Good afternoon. My name is Cheryl, and will be your conference operator today. At this time, I would like to welcome everyone to the United Natural Foods Inc. Fourth Quarter Fiscal Year 2018 Results Conference Call. [Operator Instructions] Thank you. Faten Freiha, Director of Investor Relations, you may begin your conference.

Thank you, Cheryl. Good evening, everyone. Thank you for joining us on United Natural Foods fourth quarter fiscal 2018 earnings conference call. By now, you should have received a copy of the earnings release issued this afternoon. In addition, management will be periodically referring to a slide presentation related to the pending SUPERVALU acquisition during prepared remarks. The press release, the webcast of today's call, and the presentation related to the pending SUPERVALU acquisition are available under the Investors section of the company's website at www.unfi.com under investors tab. Joining me for today's call are Steve Spinner, our Chairman and Chief Executive Officer; Sean Griffin, the designated CEO of SUPERVALU once the deal closes, and Head of Integration; Mike Zechmeister, our Chief Financial Officer; and Chris Testa, President of UNFI. Steve and Mike will provide a business update and speak about our performance in the quarter, outlook for the fiscal year 2019, as well as provide additional information on the pending SUPERVALU acquisition. Sean will provide an update on the integration plans related to SUPERVALU. We'll take your questions after management's prepared remarks conclude. Before we begin, I'd like to remind everyone that comments made by management during today's call may contain forward-looking statements. These forward-looking statements include plans, expectations, estimates, and projections that might involve significant risks and uncertainties. These risks are discussed in the company's earnings release and SEC filings. Actual results may differ materially from the results discussed in these forward-looking statements. And lastly, I'd like to point out that during today's call, management will refer to certain non-GAAP financial measures. Reconciliations to the most comparable GAAP financial measures are included in the schedules on our press release and on the Investors section of the company's website under the Events tab. I'll now turn the call over to Steve.

Thank you, Faten. Good evening, everyone, and thank you for joining our call tonight. Before we begin, I'd just like to take a second and thank our associates, our customers, and our stakeholders in the Carolinas who have been affected by Hurricane Florence. We're monitoring the situation very closely, both for them and anyone else affected by the storm, and we're thankful to report that at the two distribution centers in the region, we did not have any building damage, product loss, or injury to our associates. Today, I'm going to start with a few comments on the fourth quarter and full-year. Mike will give you more color on results, and then we'll spend some time on SUPERVALU. As noted in our release, and as Faten mentioned, we have posted a presentation to help with today's discussion on the pending SUPERVALU acquisition. We are really excited about this transformative transaction to create a new and stronger business as a leading and premier food wholesaler with significant scale, reach, and choices for customer’s existing and new. Sean will provide an update on integration planning, and then Mike will talk about year-one performance, leverage, and capital allocation plans. While our prepared remarks are a little longer than usual, we will be sure to answer all of your questions. We'll build on all of this information with a deeper operational and financial review of the combined company when we hold our Investor Day on Wednesday, January 16 in Orlando, Florida. Turning to Q4 and full-year results. We continue to see strong growth in our supernatural channel. Supermarkets grew 4% for fiscal year 2018. However, growth slowed in the fourth quarter to 1.1%. While we have maintained our customer base, we did experience store closures, brand loss to captive distribution, and a continued hyper-competitive…

Thank you, Steve. Good evening, everyone, and thank you for joining us. On tonight's call, I will speak to our fourth quarter performance, provide some additional details on the pending SUPERVALU acquisition, and related capital allocation plans, leverage, and year-one financial expectations. I'll also provide a perspective on UNFI's outlook for fiscal 2019, excluding SUPERVALU. Starting with our fiscal 2018 fourth quarter results. Net sales were $2.59 billion, an increase of 10.7%, or approximately $251 million, compared to Q4 last year. In the fourth quarter, we continued to experience modest inflation of approximately 27 basis points, which was slightly higher than last quarter's inflation of 23 basis points. This marks the ninth consecutive quarter of either modest deflation or near-zero inflation, compared to our 10-year average of 2.1%. Given that our customer contracts are predominantly cost plus a percentage markup, the lack of historic levels of inflation continue to be a headwind to our EBITDA dollar growth. From a channel perspective, fourth quarter supernatural channel net sales accelerated to 27.5% over Q4 last year and represented 37.9% of total net sales during the quarter. Supermarket channel net sales increased a modest 1.1% versus last year and landed at 27.3% of total net sales for the quarter. The independent channel net sales grew at 5.7% over the prior year, and independents represented approximately 25.1% of total net sales. The remainder of our business declined by approximately 1.5% versus Q4 last year, primarily as a result of the divestiture of Earth Origins' retail business. On July 15, we closed on the divestiture of our 8 remaining natural food retail stores that operate under the Earth Origins market banner. Let me also comment on our food service and e-commerce channels, which have historically been included in our other channel results. Our food service…

Thanks, Mike. Turning to SUPERVALU. Our operating environment continues to evolve rapidly, and we believe that the acquisition will better help us meet the growing needs of our customers. By expanding our product offerings and leveraging our cost base, we will be able to add additional scale, which will enable us to grow and deliver value for our shareholders. Combined, UNFI and SUPERVALU, we believe to be the premier US food wholesaler. We will have, after the combination, over 60 distribution centers, 250,000 SKUs, and more than 5,700 private label brands. We will be providing high-demand products and value-added services to over 45,000 customers, including in-store and general administrative back-of-the-house programs to retailers. With over $3 billion in fresh produce and protein sales across the country, in addition to our center store expertise, we will have built out our store offering, enabling all of our combined customers access to the widest variety of products in an economically attractive way. We are focused on helping our retail customers across all channels, with broader product offerings and with merchandising, data analysis, and category management. On a combined basis, we expect UNFI and SUPERVALU to achieve greater scale, which we will put to work to further build out the store to both new and existing customers. Let's now turn to our synergy projections. I want to emphasize for you what we expect and how we expect to get there. Based on our current assessment, we believe we can achieve cost synergies of more than $175 million by year-three. In addition, we are expecting additional sales and other related synergies, which we will discuss in more detail during our Investor Day, and once we've had more time to fully understand the opportunities. If you turn to the presentation on our website, I'll walk through…

