Greetings and welcome to the United National Foods Fourth Quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. 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. You may now begin.

Thank you, O'Shea. Good afternoon and thank you for joining us on UNFI's fourth quarter and full year fiscal 2016 earnings conference call. By now you should have received a copy of the earnings release issued this afternoon at approximately 4:05 PM Eastern Time. This press release and webcast of today's call are available under the Investors section at 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'd 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. Actual results may differ materially from the results discussed in these forward-looking statements. In addition, in today's earnings release and during the call, management will provide GAAP and non-GAAP financial measures. These non-GAAP financial measures include adjusted net sales, adjusted net income, adjusted earnings per diluted share, EBITDA and free cash flow. I'd now like to turn the call over to Steve Spinner.

Good afternoon. Thank you, Halie and welcome to the team. As many of you may or may not know, Halie O'Shea is UNFI's new Director of Investor Relations and Corporate Strategy, so welcome. We are pleased with UNFI's execution of our strategic initiatives in fiscal 2016. Three years ago, we made the strategic decision to shift our business from a focus on center of the store to capture the faster growing fresh and good-for-you proteins, specialty cheese, deli and produce. This year, we have started to see the work and strategic investments behind this initiative pay off. During a year when we faced a more volatile and competitive marketplace, we have grown our fresh business to represent approximately 15% of our total sales. Our net sales grew 8% adjusted for the termination of a customer distribution contract and the second quarter fiscal 2015 reduction in net sales were 3.5% on a GAAP basis and EBITDA was $295.1 million, with GAAP net income of $125.8 million. Importantly, this was accomplished despite industry challenges, including slower same store sales growth rates across many key customers, less inflation and competitive pricing dynamics. In addition, as many of you know, we started the year with a strong headwind as a result of our decision to terminate a significant customer relationship. We also generated cost savings and greater efficiencies across the organization. In fiscal 2016, we delivered exemplary customer fill rates and our productivity improved by 5%, while our transportation costs were down 6%. On-time deliveries which we track through onboard computers installed throughout our network, also improved over 94% on time, which is truly astounding. We generated $255.2 million in free cash flow, which is the most we've ever generated in a fiscal year and over $300 million better than fiscal 2015. As previously…

Thanks, Steve, and good afternoon, everyone. Net sales for the fourth quarter of fiscal 2016 were $2.21 billion, which represents growth of 7.4% compared to fourth quarter of last year. Excluding the year-over-year impact of the previously disclosed termination of our customer distribution contract, our net sales growth for fourth quarter increased 12.7% compared to same period last year. The acquisitions of Nor-Cal Produce and Haddon House Food Products contributed approximately $138 million of net sales in the fourth quarter. Excluding Nor-Cal and Haddon House acquisitions, the impact and the impact of the customer contract termination, net sales grew 5.7% in the fourth quarter versus Q4 last year. Global Organic which was acquired in March was integrated into our Albert's business in Q4 and therefore is no longer separable from the underlying business. Inflation was essentially flat at only plus 3 basis points versus fourth quarter last year. This marks the lowest level of quarterly inflation in at least seven years. While we saw modest inflation across the center of the store, we experienced deflation across our fresh business. From a channel perspective, supernatural's net sales in Q4 were up 4.0% over the prior year and represented approximately 33% of our total UNFI sales. Supermarkets' sales increased 4.4% versus the prior year and landed at 28.2% of total sales. Excluding the Nor-Cal and Haddon House acquisitions and the customer contract termination, supermarkets grew approximately 7.9% in the quarter versus last year. The independent channel grew at 11.7% over the prior year, including the impact of recent acquisitions and representing 27.8% of total UNFI sales in the fourth quarter. Excluding the Nor-Cal and Haddon House acquisitions, the growth of our independent business was 4.2% in the fourth quarter versus Q4 last year. Finally, food service net sales were up 13.0% over…

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

So, Steve, let me start with capacity utilization in the warehouses. So, where do you think you stand right now I’m curious in particular the newer facilities, where do you – and where do you think you'll be based on your 2017 guidance? What do you think you'll be at the end of 2017?

Yeah. Hi, John. The nice thing about having built capacity is, we have capacity and so, we're now certainly focused on filling those buildings up, but I'm going to defer the answer to the question to Sean who is sitting next to me, and he can give you some of the specific details around capacity.

Sure.

Hey John, good afternoon.

Hi.

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.

So, ex-Gilroy, you would be where?

