Ladies and gentlemen, thank you for standing by and welcome to the UNFI Second Quarter Fiscal 2020 Earnings Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Steve Bloomquist, Vice President, Investor Relations. Thank you. Please go ahead, sir.

Good morning, everyone. Thank you for joining us on UNFI's second quarter fiscal 2020 earnings conference call. By now you should have received a copy of the earnings release issued earlier this morning. The press release, webcast and a supplemental slide deck are available under the Investors section of the company's website at www.unfi.com. Joining me for today's call are Steve Spinner, our Chairman and Chief Executive Officer; Sean Griffin, our Chief Operating Officer; Chris Testa, President of UNFI; John Howard, our Chief Financial Officer; and Jill Sutton, UNFI's Chief Legal Officer. Steve and John will provide a business update, after which we'll take your questions. 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. Definitions and reconciliations to the most comparable GAAP financial measures are included in our press release. I will now turn the call over to Steve.

Thank you, Steve. Good morning everyone and thanks for joining us on today's second quarter call. Earlier today, we announced results for our fiscal second quarter where, as expected, both adjusted EBITDA and adjusted EPS improved sequentially compared to the first quarter. Both would have been higher, had we not incurred $33 million or $0.44 per share in charges related to three very public customer bankruptcies in the quarter. But before we get further into the quarter, let me first comment on the ongoing COVID-19 preparedness and general business conditions. First, our supply chain teams have been exemplary in their execution during the last two weeks of increased demand operating our facilities safely while meeting material increases in demand across the network. In many cases, our teams are working around the clock, seven days a week to ensure that our retailers are providing those products most needed by very concerned consumers. At the outset of COVID-19, our category management teams identified a core group of products that would see a material lift in sales. As a result, we were well-positioned to satisfy some retailer demand, which however exceeded even our initial expectations. Second, our growth related to COVID-19 has been significant. UNFI's last two weeks of sales has resembled our prior year Thanksgiving holiday week with the difference being, we, our suppliers and our customers did not have the lead-time required to adequately prepare. While we are still understanding the long term impact of this demand, it is difficult to forecast the impact through the remainder of the year. Our response planning, food safety and business continuity toward this crisis has positioned us to serve and protect our customers, suppliers, consumers, and associates. Third, with the effects of the last two weeks on our inventory on hand and our suppliers'…

Thank you, Steve and good morning everyone. I will cover our second quarter financial performance, balance sheet, capital structure and updated outlook for fiscal 2020. As a reminder, we've now fully cycled the SUPERVALU acquisition, which means quarterly, year-over-year results will be more directly comparable and not influenced by the mix impact of adding the acquired business. Let's start with sales for the 13-week second quarter, which totaled $6.14 billion approximately equal to last year's second quarter. Steve provided color on our sales by channel, so I'll move to gross margin, which was 12.63% of net sales, up approximately 10 basis points from last year's gross margin rate when excluding last year's inventory fair value charge. The improvement in gross margin was driven by lower year-over-year freight expense, partially offset by the dilutive impact of the growth rate of our largest customer. Promotional funding was largely in line with fiscal 2019 second quarter. Included in this quarter's gross margin rate was inventory reserve expense of approximately 7 basis points or $4.2 million associated with the three customer bankruptcies, Steve spoke about earlier. Inflation in the second quarter was 1.4%, down slightly from last quarter. Second quarter operating expense was $750.8 million or 12.23% of net sales, the same rate as last year's second quarter. Included in this quarter's operating expenses were $28.9 million in bad debt expense from the three customer bankruptcies or approximately 47 basis points as a percent of net sales. Prior to this bad debt expense, our cost reduction efforts and incremental synergy realization led to a 4% reduction in operating expense dollars. As a result of this quarter's bad debt charges, we're taking additional incremental measures to monitor the credit risk profile of our customers and placing a greater emphasis on controlling customer delinquency migrations, making…