Terrific. Thank you, Steve. Good evening, everyone. Welcome to the call. Yes, we've been hard at work on SUPERVALU integration planning, and we feel really good about the progress that we've made so far. As Steve has noted, we have retained PwC as advisors through our integration planning, and we have developed a very solid plan. As is referenced in Slide 9 of the deck on integration planning, we have assembled a strong team of associates, leading various functional workstreams from both the UNFI and SUPERVALU organizations. These teams and functional workstreams are now moving through the process of discovery to evaluate the current UNFI and SUPERVALU operations. Our mission is to run the combined businesses successfully, beginning on day 1, and to accelerate momentum through the first 100 days post-close. We believe that there are many opportunities to benefit from, even on day 1. Not limited to, but by example only, indirect spend. Indirect spend is the procurement of non-saleable, non-inventory goods and services, such as fleet, material handling equipment, IT services, and any third-party suppliers or supplies. The opportunity to aggregate the purchasing strength of both companies to lower costs is significant, and only an example of the upside. We are adhering to an integration timeline and building specific milestones along the way to maintain control and governance with clear accountability for our first 100 days and then forward. Our integration team is fully staffed with experienced subject-matter experts with appropriate advisory resources to manage the integration timeline, and most importantly, the expected deliverables. Let me take a look at some specific areas of opportunity. Steve talked about certainly rationalizing duplicative SG&A costs. Think about the additional assets in scale, and optimizing the combined company's inbound and outbound transportation expense. Now with 60 distribution centers, we will need…

Thanks, Sean. I'm going to go back to the deck, and we're going to start back up again on Page 7 of the presentation, where we outline our expectations on the buckets of synergies, our targets and expected one-time costs. We've broken them into two primary categories: operational and overhead. You can see that we've set a reasonable expectation of the time to achieve the synergies, with 25% in year-one, 65% in year-two, 95% by year-three, and 100% by year-four. For one-time costs, we expect to incur the bulk of the costs to achieve the cost synergies in the first two years, with a tail in years 3 to 5, primarily related to the integration of IT systems, as we take the best of both systems and deploy them across the combined network. One important note on Page 7 is that the synergy estimates that we're quoting are incremental to SUPERVALU's assumed synergies from the last two acquisitions that they've made primarily. Turning to Page 8, we lay out more detail around our major areas of synergy. First, overhead optimization, which accounts for approximately 66% of the synergy. The largest opportunity is streamlining and removing duplicative SG&A costs, followed by rationalizing contracts, and consolidating IT spend, which has both an operating and a CapEx benefit. The secondary of synergy representing 34% of the target is related to operational efficiencies. As you saw from the map on Page 7, our expanded distribution network as a result of this combination provides opportunities to use excess capacity by relocating third-party inventory to our distribution centers. We will streamline our DCs by consolidating in markets where we overlap, reducing the direct costs of the DCs, and also by allowing us to optimize transportation costs, and increase distribution center productivity. The last area of synergy…

Thank you, Steve. As you have heard from Steve and Sean, the acquisition is strategically compelling and positions us well for future growth and value creation. Now, I'd like to touch on the information included on Slides 11 through 13, and cover year-one expectations for the combined companies, including capital allocation plans, debt structure, and leverage. In the first full-year after the acquisition closes, we expect combined company net sales, excluding retail and discontinued operations, to be approximately $24.2 billion to $24.8 billion. Year-one adjusted EBITDA is expected to be $655 million to $675 million, excluding retail, one-time deal and integration-related expenses. In addition, we expect a low double-digit percentage increase in adjusted EPS versus our fiscal 2019 guidance, excluding one-time costs and the impact of purchase accounting. After year-one, we continue to expect double-digit adjusted EPS growth, excluding retail one-time costs, and the impact of purchase price accounting. As Steve noted, we'll be giving you more detail on our long-term expectations at our Investor Day in Orlando on January 16. Cost synergies are the primary value driver in this transaction. As we move forward, we are focused on a successful integration and delivering these cost synergies. As Steve mentioned, we are expecting to achieve more than $175 million in cost synergies in year-three, and achieve our run rate cost synergies of more than $185 million in year-four. These assumptions exclude growth synergies and are in addition to the synergies expected from SUPERVALU's acquisitions of AG Florida and Unified Grocers. As we have continued our confirmatory diligence process, we are increasingly confident in delivering these synergy assumptions. While we are not depending on growth synergies to be a large driver of value in this deal, we continue to believe that there are significant opportunities as we have outlined. Once the…

Thanks, Mike. Before I wrap up, I do want to acknowledge and thank our UNFI associates who have worked around the clock throughout 2018 to keep up with our very high growth rate. From drivers to warehouse associates and logistics teams to operations management. These are the associates who exhibited leadership, poise, and dedication throughout this time. I would also like to thank all of our associates and SUPERVALU associates who are working on the integration planning. I'm very proud of our people. UNFI associates and our management team have continuously demonstrated their dedication throughout this period and have worked tirelessly to provide exceptional service in a dynamic, changing retail environment. Their work is exceptional. In summary, we believe this is an exciting time for UNFI. Our industry is evolving, and we are changing with it to meet the needs of our customers, and grow together. Scale, supply chain, and people are what differentiate distribution options. Together they're poised to help retailers drive down costs and increase consumer traffic. Consumer demand for the products we sell is robust, and we have a strong pipeline of exciting opportunities ahead. We believe our combination with SUPERVALU, demonstrated leadership within better-for-you distribution, will provide long-term growth opportunities and enable us to achieve our goals and long-term objectives. At this point, I'll turn the call over to the operator to begin the question-and-answer session.