Well, I don't know that we can get into that much detail, but now maybe directionally high 70s or 80s?

Yeah. 78 somewhere in there.

Got it. And the $1 billion of renewed or extended business, I'm curious how much of that was previously done direct by your retail customers versus maybe other distributors, and we – I assume that would be maybe – maybe incorrectly that would be lower margin than your base business and if that's true, how – how would the margin on that $1 billion compare to renewals from the prior year?

Yeah, I mean the vast majority of the $1 billion was related to renewals, extensions and expansions.

Yeah.

And so, and they happened throughout fiscal 2016, some contracts were expiring, some were not, both the customer and UNFI felt that it was important to go ahead and renew those early. And so they don't really relate to new contract wins, but more renegotiations, new contracts with existing customers. For the most part, if you look at the gross margin throughout our fiscal 2016, we had traction and a lot of it was related to sort of competitive environment and the renewals in these contracts.

Okay. And then just lastly the rollout of – of national – the national rollout of conventional produce, so what's the timetable on that?

We feel that that's a little bit of a competitive advantage for us to kind of keep that under wraps for a while. We have a strong, really strong I think leading conventional produce acquirer, one of the leading produce – conventional produce acquirers from a quality's perspective in Nor-Cal and you could use a little common sense to determine where we were going to bring conventional next. But I think as we get further deployed, we'll probably be in a position to answer that question with more clarity.

Do you think we'll move eastward across the country, is that the idea organically until you buy somebody or not?

It's a little bit of both. It's a little bit of existing customers looking for us to satisfy their conventional produce needs in the same way we're already satisfying their organic needs, it's a contiguous markets. So, it's a little bit of both.

Okay. Thank you.

Okay, John.

Thank you. Our next question comes from Scott Mushkin from Wolfe Research.

Hi. This is Brian Cullinane on for Scott. Thanks for taking the question. Just wanted to touch on a couple of things. First on maybe the inflation, deflation environment. How do you guys kind of see overall – it's over – overall you said, it's a little bit inflationary, with some deflation in some of the fresh categories. Your distribution model, how do you think that handles that in comparison to kind of your retail customers, it is simply just passing on through or how do you guys kind of see that environment?

Yeah. I mean, 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.

Got you. That's helpful. And then, this is I guess maybe a little bigger picture, but as you evaluated again new customer, how much do you guys look at like the health of their business. Like see, there is some kind of local grocers that are struggling and if there are maybe the potential to go under restructuring or something like that, how much do you guys take that into account as you're working for the new business?

Yeah, Brian, this is Mike. The creditworthiness of customers is certainly part of the equation and the evaluation that goes into how we establish a contract and also our expectations in the contract. And, as you can imagine, there is a full range of folks that we're dealing with. We try to support our customers in the best way that we can, try to encourage a good business. But, at the end of the day, we've got to make sure we've captured the risk associated with credit as we establish any contract.

That's helpful. Thanks for taking the questions.

Okay.

Thank you. Our next question comes from Rupesh Parikh from Oppenheimer & Company.

Thanks for taking my question. Steve, I want to start first with the higher level question. So, we've clearly seen a little bit challenging reports from all the grocers out there. So, just curious from your perspective, and as you look through your lens, are you seeing anything else out there that could explain some of the weakness out there besides just the hypercompetitive environment? Just curious if you're seeing differences geographically, product category or anything else that you can help us with?

Yeah Rupesh I don't think so, 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. And so, going back to some of the statements that both Mike and I made in our commentary, I think we have a fair amount of the uncertainty built into our – into our guidance, but we feel pretty comfortable with that momentum that we have based upon the acquisitions that we've made, some of the excitement around UNFI Next for emerging brands among other things. And so, the long answer is, no, I don't see anything else out there, that hasn't already been discussed.

Okay. So from your perspective, is that – you look at the natural organic category, it seems that’s still holding up well, so would you say from your perspective the demand for natural organic products still remains pretty consistent with what we've seen in recent years?

Yeah, I haven't – certainly haven't seen the overall numbers for 2016. I think that, this has obviously been happening for some time. 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.

Okay. Great. One last question from me. Just to help us better understand the impact of acquisition of this year, is the rate of frame, how you guys were thinking about the EBITDA or EPS contribution related to the FY 2016 acquisitions?

2016 or 2017 Rupesh?

For 2017, so as we're looking at your guidance this year, what that contribution – contribution is from the acquisitions on the EBITDA and EPS line?