Thanks John. As I close the call today, I would like to share a few points around UNFI's environmental, social and governance efforts often referred to as ESG. Given the importance this has for us, earlier this year, UNFI released its 2019 Corporate Social Responsibility or CSR report, which outlines the progress we've made on sustainability issues. We're well aware of our footprint and the impact we have on the planet, and we're committed to making future incremental improvements. One of our significant initiatives is to reduce waste, particularly food waste across our operations and are proud to say that an estimated 48% of the food waste generated by our operations now gets diverted away from landfills. UNFI was named Food Logistics 2019 Top Green Providers list for the 6th consecutive year, an honor that recognizes companies that enhance sustainability within the food and beverage industry through products, services and exemplary leadership. Our CSR report also disclosed that UNFI's CDP climate change response and actions improved our score over the prior year, a reflection of our increased focus on evaluating the environmental impacts of our supply chain and a higher level of oversight toward sustainability topics. Our teams remain excited and energized and they're focused on creating a better UNFI for all of us. Before I turn the call over for questions, I'd like to reiterate that we're encouraged with the first half of fiscal 2020 and the underlying operating performance and trends of the business. We began this year with a great deal of learnings that came out of fiscal 2019 and we enter the back half of this year in a stronger position than we were just six months ago. We're focused on maximizing the value of combined companies to drive further operational and financial improvement and we're encouraged by our new business pipeline. This quarter was indicative of the inevitable changes that are influencing this industry. Scale and differentiation are becoming more important than ever and we continue to believe that UNFI is well positioned to capitalize on the shifts that are taking place and that will continue to take place. As John and I have both mentioned, our guidance has changed only because of the customer bankruptcies that impacted this quarter's results. We remain optimistic about the future and look forward to updating you on our progress. We'll now take your questions.

[Operator Instructions] The first question comes from Rupesh Parikh of Oppenheimer. Your line is open.

So Steve, I wanted to go back to some of your comments on the coronavirus. I was wondering if you can provide maybe more color in terms of what you're seeing from a cadence perspective. Did you see initial surge leveling off of demand? I just wanted to get a sense of how that material increase in demand look like, I guess, through, I guess maybe the past few days.

Sure.

And also with that increase in demand, What's the mix impact on your business related to both the product side and from a customer perspective?

Sure. Good morning, Rupesh. Yeah. Let's keep in mind, a couple of things before I answer that question. Number one, obviously we're not raising our top-line guidance and we're still kind of watching to see what happens, because as I said in the comments, we're seeing a lot of increased demand throughout the country and again, as I said in the comments, you know when you plan for Thanksgiving, you have six months to ramp up the cost, you hire the people, you get the trucks. In the case of COVID-19, we did not have that luxury. And so when you look at year-over-year growth, over the last two weeks, we've - our business is up double-digit versus prior year. That's a big number. Whether that continues or not, I can't even begin to tell you. Are we going to see more and more people leaving the restaurants and eating at home? That's possible. Are consumers loading their pantries? That's possible. I think we're seeing the double-digit growth because customers trust the products that we sell, USDA Organic, [free from] [ph], and that's why we're seeing significant increase in demand. But obviously it's very early. And so we certainly are uncomfortable making any predictions as to what this does to UNFI for the rest of the year, given the fact that right now, our primary focus is safety, security of the teams, security of the customers, making sure that our distribution centers are operating in a very, very clean and careful and disciplined way and, obviously making sure we get the product out into the retailer. So that's our primary focus right now. So that's, I think, the answer to your first question. The second question on mix, you know, like I said in my script, we identified 300, 400 items that we assumed would have significant lift across categories that you would expect, frozen vegetables, frozen fruits, general staples, canned goods, rice, there's nuts, and certainly we have seen that. But, of late, we've also seen a general lift across the balance of the stores as well. And so I think in the near term, it's - we're just going to have to wait and see. Again, we are doing everything in our power to get products delivered to the retailers as quickly, safely and efficiently as we possibly can.

