United Natural Foods’ (UNFI) Q3 2017 Results

Steve Spinner – Chairman & CEO

Same store sales under pressure

“Same-store sales at 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.”

Deflation being experienced

“We continue to experience deflation…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%.The general lack of inflation also caused what we believe to be a short-term pressure on gross margin dollars…Deflation has continued but is moderated.”

Retailers facing growth headwinds

“…when you look at general same-store sales 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 closing as retailers are coming together and so in the near term that’s been a real headwind for us, but inflation will return.”

Michael Zechmeister – CFO

Lack of inflation is a headwind

“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.”

United Foods FY 3Q17 Earnings Call Notes

Steve Spinner – Chairman & CEO

We continue to experience deflation

“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%. The general lack of inflation also caused what we believe to be a short-term pressure on gross margin dollars”

Deflation has continued but it has moderated

” Although industry headwinds have not abated, we see some reasons for cautious optimism. Deflation has continued but is moderated.”

UNFI FY 2Q17 Earnings Call Notes

Steven Spinner – Chairman and Chief Executive Officer

Ongoing challenges faced by deflation

“And while we are encouraged by these initiatives, we also have to acknowledge the ongoing challenges facing our industry. Our customers are facing a difficult retail environment due to deflation and increased competition. We view deflation as cyclical, inflation will come back at some point but while it’s here, it’s leading to some very real challenges for us and our retail customers. Many of our broadline customer contracts are on a cost plus basis, so when we have less inflation or deflation, the gross profit dollars we generate for case is lower.”

Outlook incorporates little to no improvement in inflation

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

Deflation is cyclical

“Well Eric, the issue that we have and it is cyclical. I mean obviously it is not going to last forever is that the produce deflation got worse in the second quarter than it was in the first. And so, in the produce world, as the product deflates we still incur the same amount of cost to get the products from the DCs into the retailers. Yes, we have considerably less gross margin to cover the cost. And so, it is a short term issue, and misery loves company; everybody has got the same problem. As far as when it’s going to cycle through, your guess is as good as mine, the only thing I would say is we have a high degree of confidence that is not going to be forever, it will turn but we are just not sure when.”

Would rather buy companies doing well than struggling

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

Increasingly doing direct to consumer fulfillment for customers

“Yes actually you are right in that we can’t sell direct to consumers as UNFI one of our fastest growing platforms to sell direct to consumers on behalf of our retailers. So essentially becoming the endless aisle for a retail partner where they are looking to expand their product offering to their consumers, we are doing that today, it’s just the consumer doesn’t know that we exist. We’re just doing the back-of-the-house fulfillment. We have a network of e-commerce fulfillment centers across the country. We’re adding to it, so that we get it to our customers in the most efficient and cost-effective manner. So we’re investing in e-commerce’s platform and we certainly spend a lot of time with some of the larger e-commerce providers to ensure that we have – we’re have were giving them access to all of the fresh and vitamin supplements in center store gluten-free organic et cetera as we possibly can. ”

Michael Zechmeister

Inflation outlook is lower

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

UNFI FY 4Q16 Earnings Call Notes

United Natural Foods’ (UNFI) CEO Steven Spinner on Q4 2016 Results

Still challenging food retail environment in fiscal 2017

“Before I turn the call over to Mike to discuss the financials, I just want to comment on some of the headlines in recent weeks. Some of our publically traded food retailers have recently commented that they are experiencing slower same-store sales trends and ongoing pressure from food deflation. We believe our guidance for fiscal 2017 incorporates a still challenging and difficult food retail environment as well as little to no inflation. However, as always, we are intently watching and listening to our customers.”

A deflationary environment works against us

” as a distributor, that’s primarily cost plus. The math works against us, when we don’t have 3% inflation, right? So, 3% inflation we passed it through, and the math works in our favor because we’re using percentages. So, we’re delivering the same case, we can have a little bit more margin, where we have no inflation, it’s a little harder. We still have to ship the same case and it still costs us the same, we’re just generating less margin. If I may also that, when we’re in periods of high product cost inflation, our opportunity from a buy side, from a purchasing side, from an inventory optimization side improves and so we have incremental gross margin gains as a result of forward buying against those product cost increases.”