Yeah. There is certainly, let's take EPS first, we didn't give specific guidance related to the acquisitions on the EPS line, they're definitely accretive to the results for the year. On the EBITDA margin, they're relatively neutral to our overall business in terms of their contribution from an EBITDA margin standpoint for fiscal 2017. So, the gross margins are better, but they come with higher expenses, because these are higher service, higher touch businesses. And but when you get down to EBITDA margin, they're very similar.

Okay. Thank you for all the color.

Okay.

Thank you. Our next question comes from Eric Larson from Buckingham Research Group.

Yeah. Hi, everyone. Thanks for taking my question. Two of them. Can you give us a little bit more of a breakdown of your $255 million – well, I guess you have $335 million of free cash flow for the year, but obviously we can figure out the capital spending, what was the contribution from improved working capital and can you break that down a little for us?

Yeah. Thanks, Eric. We had terrific performance this year as you've seen on our free cash flow, as you mentioned CapEx is certainly a component of that, you can see that, it's not the lion's share of it, we also had good cash off of our business that contributed. But I think, overall, as you look at it, it's improvement in inventory and improvement in day sales outstanding that led to the largest gains for us in the quarter. Over the year, we've made improvements across all of our components of working capital and we will continue to try to work those areas for improvement going forward.

In your 120 to 150, would that be continuation of all of those, obviously, your CapEx is going to consume a little bit more capital next year, little more cash. How does the breakdown looks for 2017 to get to that 120, 150 guidance?

Yeah. You said it. The CapEx is up slightly, and we feel confident in that range, 120 to 150. We'll continue to work – the working capital for improvement. I can tell you that, that range incorp - encompasses the second highest free cash flow year in company history, if we're to deliver that. So, while it is lower than what we deliver in fiscal 2016 and fiscal 2016 was the highest by quite a distance. We still believe it's good cash flow for next year.

Okay. And then, at the end of your fiscal year last year, you said that, it was – at least two years and maybe three before you need an another distribution facility, I think, maybe you're talking Greenfield, but maybe also Brownfield. Will it be fiscal 2018, before you see any meaningful pick up in CapEx to – for capacity needs?

Yeah. I mean, we clearly have not articulated guidance outside of 2017. So, I want to be careful, that we don't give multi-year guidance. We just acquired a couple of new buildings in Nor-Cal in Halo, which is in Edison, New Jersey and Richburg, South Carolina. So, we've a lot of focus on getting those two buildings into the UNFI network. They have some expansion capability, which would service really well in that Mid-Atlantic corridor, which we will certainly need as our business grows. But I don't anticipate having a major new building in the next 18 months or so, unless of course there was a significant reason to do it.

But let me also, Eric, if I may, this is Sean. When we built a distribution center of the type that we have built here in UNFI over the last five years or so. These buildings are built to flex. So, as an example, and you will see in Wisconsin, we have our 450,000 square foot phase I building that is delivering the returns that we would expect. That building can expand by another 300,000 square feet and any storage or compartment, we need, whether it's chilled, frozen or dry, and we can do that at a very low cost versus a Greenfield or Brownfield new building, and from a time perspective, in a very expeditious manner. So, and as you know, we've got several buildings now over the last five years, that we built in that fashion. So, we can move quite quickly, if we need to, and add an economical spends.

Okay, great. Thanks for that. And then my final question, it's really related to your guidance, first of all in your sales guidance for the year of 11%, just make it simple 11% to 13%, how much of that is acquisition revenue? What would be kind of an organic, how will that breakdown organically versus acquired sales?

Yeah Eric, there is a – I don't think we broke that out in our guidance, but – so first of all the guidance is 11.3% to 13.3% in a year.

Right.

And as I recall, it was seven percentage points or eight percentage points that comes from acquisitions.

Okay. Thanks. And then the final question, I'm sorry I'm to asking so many here. Your EPS guidance of $253 million to $263 million, if you look at your adjusted number of $259 million for the year, is kind of – your kind of at about the middle of your adjusted number, in your GAAP numbers, in your GAAP EPS guidance number, are there any anticipated adjusted – expenses that would be adjusted for that, so that your adjusted number would have growth on top of your $259?

Thanks, Eric. No, unlike last year, we didn't – we're not providing any guidance for restructuring going into the year.

Okay. Thanks everyone. I appreciate it.

Okay. Thanks.

Thank you. Our next question comes from Zach Fadem from Wells Fargo.