One quick - one additional question. Just on the independent side, as we look out for the balance of year, is the decline we saw in Q2, the right way to think about, excluding coronavirus impact, in terms of how to think about the decline in the independent segment?

Yes, Rupesh, it's John. I would say that our largest customers are doing the best. I mean, our top 100 customers are growing by 4.3%, scale wins and we do expect that we would see some rebound from an independent perspective, but it's a difficult macroeconomic environment out there. And it's particularly impacting our independent customer base.

Great, thank you for all the color.

Chris T, did you have something you want to add on that?

No, Sean here. I think the independent base certainly is the most challenged in this environment. There are ones that are differentiated that are thriving and the rest of them, that is where we're going in with our solutions regarding category management, building out the store, cross selling, offering them products and services that we traditionally didn't have to make sure that they remain viable.

Yes, just, Rupesh I would add one thing is, don't forget that the bankruptcies - the three bankruptcies were all in our independent channels.

Your next question comes from Chuck Cerankosky of Northcoast Research. Your line is open.

Jim Salera on for Chuck. First, just a quick housekeeping item. When we're looking at the $170 million that you guys are expecting from the real estate sale at Cub, is that net come out of the $200 million to $250 million that you guys were expecting for the overall sale? So, should we still be looking for just an additional $30 million or $80 million on that or is that in excess like you guys expect to get more out of that?

I think the answer to this is - this is John, it's - there is a certain degree of that will come out, but we fully expect to receive well in excess of that net amount. We don't look at that as the combined value from a $170 million perspective. So we are trying to look for opportunities. As we think about the value of the real estate and the value of Cub, what we're trying to accomplish here is maximizing both of those assets to the best amount that we can. So that's why we entered into the sale leaseback transaction and we're contemplating to get the full value for the land and we'll look for the full value coming out of the operation side as well.

And then if you guys just kind of take a look over your distribution network, do you see any opportunities to either have some excess capacity like Tacoma where you can get some more cash out of the network or maybe consolidate some more DCs like you guys are doing in Oregon and in California? Is that something that you guys are looking at this time?

Yes, so, just as a reminder, we have two primary network realignments going on, one in the Pacific Northwest and one in Southern California. So Pacific Northwest is essentially complete. And now we're jumping into Southern California, where we're taking multiple DCs and putting into a smaller number. We will look to the rest of the country when the time is right, but we got to get through these first two projects before we start to move on to another. As it relates to the second part of your question which is monetizing existing distribution center real estate, that's really not something that I'm particularly in favor of, just because the economics don't work for us. We've got $750 million roughly of liquidity, we don't need the cash and generally doing the sale leaseback on an existing distribution center just has a meaningful negative EBITDA impact on the running of those facilities. So that's not something that we would consider right now.

I would add to that, in addition to Steve's comments, as we execute our script, if you will, around consolidation, we do recognize that there are some opportunities from a distribution center perspective where we own the facilities that we believe we will be able to market and monetize those assets.

Your next question comes from Karen Short of Barclays. Your line is open.

I just wanted to clarify a couple of things on the independent line. The bankruptcies that obviously, and there were liquidations, whatever they may have been in the independent side, weren't really announced until after your quarter ended. So maybe can you just help me understand a little bit more in terms of the actual impact on the independent channel? Because, I mean, I appreciate that you probably were scaling back on supplying some of these, you know, end use customers, but maybe a little color there.

Yes. Karen. This is Chris. I would say that, yeah, we are going to see the majority of the bankruptcy from a top-line perspective through the second half of the year. There was some that happened in the Q. But the majority of the top-line impact will be moving forward.

Okay. So again back to that - the initial question, I think, from Rupesh, how should we think about independents going into the next quarter then as it relates to having that full impact in the next quarter?