[Operator Instructions] Our first question comes from the line of Edward Kelly of Wells Fargo. Please go ahead. Your line is open.

Hi, good afternoon, guys. I wanted to start off on SUPERVALU. Can you talk about the biggest challenges associated with integrating these businesses, given the diverse SKU base? How much change operationally is going to be required to capture synergies? How much risk is there within the integration? And how do you mitigate that to the best of your ability?

I'll start it off first, Ed. We have hired PwC, which we mentioned in our commentary. And PwC has a terrific and very disciplined plan for developing the strategies for bringing the two companies together, identifying the synergies, balancing the risk, and putting us in a place where we can really win. We can do it right. We can be consistent with our culture. But we can run the plan and run it in a way that balances the risk associated with capturing the synergies. Sean?

Yes. Ed, the way that I see it in terms of having spent a lot of time looking at the diligence and now that we're in the planning stage, we feel really good about where – let's call them the buckets of opportunity lie. I would say that we were cautious in thinking about the phasing. So, the timing of the synergies really is frankly what we need to deliver on. That's what we need to focus on. We know where those opportunities lie. We know what the SG&A looks like. We know what our plan looks like in terms of having 60 distribution centers, and what the best path forward is in terms of optimization. We took an approach where we're only looking at 25% in year-one, 65% in year-two, and then 95% in year-three. The short answer is timing.

Yeah, I would also add that if you were to ask me that question a month or so ago, I would've said I would've been a little more worried about retail, given that it's just not something that we're particularly – we don't have a competency in retail. But now that we've gotten a chance to really get into it, look under the covers, meet some of the SUPERVALU people who are really tasked with divesting these assets, and certainly consistent with the announcement earlier this week on the sale to Schnuck's, I'd say I feel much better about our ability to divest ourselves of retail in a really reasonable and economic timeframe.

And then just a follow-up, Steve. Taking a step back and strategically thinking about the acquisition and what it says about how you're thinking about the business. You're increasing your exposure to independent and regional supermarkets, decreasing exposure to the higher growth to lower margin Whole Foods business. I guess what does the merger say about the Whole Foods contract long-term, the optimal mix of this business over time? Is it as simple as just putting these two businesses together, getting the synergies, and that's our margin? Or is it more complicated than that?

I would answer a couple ways. Retail world is shifting and changing. There has to be consolidation. And I think my view is, I wanted to be at the front end of it, as opposed to the back end of it, number one. Number 2, scale is what drives the day in distribution. Scale drives the day. Having big distribution centers where you run a lot of volume through them gives us the ability to lower costs, be more efficient, higher service to the customer, closer to the customer, and quite frankly, scale is, like I said, is what drives the day. We have to be bigger, we have to be closer to the consumer, and we have to drive more volume through our DCs.

I would just add that no one is suggesting that it's not complex, that this proposition is simple to execute, right. However, when we think about the grocery retail environment, the four walls of a retailer, this combination puts us in a position where we can win in every department in a retail store, retail grocery store. And then beyond, there are some very interesting and compelling service offerings in the SUPERVALU arsenal today. That when we think about UNFI's independent customer base, there's a lot of value in the back-office, transactional, financial transactional, payroll services that our independent customers don't have the scale to win those services at a low cost. And so, we have a lot of opportunity to have a great deal of traction and stickiness with a much broader customer base.

Specific to your question about independent supermarkets, one of the things the independent supermarkets desperately need is far greater access to the items that UNFI is particularly good at. So, there's a tremendous amount of selling synergy associated with selling our products into the existing SUPERVALU customer base.

Great. Thanks, guys.

Your next question from the line of John Heinbockel of Guggenheim Securities. Please go ahead. Your line is open.

Steve, if you look at your core business and SUPERVALU, take out synergy on their side, the profitability has been under pressure, right? For a little while now. How much of that do you think is transitory freight-related, getting your arms around demand? How much more secular when you think about mix? Then the secular piece, what do you think both you and they need to do to stabilize profitability in the core business?

Let me try the last one first. So, obviously – I think you asked me without synergies, but obviously one of the primaries is synergy in commercial terms. Bringing companies together and taking a look at commercial terms and making sure we're getting the best of both. Indirect procurement is just a really significant synergy in acquiring fleet, material handling equipment, inbound freight, and so on and so forth. And then there are things that we do really well that they don't. And there are things that they do really well that we don't. So, in the short-term, that's the low-hanging fruit that we really need to get our hands around. As it relates specifically to freight, for us, because obviously I can speak a lot more competently about our view on freight, as opposed to their view on freight, is we were just slow or slower than we thought we would be in passing through, number one, the fairly significant increases in the inbound cost. And two, I think we underestimated the rate of increased freight costs that we incurred in the quarter, and as a result, didn't pass through. So, I think it's a timing issue. We just got caught behind the 8-ball a little bit. I feel pretty good it's not going to happen again.

I'd just add, John that, UNFI's model in terms of inbound freight, we have greater exposure to the volatility of the market. We've managed approximately 40% of the inbound tons. SUPERVALU has a different model. It's obviously more CPG, more conventional. It is more supplier delivered. So, when things are attractive in the market, the exposure that UNFI has to this model is beneficial to our gross margin. What we saw in Q3, now into Q4, of course, is the reverse. We missed it. We missed the rising costs. We certainly had a plan to phase in the freight increases, and we did. They just didn't get there against the costs. Now, the good news is that we are beginning to see that now print in the early innings of opening up our FY 2019.

