United Natural Foods Earnings Call Insights: DC Performance, Gross Margins and Seasonal Patterns

On Tuesday, United Natural Foods, Inc. (NASDAQ:UNFI) reported its third quarter earnings and discussed the following topics in its earnings conference call. Here’s what the C-suite revealed.

DC Performance:

Meredith Adler – Barclays Capital: I’d like to just talk a little bit more about expenses. You’re currently doing a great job in that area. I am wondering whether putting aside the new technology that goes into the warehouses, the things you’ve done recently, is that going to be like a continuing benefit year-over-year or should we expect that one should cycle what you’ve done this year that it will kind of level off?

Steven L. Spinner – President and CEO: We’re certainly hoping to get continued benefit out of continued improvement. That’s kind of why I directed the comments to some of the ranges in operations throughput, transportation throughput, and miles per gallon to reflect that. While we made a lot of headway, we still have a lot of opportunity because a lot of the DCs for a variety of reasons still perform in a place that we think we can get considerably better throughput and miles per gallon. So, I mean I think the short answer is we’re certainly hoping that for the next couple of years we can continue to get more expenses out of the system.

Meredith Adler – Barclays Capital: So the differences in the DCs in terms of their performance is, even though there are reasons for it those are not so structural that you can’t get them at least to get closer to the best performance, is that right?

Steven L. Spinner – President and CEO: Yeah, generally speaking there are some structural differences in size of the DC or customer mix or the amount of miles they need to run, but adjusting for those things we still think that there is a ton of opportunity just based on the maturity of the workforce of each one of DCs, the level at which our national team have put forth their best efforts. So we feel pretty good about continued opportunity in those couple of areas.

Meredith Adler – Barclays Capital: Then I have a question about the new DCs, you have Denver and New England. Obviously – well, I’m just wondering is there anything in the way you are going to be building those facilities, the way they’ll be structured, that will be vastly different than what you’re doing now. I assume you’ll have the new warehouse management system, but is there anything else that you think you can do to drive productivity simply by the way the facilities are…

Steven L. Spinner – President and CEO: Yeah, I mean that’s a great point, Meredith. You know the Denver situation is today, we operate out of three buildings. So, as you might imagine, the cost to do that is pretty significant. So just by getting from three buildings to one building gives us a tremendous amount of scale and opportunity. In New England, it’s a little bit different. We’ve got two distribution centers that are out of room and are landlocked. So that will be a longer term project by which we build the new center and gradually put the volume into the new facility and build scale, which obviously gives us the ability to drive down costs as well. So, it’s really a matter of, the bigger you can build it to a point, the greater your ability to drive up your EBIT margin within the facility.

Meredith Adler – Barclays Capital: So, does that mean you or maybe you haven’t said anything yet about closing the two DCs that are in New England now, or will you just try to relieve some of the pressure on them because they are at the back?

Steven L. Spinner – President and CEO: Yeah, we’re just going to relieve the pressure.

Gross Margins and Seasonal Patterns:

Scott Mushkin – Jefferies & Co.: I want to follow-on with what Meredith was talking about the margin discussion, and I wanted to start with gross margins. I think the basis point decline was just (as much) greater than it was in the second quarter on a sequential basis. I guess, just kind of looking at that gross margin line, do we start to cycle some of the big declines at some point as we cycle the Safeway contract, and how should we be thinking about gross margins, the pressure there going forward?

Mark E. Shamber – SVP, CFO and Treasurer: Yeah, Scott I think that you’re dead on with that question. I mean, we probably have – from a year-over-year standpoint, we will see some pressure for Q4 and not as great of a pressure in Q1 of fiscal ’13 but from a sequential standpoint we should revert back to some of the normal seasonal patterns that we see so – using Q2 to Q3 – this current quarter is an example, we usually see a lift in the gross margin by virtue of the products being sold and the fact that the independents are stronger sequentially usually from Q2 to – Q3 versus Q2 even though on a year-over-year basis with the higher supernatural and conventional supermarket basis they may have declined. So I think you’ve got another quarter or two where we’ll have measurable numbers from that standpoint, and then we should go back into – I don’t want to say in necessarily single digits, but I think you would see much less pressure on the gross margin than you had seen for the last six to eight quarters.

Scott Mushkin – Jefferies & Co.: So, I wanted to kind of take that discussion a little bit further on what Steve had said kind of the expense in trying to continue the momentum there. I mean as we go out and think about UNFI out over the next few years and the operating margins, if you look back, 3.5 was kind of the cap there. I think it’s the best you guys have ever done on a yearly basis. Do we still think that as the top end of your range or do you feel with some of the changes that are being brought to bear on the Company that 3.5 is not a cap anymore that over time we could actually see operating margins actually exceed that over a long view obviously?

Steven L. Spinner – President and CEO: Mark and I have probably two perspectives. I would give you one and that is that we are still pretty comfortable with the 9 to 12 basis points of margin improvement every year going out the next couple of years. Whether that gets us there – if you do the math, it certainly will. Mark, you probably have some commentary as well.

Mark E. Shamber – SVP, CFO and Treasurer: Yeah. I mean I think from my standpoint, Scott, what I’ve said to folks when they ask the question is that, we still think that we can get to 3.5% for a full year number in that, depending on what levers we’ve had to pull and where we stand in using, let’s say the warehouse management role, as an example, what we still have for levers that we might be able to pull further would influence that. So I think it’s premature to say whether it’s a kind of a high end as to the ultimate as to where operating margin get to or if it can get any better. But as Steve said, we are comfortable with the 9 to 12 basis points we’ve laid out, and I think that when we are at a position where we are at 3.5%, we’ll be better able to evaluate as to what we think the ultimate high-end operating margin for this business could be.

Steven L. Spinner – President and CEO: Just one more point of clarity. There is a very large food service distributor who has done a good job certainly in their earlier days of building their operating margin to a point that’s north of ours. They did it by scale. More volume through bigger centers gives the distribution company the ability to spread out those fixed costs over a much wider berth, which is the reason why we are tending to build bigger centers; our Pennsylvania center, or Moreno Valley, Southern California center, our new Denver center and our New England center, are all what we would consider mega centers, which give us the ability to have that scale. Without it, it would be really hard to do.

Scott Mushkin – Jefferies & Co.: I just want to slip one last follow-up question in there then I will yield. Is acquisitions part of that scale drive, any thoughts there?

Steven L. Spinner – President and CEO: It could be. We don’t have M&A in our internal models that help us build the scale, but certainly if those opportunities were there they would help us get there sooner.