Yes, I mean we generally don't provide guidance on what's happening in any particular channel. I can tell you, Karen, that the success that we have in cross-selling and professional services will find its way into the independents. I wouldn't say that the independents are going to get materially better, but on the other hand, I wouldn't say that they're going to get worse either.

And then on the sale leaseback on the Cub stores, I guess, can you just give a little more color on your outlook on the actual sale of those assets? And then I think you had indicated at ICR, I believe, that there was no multi-employer pension exposure related to Cub. But can you just clarify that? But then - but more specifically talk about like why would you be doing the sale leaseback if you thought that there was a greater potential of selling that asset?

So yes, let me take the first part. So we always had considered a sale leaseback on the real estate - just the real estate associated with Cub because it economically makes sense for us to do it. It was built into all of our models when we thought about Cub and the future of Cub. So that's just something that was going to happen one way or another. As it relates to the Cub sale, you know, you don't have to be a rocket scientist to figure out that this is a really tough climate to sell retail and Cub is an incredibly strong banner. It's number one market share, makes a lot of money, it throws off a lot of cash. And so we're just not going to give it away. And so, the process is taking longer than I think we had expected, just because of the general climate within retail. And so that's really the answer.

And the multi-employer, you said there was no - there is no multi-employer pension exposure on the Cub side.

There is a -multi-employer pension on Cub. From my perspective, it's really well-funded. So it's not an issue from a valuation perspective. But this is not a map that you typically would think of. It's a - it's almost fully funded plan.

And then last question from me. Just in terms of the environment broadly with coronavirus, are you - how do you see the manufacturers, I guess, ranking priorities for actual supply, like, is there an issue where the stronger you are, the bigger you are, the more scale you have, you are more in line or like further at the top of the line to get supply or how is the environment kind of playing out from that perspective for you and how do you see that going forward?

So I don't want to speak for suppliers, so I can only give you my view based on historical data. Okay. And that is the higher the visibility of your customer base, right, the greater the visibility, the bigger customers that you serve - the importance of the customers that you serve, the greater your opportunity to get product first. And we've seen that play out several times in the past when we run into short supply. So I feel good that as the product becomes available, that we'll be the first once again.

I think the environment, Karen that you you're describing, manufacturers will sort of talk about that as an allocation and we've been in those environments before. We expect that we will, based upon the very diverse customer base that we serve, that we will have an opportunity against those allocations. We think we'll be first in the line.

And just going back to a question that Rupesh asked in the beginning on mix, we originally saw this as being limited to those items that you would think of when stocking their pantry. But we're seeing the lift across the store. So it's not just canned soups and beans and rice, it's produce and protein and perimeter and center store, which leads us to believe that there are more and more people, more and more consumers spending more time eating at home than they are going out.

Actually last question on that is, are you seeing any skew on geographies or is it broad based across the country? And then UNFI can continue to decipher whether or not there is a much bigger e-commerce shift? I don't know, it'd be hard for you to tell.

Yes. So glad you asked that. So not surprisingly, we saw the biggest lift and the fastest lift on the - in the coastal cities, the New York market, California, Washington market, but we're now seeing similar lift, albeit later, in other large Midwestern cities as well.

Your next question comes from Chris Mandeville of Jefferies. Your line is open.

Steve, so I appreciate your comments around taken some additional steps to monitor bad debt, but I suppose maybe absent the three recent bankruptcies, how is that trending? How should we think about store closure risk remaining absent near-term benefit that subscale retailers might receive from COVID? And is there any additional color you can offer with respect to potential new business, be it, adding customers or greater penetration, given the fact that you called out a robust pipeline, but yet in the quarter, anyway, you really only grew with the whole foods channel?

Yes, well, let me take a stab at the first one, and I'll turn - then John will give you more color and then we'll come back to the pipeline and Chris will probably answer that one. So first of all, UNFI has a long history of managing its bad debt. If you look back over time, our actual bad debt as a percentage of sales is actually pretty nominal. And so this is just one of those rare situations where you had career ones, which I can't remember that ever, ever happening before. So we do have very rigid policies in place that look at risk and obviously when you get three bad debt scenarios in one quarter, let alone one month...