It’s hyper competitive at the shelf

” I think kind of we’re all seeing the same thing. It’s hyper competitive at the shelf, I think from what we read is the same thing you read, the retailers are feeling the same pinch on – in terms of their margin structure, certainly some of the retailers are talking about reduction in basket size and obviously that same kind of pressure ultimately finds our way to us. So, the one side of it is, misery loves company, the other side of it is, the tide has to arrive at some point. ”

Still considerable demand for organic products but many many more outlets

“There’s still considerable demand for the products across center store and [ph] Brenner, it’s just being dispersed over a much wider approach. So, there’s many, many, many, many more outlets by the same product.”

Sean Griffin

Shoot for 85% capacity utilization

So, what we’re looking for, from a utilization perspective out of our network that we believe is optimum is in the range of approximately 85% capacity. It’s our best perspective around productivity and service, as well as giving us some flex around new customer wins. So, today with the addition of Gilroy, our capacity is in the mid-70s. So, you can kind of do the modeling between mid-70s to 85% based upon FY 2017’s revenue guidance to sort of come up with our opportunity to add business without doing any further expansions.

UNFI 3Q16 Earnings Call Notes

Steve Spinner

Three strategic acquisitions in the last several months

” over the last several months with the completion of three strategic acquisitions. As many of you know, we completed the acquisition of Global Organic and Nor-Cal in the third quarter and most recently in May, we completed the Haddon House transaction. ”

Michael Zechmeister

Expect contraction in center store

“I mean I think the base business is generally stable. We know over time as I said in my prepared remarks that I think that those are going to continue to be contraction in the center-store, nothing new there which is why we work so hard to build out the perimeter and related kind of fresh offerings.”

Private labeling impacting center of store

” think that in the center of the store, one of the biggest drivers certainly in the national side is private labeling in mass and conventional which is escalating at an extremely rapid pace. So certainly the larger national branded manufacturers in the natural channel, one of the biggest uphill battles they are facing is just the plethora of new private label natural brands that are finding their way into mass and drug and convenience and conventional. So certainly that’s a trend that I think we’ve all been fighting with for some while, but again if you look back overtime, private labels tends to have a very cyclical nature to it, a lot of it comes on and then it backs off, a lot of it comes on and then backs off.”

Retailers will contract their center of store over time

“I don’t think there is any doubt that retailers are — will overtime contract their center-store as perimeter and products that they can be differentiated in, become more important. And so we’ve adjusted our model with that and so I think what you’re seeing in our sales growth is kind of this window of time where we’ve built the infrastructure, we’ve started to have contraction around, becoming penetrated in those categories, but not enough to move the needle.”

UNFI FY 2Q16 Earnings Call Notes

United Natural Foods’ (UNFI) CEO Steve Spinner on Q2 2016

Over indexed to natural channel, where growth has moderated

“we are caught in this uneasy position, temporary uneasy position where we are over-indexed in the natural channel or under-indexed in conventional. We’re unbelievably excited about getting into this new channel of gourmet and ethnic. There are many gourmet and ethnic or specialty chains that have never been a channel at all for UNFI, so this is brand new. And another way to think about that is, while growth has moderated in the natural channel because the products have been around for so long, when you think about the gourmet and ethnic channel, the fastest-growing category within those stores is natural and organic.”

Under indexed in mass and drug channels

“we are way under-indexed in mass and there are tremendous opportunities for UNFI in mass and drug that we are taking a serious look at that three or four years ago we would’ve never looked at. And so because our distribution system is so robust, there are incredible opportunities for UNFI from a logistics perspective, from a redistribution perspective, from satisfying other conventional mass and drug distribution requirements that we are pretty excited about.”

We’re in a bit of a lull in the natural channel, but optimistic we’ll come out of that

And I would also tell you that being somewhat of an optimist, we’re at a little bit of a lull, as you know, within our natural channel but I feel fairly optimistic that we will also come out of that. It may take a couple years, but we will come out of that, too.”