Okay, then maybe secondly, you talked about consolidating DC capacity. In order of magnitude, what are you thinking about in terms of maybe square footage? And then one of the problems for both of you was capacity to handle the growth. Do you sort of run the risk if you shut down some of that capacity, that you need it for growth? Or maybe you just think it's in the wrong places? What's your thought on that?

On the first question, John, we'll give you more color about network and consolidation of DCs when we get together in January. We're not going to have a lot of detail on that yet, because that's just going to take some time to really understand. The good news, and there was some commentary on this, is we spend a lot of money on on-site storage. In other words, we don't have the capacity in the DCs. So, we're forced to either store products in trailers that are really inefficient, or we have to rent space at public warehouses and transport it back to our DCs on a daily basis; really inefficient, really expensive. So, right out of the gate, we're going to get out of public storage wherever we can, and we're going to get out of trailers wherever we can, and that's a huge win. We also have a couple of markets in the U.S. that we're at capacity. So, when a customer says, we'd love you to do some additional service, distribution, our answer unfortunately has to be you're going to have to hold until we have some capacity within that market. And with the addition of the new DCs, we no longer have that issue.

Thank you.

Your next question from the line of Karen Short of Barclays. Please go ahead. Your line is open.

Hi, thanks. A couple questions just on guidance. I realize it may be irrelevant shortly once this closes, but it seems to me that at the midpoint of guidance, your EBIT margins are really only slightly contracting. I know you talked to some puts and takes, but that just seems very optimistic. I guess I ask it in the context partly of freight, because last year when we had the hurricanes, that was the start of freight issues. It kept getting worse, even well beyond the hurricane impact. So, could you talk to that? Then I had another question on the acquisition. Thanks.

I'll take the freight, and then, Mike, you can take the margin. For us, the freight issue is an inbound issue. We move a decent amount of the inbound freight on our own trucks. A little less than 50%. About 40-some-odd-percent we move on our own fleet. The rest we do through contract labor. Again, on the outbound to the customer, we're fairly hedged there because we have fuel surcharges that cover those increases. On the inbound side, it's more a timing issue than anything else, Karen. When we get the increases, we pass them through. Unfortunately, it takes one or two quarters to do that. The rate of increase in Q4 was far greater than we thought it would be, but we expect that to come back.

Just to add to those comments, Karen. The margin dilutes a little bit in fiscal 2019 in the guidance, as you suggest. But the story really is that inbound freight piece that we talked about. That's the improvement that we'll see going forward, and as we alluded to, we're already seeing some of that benefit come in.

Okay. On your our actual e-commerce slowdown, could you maybe just quantify what the impact of rationalizing the e-commerce customer was on the growth rate? And then I did have one question on the acquisition.

It wasn't any one particular e-commerce customer. So, if you remember, a couple years ago, we went through a very careful analysis in our food service business. We took a look at those customers here we could no longer deliver or we could no longer serve. We either increased the price or we dropped out of delivery because we just couldn't make it work. Quite frankly, we hadn't done that on e-commerce, and we did that in this particular quarter. So, I think it is more timing than anything else.

Just also, well, also just an incredibly dynamic environment with eCommerce; with huge swings up and huge swings down. Remember, it's 3% or less of our business. As far as our own eCommerce operations on Honest Green, we continue to invest in that. We saw triple-digit growth in Honest Green and that is when we're doing fulfillment on behalf of the customers with our own e-commerce operation. It's continuing to grow.

Yeah, I think it is more timing than anything else.

Okay. I get it that scale is what matters in distribution, but you talked to larger drop sizes, and I guess what I'm confused about is why would you end up with larger drop sizes just because you have scale when you don't have really any overlapping customer base between the two assets?

It's really a matter of if you think of not today, but in the next couple of years, the DCs are going to be blended. So, DCs will likely be split by fast-moving and slow-moving. So, we will be delivering a very broad mix of SKUs to our customers. So, if they buy protein, produce, center store, frozen, refrigerated, dairy, it's all going to come on one truck.

Okay, that makes sense. Thanks.

Your next question from the line of Scott Mushkin of Wolfe Research. Please go ahead. Your line is open.

Good evening, everyone. This is Mike Otway in for Scott. I appreciate you taking the questions. I guess first on the supermarket side, the business slowed in the fourth quarter. Steve, you gave a few highlights as to what transpired Any other color there? What are you guys anticipating for next year? Are you anticipating a pick-up in that business?

Yes, I mean, what I talked about is that the quarter, again, a little bit of timing. Again, we did have some store closures. Not business we lost, it's just existing customers closed stores. Not as many store openings that we’ve thought, obviously. Again, we have this dynamic of as SKUs start moving faster, they go to captive where a captive is available. But again, that's more timing than anything else. We're not really in a position to provide any color around guidance and conventional for next year, but remember, SUPERVALU's largest customer group is independent supermarkets. One of the things the independent supermarkets need the most are the products that we have. So, one of the greatest certainly growth opportunities outside of the cost synergies are associated with us selling our existing better-for-you products into SUPERVALU's existing independent supermarket customer base.

I would just say that to recognize that we did have a deceleration in the supermarket channel in the quarter. On a full-year basis, we actually did pretty well in the supermarket channel and met our own internal expectations at about 4%.

Got it. Thank you, both, for that. I guess Mike, a quick clarification question in terms of pro forma accretion. I think in the slide deck that you guys had following the deal announcement, it was just accretion in year one, and it looks like it's low double-digit accretion. It looks like that has improved. Am I right in that? If so, what's driving the improvement there?

Yeah, we just wanted to provide a little more clarity on what that was. We had said significant the last time we were out. Now we're saying low double-digit EPS accretion on an adjusted basis, excluding the one-time cost and purchase price accounting over the fiscal 2019 guidance that we just provided for EPS.