10 days.

10 days, it forces you to look at things a little bit differently. So I'll let John comment on that.

No, I appreciate that. So we did go through an entire full blown process to examine our existing receivable base, particularly on the natural side where the customer bankruptcies occurred. The three customers that did have the situation in Q2 in that 10-day period, all three of those were substantially current in their terms. The majority amount they owed us were within terms and so when we looked at our rest of our receivable base through that review, everything that we're seeing now with the data that's available, we don't think there's any other significant exposures certainly nowhere close to the magnitude that we experienced in Q2. And we're going to continue to monitor all of that throughout the rest of the year and continue to look for process enhancements as we go through that.

Let me just comment on the first part of the pipeline and then Chris can certainly take over. Right now, our focus is primarily on COVID-19. Our distribution centers, from a sanitary safety, product inbound, product outbound, fleet drivers, warehouse associates, etc, are - and by the way, the retailers as well are spending 28 hours a day on COVID-19 to make sure the stores are ready and the stores are following all the safety procedures that we are in our distribution centers. So I think it would be unlikely to think that over the next couple of weeks, but there is going to be a lot of business changing hands with all hands on deck, just making sure the product gets into the stores. But like I said in the comments, the pipeline is full and I'll let Chris comment on that.

Yes, I mean, just real quick on the pipeline. If you think about it very simply, we have two ways to grow and that is by selling more to the existing customers and, of course acquiring new customers and our pipeline is full with both. In the fiscal year, so far, in the first half, the cross selling wins have been allowing us to sell more to the existing customers. And that is natural customers either taking on conventional products through our brands plus pro services and so forth and our conventional customers buying more from us natural products that they've never had before. So those are starting to build as we get - make it easier for the customer to choose those options from us and then the larger wins where we're looking at a pipeline of acquiring new business. Those are in-line and we're ready to go.

Yes, I would just add that we've been so focused on integration and I think this quarter proved that we're really through the integration and now we're really focusing on execution. COVID-19 makes it a little bit more complicated, but the company is certainly in great position to execute today. And if you recall, going back to the acquisition, SUPERVALU had recently acquired Unified Grocers and AG of Florida. And so, there were some business loss associated with integration that took place at that time that we haven't yet lapped. And so I feel really good about where we are, both in terms of the pipeline, the rate of execution and our ability to move the company forward at this point.

To build off of that, Steve, and then I want to circle back really quickly, just to COVID. Can you guys just speak to the competition that you're seeing of late in distribution between like, the specialty and conventional?

I wouldn't say there is anything different or unique about the competition. We are now the largest by a pretty big factor. Our distribution centers are closest to the retail orders. Our people are incredible. We offer a high level of service across so many different product categories, very diversified supplier base. And so from a competitive perspective, I think we're much, much better prepared than anyone.

And then just on COVID again, you referenced that you attempted to be prepared to do best - as best as you possibly could have been, but yet that the surge has exceeded your expectations. So I guess is there any additional color you can offer around how to think about the EBIT margin that will be attached to any potential sales uplift because I would venture to guess that you're not necessarily servicing these customers in the most efficient or the ideal manner, so help us understand maybe the offset in OpEx relative to be uplift from sales potentially.

Yes, I wish I knew the answer to that. Right now, again, our focus is to get the product into the store. And so we're thinking less about doing it in the most effective and efficient way and more in the most safe way, and getting the demand fulfilled at retail. And so I think we're just going to have to wait a couple of weeks, couple of months to see how it plays out. Obviously we're always going to be better with revenue growth, a lot of revenue growth or none. But again, that's not our focus right now.

Your next question comes from Edward Kelly of Wells Fargo. Your line is open.