What UNFI will look like in a couple of years

“it’s highly unlikely that we will ever carry Coke and Pepsi and Fritos, that’s just not what we do, we do want to build out the customer store. And so when you think about what UNFI will look like in a couple of years, it’s certainly conventional produce, organic produce. It’s every natural protein known. It’s rack deli, food-service, prepared foods. It’s center store, it’s frozen, it’s dairy, it’s gourmet and ethnic, it’s specialty, et cetera, et cetera. So what we want to be in a position to do is to solve a customer’s needs across all or some of their store.”

In a squeeze between capacity and volume for the moment

“the challenge for us right now is we are just in that squeeze between having the capacity and not having enough volume to push through it. But I think our building out the store is not only appropriate, but it’s going to get us to where we need to be.”

Suppliers promote where they’re getting growth

“this is a gross generalization, but suppliers generally promote where they are getting the growth. And so when you take the growth out of the channel you see a significant reduction in the amount of promotional activity. Promotional activity is a significant source of margin from UNFI, so if the suppliers divert the promotional activity to other channels, we’re going to feel the pain.”

Using price to attract new business is a recipe for disaster

” look, we’re not going to use price to attract new business because that’s a recipe for disaster, but we are going to be competitive where we have to. ”

United Natural Foods FY 1Q16 Earnings Call Notes

United Natural Foods’ (UNFI) CEO Steven Spinner on Q1 2016 Results

We’re operating in a rapidly evolving environment, with an increase in competition across every channel

“I believe we can all agree that we were — we are operating in a rapidly evolving environment. We all know that consumer preferences for healthier food option have been changing for the last several years. In fact, the acceleration that has taken place over the last 6 to 12 months has been spectacular and this is demonstrated by the significant and rather recent increase in the number of retail options for consumers to purchase natural organic products. As a result, we’ve seen an increase in competition across every retail channel and corresponding competition within wholesale distribution and supply chain. ”

There is no doubt that today we are mainstream

“Private label natural and organic products which we estimate at approximately 30% of the retail market is growing extremely quickly and center store is under pressure as consumers choose fresh and healthier option. Throughout the 90s and up until 2014, our industry was a niche. There is no doubt that today we are mainstream.”

M&A will play an accelerated role in consolidating manufacturers. Gross margins will continue to decline

“M&A will play an accelerated role in the consolidation of manufacturers and producers within natural, organic, and specialty. M&A will play an accelerated role in the consolidation of food retailers driven by cost reduction and differentiation. Gross margins will continue to decline as competition increases both at retail and wholesale, forcing a greater reliance on differentiation, efficiency, and scale.”

Acquisition pipeline strong

“The DPI would not have been on our list for a variety of reasons. But there are a ton of specialty, ethnic, gourmet, fresh, fresh across probably five or six or eight different channels. And so our pipeline is really strong. We got done making the Tony’s acquisition 16 months or so ago, we feel like we’re ready to do another one. We feel that the valuations for us are still realistic and so we — I’m extremely optimistic that we’re going to make some good progress there.”

Not seeing customers moving to self distribution

“On self distribution, I haven’t seen a lot of change in movement to self distribution. As a matter of fact we’ve had a great deal of success in moving some customers away from self distribution. I mean, if you take a look at the $785 million in contract expansion, a large percentage of those contracts have their self [ph] distribution option. And so, I think it’s something that we see as retailers having a tremendous confidence in the services that UNFI provides that they just can’t do themselves.”

There is increased competitive pressures across a wide berth. Our margin certainly isn’t going to go up

“I mean there is the increased competitive pressures across a pretty wide berth, right. So because so many more retailers carry the product, so the retailers themselves are competing with one another. On the supply chain side, many more wholesale distributors they’re direct et cetera, et cetera are carrying the product which is making it more competitive. And so, I think as you look at UNFI as I said earlier, our margin certainly isn’t going to go up as we renegotiate these contracts. So the challenge for us is to make the distribution system and the supply chain related to it more efficient.”

This is what happens when you go from niche to mainstream

“I think that because we’ve gone from a niche to something that’s very mainstream, I think the natural occurrence across whether it’s the retail level, or at the wholesale level, at the supply chain level it’s going to become more competitive whether it be for services or whether it be ultimately for the price of the consumer.”