Got it. Has it improved a little bit or is it about the same, it's just language?

Yeah, it's very similar to what we were looking at before.

Got it. Thank you.

Your next question from the line of Kelly Bania of BMO Capital Markets. Please go ahead. Your line is open.

Hi, thanks for taking the questions. I wanted to just ask about the guidance for sales next year. I think what you're saying on a 52-week basis is about 6.5% to 8.5% growth. I guess just a decent moderation from this year. So, was curious if you could explain why and what you're expecting to moderate? And if there's any color you can provide on mix, which sounds like it continues to be a surprise with your largest customer and how we should think about what kind of mix is embedded in your guidance for next year?

Kelly, this is Mike. Thanks for the question. First of all, the 52-week comparable guidance is 6.5% to 8.4% growth. As you know, we've got a 53rd week next year, so that makes the growth 8.6% to 10.5%, due to the comparable 53rd week. In terms of that compared to the 10.3% growth we had here in fiscal 2018, you have to remember for our largest customer, we're lapping a variety of new product categories that we brought into that customer as we built out the store there. So that mitigates a little bit of that growth trend that we saw.

Okay. And so, any other color on the mix that is embedded in your guidance for the year?

No. Like I said, we continue to expect our largest customer to have a strong growth rate, but not as strong as what we saw in fiscal 2018.

Okay. I guess another question on SUPERVALU, as you talked at the customers, you talked about pretty minimal cross-over, but are SUPERVALU’s customers using a different natural and organic supplier or are they not using a natural and organic supplier at all? I'm just wonderful where the opportunity could come from if they're already under certain contracts, or if it would be a new relationship for those customers?

It's going to be really different by geography, by customer. There are some customers that I think just have a very limited selection of the items that we sell, for whatever reason. I think we can really help those customers have a much broader product offering to place in the stores. That's what we do really well. I think a lot of this customer-level detail, we're going to have to get into in a much bigger way once we close. I think our plan would be to share a lot more of the detail around the growth opportunities with you in January at the Investor Day.

Just to add to Steve's comments, there's efficiency here too to consider. Today, for our kind of products to make it to those customers, they may have to do it through a cross-dock operation or a less efficient manner to get to the customer at the end. It's one of the opportunities here. Either if it is some of the same SKUs, that we can get it done more efficiently.

It's a broader portfolio of offering that this particular broad customer base may not have access to.

Again, I think the reason that scale wins here is today, the more a retailer, conventional retailer in particular, can buy from a singular source, the better it's going to be for them. It just drives down their cost overall. It reduces pressure in the back of the store to receive more and more invoices. And so, certainly, the message we're hearing from customers and the pressure that we're hearing from customers is please, tell me more of the store. Whether it be conventional, whether it be produce or protein. I need to aggregate my purchases. Less trucks, more scale, lower cost.

Okay, that's helpful. Maybe just one more for Sean. You'll be leading this integration here and a couple months ago we thought you were retiring. Just curious how long are you committed to the 3-or-4-year period to kind of see this through completion?

We haven't specifically talked about commitment, but I'm in it to get the job done, Kelly.

Okay, thank you.

Your next question from the line of Paul Trussell of Deutsche Bank. Please go ahead. Your line is open.

Good afternoon. Just when we look at year-one, could you talk about the synergy breakdown between overhead and operational cost savings? And how should we think about year-one CapEx? And just overall, if you can talk about your philosophy around cash and investing, making capital investments, versus paying down debt, and ultimately what's the timeline to get to that leveraged target of 2 to 2.5.

Let me take the first part of that question, if I may. So, when we're talking about year-one, when we think about it this way, it's quick wins. I actually unpacked one earlier around indirect spend. We have a significant addressable spend. Half a billion dollars in addressable spend. That in aggregation with SUPERVALU delivers a lot of strength in terms of negotiation with goods, services, etc. And you're talking about an impact that has nothing to do with customer-facing transactions. It's something that happens in the background and can be delivered early. It's that type of a synergy that lines up in our year-one bucket. Some of the other synergies around optimization around our distribution center network, efficiencies around streamlining technology systems; those obviously have a longer lead time and would generally be looking at year-two, year-three or beyond.

And Paul, to your other question about CapEx spend and leverage, let me make a few comments. So, first of all, in our UNFI guidance, we talked about spending 1.5% to 1.7% of sales. That's really driven by some capacity expansion projects that we feel very good about with or without the SUPERVALU acquisition. So, we'll continue with those. Generally speaking, we will look at investments on a risk-adjusted return basis and go after the best opportunities first. This is part of our integration planning. It's part of the workstreams. It's part of making sure we get to the biggest synergy buckets first. The business has the ability to spin off a lot of free cash flow. I can speak for the management team here. We are a team that is comfortable at operating at low leverage. We just completed fiscal 2018 with leverage of 1.15x. Our long-term target, as you pointed out, is 2.0 to 2.5. So, as we come out of the gates with SUPERVALU, we talked about our leverage at 4.7. We're very interested in getting that down. That's the discipline that we'll talk about getting back to an area that we're more comfortable with. As a result, we will forego near-term M&A opportunities. We will forego share repurchase in order to prioritize paying down the debt to get after our leverage target. We don't offer a dividend. We didn't start that up. This is to get after that leverage. So, we'll work that down and we'll try to get back down into that target leverage range as quick as possible, but it won't come in the first couple of years. It will take us a little longer to get there.

Appreciate the color. Just to circle back to gross margin. I apologize if I missed it. Did you specify or quantify how much of the contraction year-over-year was related to the shift in customer mix versus what was the impact from the inbound freight cost?