Hey, good afternoon guys. I just want a follow-up a little bit on the last question, so with your fiscal 2017 guidance and planning about 5% to 6% growth ex-M&A, can you talk about some of the organic growth drivers there in – just given the challenging environment from many of your customers, can you talk about what you're seeing and what gives you confidence that you can get to that 5% to 6%? And perhaps you can talk a little more about the impact of deflation and whether there are any new customer wins embedded in the guidance?

Yeah. Well, we don't embed customer wins in our guidance unless we know we have. Right. So, the contract signed, then we put in our guidance. If the contract is not signed, then we don't. We do have a what I would call a vibrant kind of new customer pipeline that we're working on all the time. I think the thing that I'm most excited about is the reorganized sales force and as an example, up until August, we had a sales associate from Albert's calling on a customer, Tony's calling on a customer, from UNFI calling a customer, from Select Nutrition calling on a customer, sometimes from e-commerce, sometime from food service. So, it is possible that up until August, we could have had four different sales associates calling on the same customer. And in August, we reorganized the team into one singular sales force. So now, one person is responsible for the entirety of UNFI's product offerings and each customer. So, we are really hopeful that that will bring us some opportunity that we have not experienced before. So, I think that is the single largest driver of how I would view our 2017 plan other than like I said earlier the dynamics with customers that we hope to do business with.

Okay. And also, can you update us on the promotional environment, just given recent competition across the grocery space, I'm curious what you're seeing in terms of trade spend or list price reductions for a lot of the center store and also perishable products. And can you also talk about just the impact on your business of things like forward buying and then pricing with your customers?

Yeah Zach, I'll take it and cut at that. So, we've been seeing headwinds year-over-year from reduced consumer promotion activity. It was stronger headwind in Q1 and Q2 and then, as we talked about last quarter, we were seeing headwinds in Q3 year-over-year, but it had moderated some in Q3. As we go to Q4, we've still got year-over-year headwinds, but they have moderated some versus the first half of the year. So, that continuation is there. On the forward buying side, as Sean pointed out earlier, we do better on forward buying in times of inflation, because there are more instances of price advances, which allow us to take advantage of a forward buy at a lower price and own that inventory at the lower price while the price advance was into place. So, an inflation numbers and aggregation of thousands of instances of price increase or decrease, and of course, when we are flat, we just have less instances of increase that we can take advantage of.

So, just to confirm, so in periods of deflation, I mean, if you are holding that, that inventory that you buy too long, I mean, is it possible that you take a loss when you sell it through?

Well, I don't know about taking losses when you sell it through, but the reverse certainly does happen in a deflationary time. The good news for us is, as we pointed out that deflation is happening across our fresh business and that's a business that we don't hold inventory for nearly as long, so the impact is minimized as a result.

Got it. Thanks so much. Appreciate the color.

Okay.

Thank you. I have time for one last question. Our last question comes from Robby Ohmes from Bank of America.

Hey, guys. Thanks for taking my question. I guess, Mike, I wanted to just clarify the 7% to 8% from already announced acquisitions, sorry the 7% to 8% from acquisitions, is that the already announced or for fiscal 2017, does that include other acquisitions that you haven't announced?

Thanks, Robby for asking the question and for the clarification. Yeah. It does not include any acquisitions that have not been announced. So, it is the continuation of the acquisitions we made in fiscal 2016, and it does also include the addition of Gourmet Guru which was acquired in – after the end of the fiscal year and early in our Q1.

Got it. That's helpful. And just one other quick follow-up. The fuel surcharges outlook, so just – so I just want to clarify. So, your diesel costs were up, but the national is down, so are fuels you're not getting any benefit from fuel surcharges at this point in time, is that right?

Yeah. It's – you have to look at quarter-over-quarter versus year-over-year. Clearly, the year-over-year we're seeing – we've lost quite a bit of surcharge. Quarter-over-quarter, the fuel prices actually went up quite a bit, market price was up 23%. So, quarter-over-quarter, quarter four over quarter three, while surcharges haven't kicked in, we certainly were paying a higher price and so, it's a little bit different when you compare year-over-year versus quarter-over-quarter. As you look forward, we're not in the business of forecasting oil or diesel prices. So, we use market expectation in our plan.

Got it. That's very helpful. Thanks so much.

You're welcome.

Thank you.

Thanks again for joining us this afternoon. We're focused on fiscal 2017. We look forward to discussing our first quarter results later with - later this year. Thank you for your continued interest in UNFI and have a great day.

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