side to add conventional produce, and so that has inspired us for example largely around the strategic acquisition Nor-Cal product, so we do expect that we have opportunities on the conventional side and on the produce, in the produce category and working through where we go next there.

Okay. All right. That’s very helpful. Thank you and then maybe just a fast follow-up, just on the M&A outlook kind of I know you said pipeline remains full. If you could just refresh us kind of where some of the greatest basic areas opportunity are? And then also on Tony’s specifically kind of how much of the distribution network has Tony’s products at this point? Thanks very much.

So the first part of the question is, we’ll continue to acquire businesses that are adjacent to what currently do, whether it would be an specialty cheese or produce or specialty ethnic gourmet, those are the types of products that we are going to continue to look at acquiring, those things that further help us expanding our building outs for strategy. Pretty disciplined, we don’t deviate from it, things to work. You know it relates to Tony’s we rolled down many of those products in many of our distribution centers as we started taking on anchor customers, but we’re not going to get into the specifics of where and the percentage because there’s just a competitive part of that we would rather not disclose.

Okay. Fair enough.

I would say that just a little bit more color is that the Tony’s assortment, specialty cheese, deli, et cetera is available in the Pacific region, the central region and the Atlantic region of UNFI’s distribution plan. Not necessarily in every DC but certainly in all regions.

Okay, great. Thanks very much guys.

And now our final question comes from the line of Ms. Karen Short with Barclays. Please go ahead.

Hi. Just a couple of questions. I guess, obviously your guidance is more or less maintained but it seems like D&A came in later than what we were looking for what you guided to fourth quarter? So, any color there, is this quarter run rate, the rate run rate use for D&A, that’s my first question?

Karen, in the quarter depreciation, amortization was $4.5 million higher than Q1 from a year ago, and I think that’s a pretty good number in terms of thinking about run rate for the year.

Okay. And then I guess a couple of questions just in terms of your commentary, Steve, you continue to evaluate opportunities in acquisitions, I guess the first question is, are you still committed to the $120 million to $150 million of free cash flow? And then maybe I obviously realize that the free cash flow number excluding acquisitions but maybe just some elaborate a little bit on that comment?

So, you’re asking me are we still committed to 100 plus million of the cash flow? I would say the answer is yes. Yes, Karen just to add you’re correct our guidance in September was 120 million to 150 million pre-cash flow. In my comments indicated that felt good about where we landed on working capital in Q1 relative to expectations and when we reaffirm our guidance free cash flow number was certainly part of that. And I would just add that, from an M&A perspective obviously we’re integrating four business, two of them are fully integrated into our business systems, we got a couple of big ones coming up and so ideally we’d like to take a little bit of breath there so we can do some of the heavy lifting that we have to do with businesses that we’ve acquired. However, if we’re put in a situation where we have to act or we to lose it than we’ll make that determination, but I think we’ve got a pretty good model for attracting the M&A, We got a pretty good model for negotiating the M&A in a very disciplined way, at least in our view. And so I think from a timing perspective we can control that process.

Okay. And then just a last question since you gave us Ahold, Delhaize as examples, just to clarify, because I think there might be a misperception out there. If there is a change of controls that doesn’t necessarily mean that an entire contract with two separate banners is up for re-negotiation or cancellation. I would assume it’s entirely dependent on each individual contract, right?

That’s correct.

Okay, thanks very much.

We’ve reached the end of our question and answer session. I like to turn the call back over to management for any closing remarks.

Thank you all for joining us this afternoon and we hope that you have a terrific holiday season. Have a great day.

Thank you ladies and gentlemen. Again, we thank you for your time and participation. And this does conclude our teleconference for today. You may disconnect your lines at this time and have a wonderful rest of the day.