Yeah, that's a good question, Paul. Think about it this way. Think about for the Q4 impact, two-thirds of its customer mix and a third of it the inbound freight headwind.

Got it. That's helpful. Thank you and best of luck.

Your next question comes from the line of Vincent Sinisi of Morgan Stanley. Please go ahead. Your line is open.

Great, good evening, guys. Thanks very much for taking my question. I wanted to ask, I know you said, obviously in the process of over the next few months seeing about the consolidation of the distribution, but just wondering if you could provide any additional thoughts of is it where two are located closely with one another, you just have to make sure you don't close too much, turning to capacity constraints? Or between the two companies, given the mix differences, is there a meaningful difference in the facilities themselves? I guess said another way, whatever you ultimately end up doing, do you think there will be a meaningful amount of capital that will have to be put into the facilities themselves?

Hi, Vincent. This is Sean. So, first of all, I really don't want to go any further as it relates to identifying any region or geography around optimization. I don't think that's fair. I don't want to get into that. As it relates to the distribution centers themselves, and the characteristics, if you will, of the distribution centers, we certainly know that SUPERVALU's business model is quite different than UNFI and their portfolio is quite different than UNFI. But the actual four walls of the warehouses themselves resemble each other. They're multi-temp. These products, if we think about a distribution center, and frankly, this is the way we're thinking about it, are mixing centers. And what product itself sits within that distribution center, whether it's a conventional food product or an organic food product, assuring that the handling protocols are appropriate, it's a mixing center. So, the utilization of the existing footprint of distribution centers will play to a benefit in terms of our long-term strategy. It will not be a hindrance. And we don't expect that there are significant capital expenditures related to any kind of retro-fitting type of necessity, if you will.

Okay, all right. That's helpful. Then as a quick follow-up, with the retail banners that are left, of course, as you mentioned, not the main focus, we'll divest them. But maybe just looking back at some of the banners that have already been divested, what's been the success rate or how much of those sales have been retained to still be customers of yours? And is that a focus of the ones that are still to be divested?

So, I think, if I understand your question correctly, how important is maintaining a supply agreement with the potential buyer. That, again is going to be different by banner. So, in the locations where we desperately need the capacity, we will be more willing to separate the supply agreement from the sale of the asset. In the locations where we don't necessarily need the capacity, or in locations where it makes sense, then we would be more disciplined around making sure that a supply agreement is attached to the sale. But I would tell you, based upon certainly my initial view, we're going to have a great deal of success here. There's a lot of demand for the services that SUPERVALU and UNFI provide. We know the markets where we need the capacity, and we're willing to separate the supply agreements. We've done a fair amount of work here. SUPERVALU continues to do incredible work here. To a large degree, my hat is off to them for leading the way as we get close to the close. Again, I have a great deal of confidence that we're going to end up in a good place.

Fair enough, Steve. Thanks, guys. Good luck.

Alright, thank you.

Your next question from the line of Rupesh Parikh of Oppenheimer. Please go ahead. Your line is open.

Good evening, and thanks for taking my questions. First, on the supernatural growth that again accelerated this quarter, is there any more color you can provide on what the contribution is from new categories versus comp growth? Or just anything to help us think about that growth rate?

Again, Rupesh, we talked about lapping some of the new category growth and that's embedded in our guidance for next year. That's probably a pretty good proxy for what the number looks like.

Okay, great. Then, Mike, on EBITDA margins, there's been a number of questions on gross margins. I'm just curious, the comment was that you expect moderating EBITDA margin declines, I believe, for this upcoming fiscal year. I was just curious if you could help us at a high level understand the different puts and takes that helped to drive that improvement. I'm also wondering whether the accounting change has any impact on next year's margin performance?

Yeah, Rupesh, let me break it down a little bit for you there. So, we've talked about customer mix; made comments about how that looks a little bit going forward. We talked about inbound freight, and that headwind actually dissipates, and turns into increased product cost, which actually helps grow our dollars. So, that turns into a favorable, barring any additional rate increases it does. On the OpEx side, we've had some inefficiencies. Steve referenced it with respect to labor at our DCs. And we would anticipate improving upon performance versus fiscal 2018 in that regard. And then another part of your question was on the change in estimate. Let me just spend a little bit of time on that one. Simply put, the change in estimate that we recorded in Q3 did not have a material impact on our Q4 results. Now, it's important to understand that that $20.9 million impact was contained in fiscal 2018 within the fiscal year, and specifically within Q1, Q2, and Q3. And so, the year-to-date gross margin through Q3 captured the impact. As we look forward, all else being equal, the change in estimate has no ongoing impact to our results. However, as you compare the fiscal 2019 results in Q1, Q2, and Q3 to our fiscal 2018 results, so the year-over-year impact, you will see an impact. And more specifically, we would expect a small year-over-year tailwind COGS in Q1 of fiscal 2019, a larger year-over-year tailwind in Q2 of fiscal 2019, and then a larger yet year-over-year headwind in Q3 of fiscal 2019. So, it's really that comparison back to prior year, because the impact of the 20.9 was not spread evenly from Q1 to Q3, but was more heavily weighted toward Q3, when the change in estimate was booked in Q3. I would also say, if you want additional information, I would refer you to our investor website. On June 19, we posted a presentation there, and on Slide 19 of that presentation, you'll see more detailed perspective on the impact of the change in estimate.

Okay, great. Then if I could slip in one more question. The higher cost synergy targets, what buckets – or I guess if you could give more color in terms of what's driving those higher estimates?

More visibility. Confirmatory visibility.

Okay, great. Thank you.

Your next question from the line of Bill Kirk of RBC Capital Markets. Please go ahead. Your line is open.

Hi, thank you for taking the question. I guess this one's for Mike. If I understand it right, the adjusted pro forma EBITDA guidance of $6.65 to $6.75 does not include what would have been a positive combination from SUPERVALU's retail division. Is that correct?

Yeah, there are, as you know, there's a variety of puts and takes with respect to their EBITDA. Just covering them more broadly, as you go from the fiscal 2018 adjusted EBITDA from UNFI and SUPERVALU and you put them together, you've got some tailwinds, in that you have growth in EBITDA from both UNFI and SUPERVALU. You've got the full-year impact of AG Florida and Unified Grocers and the related synergies, and then you've got the deal synergies that we would also expect in year-one. And then in terms of the headwinds that you have to adjust for, you've got the winding down of the Albertsons TSA agreement; you've got the new expenses related to their more recent sale leaseback projects, and some of the stranded retail costs as a result of divestitures; and then there are also the potential for other adjustments depending on how we account for things like post-employment benefits related to pension.

Okay. So, in $6.55 to $6.75, there's no expectation of profitability at SUPERVALU retail? There's no EBITDA from SUPERVALU retail in that number?

Right. That's ex-retail and ex-discontinued operations.

Okay, got it. Then does that mean that the adjusted EPS accretion, does that exclude what would have probably been a negative EBIT contribution from SUPERVALU retail because they were losing money on an EBIT level? So, does the accretion exclude that negative impact of SUPERVALU retail?

It is excluding retail and discontinued operations. And without getting into the details of the accounting, when the retail banners get moved into discontinued operations, there is an impact on the underlying wholesale business profitability. Then when and if the retail banners are sold, there's another impact to the underlying wholesale business. So, we've tried to account for that. When we say excluding the impact of retail, we're taking the wholesale business as it stands, and making the adjustments that I referenced.

Thank you. And then one more on the pro forma leverage, the 4.7. In that calculation, does that include SUPERVALU's multi-employer pension responsibilities that were off balance sheet for them?

Yeah, the 4.7 includes everything. Again, I would refer you to Slide 13 of the deck, where we give you the calculation of the 4.7.

Okay, thank you.

Your next question from the line of Marisa Sullivan of Bank of America Merrill Lynch. Please go ahead. Your line is open.

Hi, good evening. Thanks for taking my question. I think you expect the acquisition to close at the end of this calendar year, so kind of midway through fiscal 2019. How should we think about the accretion or dilution in let's call it year-zero, if year-one starts in fiscal 2020? Is that the right way to think about the year-one being fiscal 2020?

Marissa, let me take that. What we said is, we expect the deal to close in the fourth quarter of this calendar year. What we provided in terms of guidance was our year-one assumptions. So, I think to your point, that splits the fiscal year. So, it really depends, in terms of year -one or the fiscal year or the stub year guidance, it really depends on when the deal closes. So, that's one of the reasons why we're going to come back and talk more about it in January in Orlando, because we expect that the deal will have closed by then. Then we will be able to talk more specifically about the impact in the fiscal year because we will know when the starting point was.

Got it. That's helpful. Then if I could just switch gears to the question of freight. You're a good way through your fiscal first quarter. Have you guys seen inbound freight headwinds consistent with where they were in the fourth quarter? Have they been increasing? Just any kind of further color there would be helpful.

We've seen the inbound freight headwinds dissipate as we've started out fiscal 2019.

Got it. Thank you very much.

Your next question from the line of Ben Bienvenu of Stephens. Please go ahead. Your line is open.

Hi, thanks guys. This is actually Daniel Imbro on for Ben. Thanks for taking our questions. Just to follow up on that last question on freight costs and gross margins, I think you said, you've seen the pressures dissipate. So, is it right to assume that your guidance includes an expected dissipation in pressure or what pressure remains at similar levels?

Yeah, Daniel, let me take that one. So, barring any additional increases in freight costs, we would expect that the current freight costs, particularly the ones that we had through Q3, where we adjusted our inbound freight rates, and our suppliers have certainly experienced the cost, and we have incurred it as a result. Those get built in to our product cost. And we're a company that likes inflation. And we like inflation because our contracts are predominantly cost plus a percentage markup. So, this inbound freight headwind acts a lot like inflation, which is helpful to us once it gets built in to our cost of goods. Our issue has been that there's a lag in that getting built in of one to two quarters. That has been a significant headwind for us, but the short answer to your question is we do expect that to dissipate, and actually become favorable to our EBITDA dollar growth in fiscal 2019. Again, barring any additional increases beyond where we're at.

Great. Thanks for the color. That actually dovetails well into my next question. If we can exclude that impact from fuel, can you maybe give some high-level color on what your inflationary expectations are? We've seen PBI inflation for consumer foods kind of roll over here recently. What are you expecting for the full year with inflation?

That's a good question. As I mentioned, we've had a couple of years now where we really haven't seen inflation anywhere near our historic levels. We've seen the reports that you've seen in terms of inflation starting to come to some of the suppliers. But as we showed you in our Q4 results, it hasn't translated through to us yet. Our inflation is up a little bit, but certainly not anywhere near historic levels. We don't think that systemically there's a reason why inflation will remain low over the long term, but we also didn't build in an expectation in fiscal 2019 of inflation going back to historical levels.

We'd love to have it if it comes.

Yeah. For sure.

Okay, great. Last one for me, if I could. Just on SUPERVALU, I appreciate that you're going to share more details around the revenue synergies at the Investor Day, but it sounds like you guys have mentioned pretty significant revenue opportunities between SKUs and different services that SUPERVALU offers. High-level, can you help us frame up the size of that opportunity? I mean, do you think it's as large as a cost synergy opportunity? Is it de minimis? Somewhere in between? If you can just help us think about that opportunity at a higher level, that'd be great.

I think it would be really premature for us to get into that. Because we just can't do it until after we close. And we're really focused right now on the $175 million worth of purely cost synergies, but to the point that we've been trying to make, and I'm happy that you brought it up. We think there are significant growth opportunities. Until we close, we just really can't get into that. We’d just have to wait until we meet in January.

We're playing the long game on the growth there.

Okay. Fair enough, guys. Thanks.

Your next question from the line of Eric Larson of Buckingham Research. Please go ahead. Your line is open.

Good afternoon, everybody. Thanks for taking my question. Mine are actually pretty quick. So, in the $95 and $110 million of costs that you're going to incur for the next two years, is that all cash costs? Are there any non-cash charges in there? Is that a cash number or will that only be partially cash?

Eric, it's a good question. It's primarily cash. We're talking about higher transaction fees, integration expenses, severance, retention bonuses, these kinds of things.

Okay. So, will SUPERVALU – and obviously we don't have all the detail – will SUPERVALU be able to generate enough free cash to cover that or will it eat into legacy UNFI? How would you look at the cash cadence on that?

Once the deal closes and we're a combined company, we're financing it as a combined company, and the debt that we bring on will be over both companies. We believe that there's significant ability to generate free cash flow to cover the expenses that we're anticipating here, in particular as you move forward and realize more and more of the synergies, that certainly benefits the free cash flow as well. As we talked about, in year-one, we're talking about 25% of our run-rate synergies, and then it goes up from there, which helps us finance some of the investments that we've got.

Okay. And just one final question. This might just be a clarification. It gets back to your leverage ratio. I think it's in your prepared comments, Mike, you said that you have a goal of taking up around two turns of leverage off, I believe after the first two years, I believe. And again, I'm not sure if that was adjusted for synergies. Maybe synergies for SVU and maybe not including United Grocers or AG. I'm just not sure. But in your press release, you say that you plan to de-lever to approximately 3.2x by the end of year-three, so, I’m just, the numbers aren't kind of filtering, they're not adding to me. I'm just not sure where. Maybe I've got some of the numbers wrong.

Let me clarify that for you. I think it's pretty straightforward, but let me give it to you. So, excluding the impact of the outgoing Albertsons TSA agreement, okay so you know about the TSA agreement. If you calculate our leverage and exclude that, because we know that's going away, that gets you to a higher number. Then you're two full turns down over three years is what we're talking about here and that's how you get there.

Okay. Got it. Thank you.

Your last question comes from the line of Andrew Wolf of Loop Capital Markets. Please go ahead. Your line is open.

Thanks. I just want to comport my understanding on the quarter and the variance in gross margin to what you're saying. So, my takeaway is that the miss was mainly versus your expectations in the inbound freight, more so than the customer mix side. I just want to make sure I'm understanding that.

Andy, to clarify that, it's the other way. It's two-thirds of the gross margin miss is related to the customer mix, and a third of it is related to the inbound freight headwind. Or in other words…

I'm asking about the miss, not the contraction. I know the contraction was more from mix, but from what I'm hearing, the miss versus your guidance was more from inbound freight, but maybe I'm missing or maybe I'm wrong...

No, no. I'll give you another perspective. So, if you think the leverage that we had in our consolidated operating expenses, that leverage virtually offset all of the customer mix dilution. Okay. So, you're question, then what would be remaining is the impact of the freight, which in this particular example is the driver of the challenges that we have in the fourth quarter.

Okay. Thank you for that clarification. And I think you said, has it already reversed or is there more to come? I'm trying to get to, are you already running up EBITDA? Because at first your guidance looks like a stretch, then when you explain about the inbound freight and the big impact and the fact that it's going to come back so quick, I'm just trying to get a little more clarity.

We talked about the fact that a lot of it was timing, and it just took one to two quarters of lag to push it through. What we specifically said, is that we saw some general improvement in our freight so far this year. So, that makes us feel better that we're in a better position today than we were when we finished the fourth quarter.

I guess the way to ask the guidance question that maybe you can answer is, you're not just looking for a back-end loaded ramp in EBITDA growth, right? It may not be even each quarter, but it's going to be. It's not just two down quarters, and then two huge up quarters. It's going to be smoother than that, right?

Yeah, Andy. We would expect the year to be similar to the seasonality that we've had in the past. So, yeah, we're not expecting a back-end loaded profit.

Great. You've been asked this, but I want to make sure I understand it. It sounds like the guidance expectations for inbound freight and fuel is roughly about flat with where it is now? Pricing? That's what you've baked in?

Yeah, we didn't. If the question is, were we assuming any increase or decrease in freight, we were not.

And fuel. Because I think you said that. I just wanted to clarify that.

Yeah.

Mike, you gave a lot of leverage ratios and so on, but it sounds like you're not baking in any credit for proceeds that you're likely to get from retail, right? You're just penalizing yourself for the pro forma lost business, but not bringing down those leverage ratios? Or are you? I didn't see that anywhere.

It's not a significant impact on our assumptions, no.

Got it. Just my last question, on the low double-digit EPS accretion year-one from the SUPERVALU transaction. That is essential the synergies, right? I mean, if you're exiting the year at $45 million, and some high proportion of that is realized, is that how to think about it?

There are puts and takes there, but certainly that gets you there as well. Pretty close.

Got it. Okay. Great. Well, thank you very much.

I would now like to turn the call back over to the presenters for closing remarks.

Thanks everyone. We're really excited to lead the way forward as the SUPERVALU-UNFI combination enhances our position with customers across many of our customer channels. We look forward to sharing more strategic and detailed information with you at our Investor Day in January. This is a big, exciting, industry-leading combination and we are proud to be a part of it. We'll bring forth all the necessary resources from our Board to our leadership teams, managers, supervisors, throughout the combined companies to maximize our success. Thank you for joining us this evening, and we look forward to seeing you in January.

This concludes today's conference call. You may now disconnect.