Anthony on for Ed. Thanks for taking our questions. So just on the 2020 sales guide and the closures you've seen to date. It sounds like you're going to kind of see continued independent's softness. Can you just help us understand a little more clearly your decision to maintain the guide and sort of what gives you confidence in your ability to hit that number? I know you kind of mentioned cross selling and some potential offset from COVID, but is there anything else we should be thinking about there?

This is Chris. I would say this is that, if you think about our customer base, right? It's very, very diversified and so what that means is, if there is, for example, a store closure, those consumers are then shopping at one of our other customers and so we're able to ride the wave of the challenging environment with the diversified customer base because eventually those shoppers are going to be looking for those products that we supply. So if there is contraction in one area - one geographic area or channel, we're typically - we're poised to pick it up in another channel, another customer.

And then just on the Supernatural channel. I know you said you were benefiting from both new and existing stores there, but can you kind of just help us understand a bit more detail the acceleration you saw and sort of what's driving that?

Yes, I don't know that we can provide any more color on any particular customer in depth. Obviously they're executing well. As a consumer, people are enjoying through our prime delivery in a lot of markets around the country. And I would say that those are the primary drivers. But for any other color, you probably have to ask them.

Your next question comes from Kelly Bania of BMO. Your line is open.

Thanks for taking my questions. I wanted to ask about your EBITDA - your adjusted EBITDA guidance. I think the first half, when you look at the combined, Q1 and Q2 is kind of coming in up around 10%, but your updated guidance includes or for the second half looks to be down between I think 9% to 20% on a year-over-year basis. So can you just help us think about the drivers and the puts and takes there and also including how much savings you're expecting out of the Portland consolidation?

Yes, so, Kelly, this is John. If you're looking at the second half year-over-year is what I think you were saying.

Yes.

Yes. So I think what you're seeing there is some of the growth that we are anticipating from the sale. But you're also seeing some of the traction from the synergies and other strategy that we've taken into account. So I think when you think about the year-over-year back half, as Steve mentioned, also, there is some of that expenses that we incurred last year as we went through some of the rationalizations that we're lapping. So I think from that perspective, year-over-year, I think that's how we're feeling comfortable about achieving our guidance. Does that make sense?

So the back half, you're guiding to be down about 9% to 20% year-over-year. And...

I'm not sure I'm following those numbers, Kelly. That's not what - I'm not sure I'm with you on those numbers.

Okay. Okay, maybe...

Last year...

We can take...

Yes, compared to 53rd week, so I think when we think about how we reconcile to last year, we've got a different set of numbers, and we can take that offline and talk about that.

Okay. I guess just another kind of question on COVID. You have companies like Walmart announcing leave policies for their employee, emergency leave policy. So I'm just wondering if you're considering or have considered putting anything in place like that to help ensure the safety at your warehouses and your drivers.

Yes. So, of course, Kelly. We're always going to do the right thing and so right now what's first and foremost is the safety of our workforce. And today, thank goodness, knock on wood, we haven't had any reported or known case of COVID-19 in any of our distribution centers or corporate offices. We have a very disciplined business continuity plans in place, which means if a DC is quarantined or closed or people have to go home, we obviously do the right thing for the associate, first and foremost, and we can cover that market from another location. So we have done the work. Like I said, we have some very, very robust plans in place that consider most of the potential alternatives, given that we're going to be a company that from a famous perspective is always going to have a preference because the grocery stores are going to need to get products and our folks have been into our conversation with all the regulatory agencies and like I said, we'll do the right thing.

Right. This is Jill. We also think if we have an impact of the DC, it will be experienced for a fairly short period of time, but we will be able to follow decontamination procedures through the federal and local governments and hopefully bring those DCs right back up online quickly, and to Steve's point, in a way, we're able to serve customers and our associates and keep everybody safe.

That was our final question. I will now return the call to our presenters.

Let me end the call today by again personally thanking all of our associates who just demonstrated an incredible level of dedication, and commitment to serving our customers during these truly unique times. And for our perspective, we're all hoping that the COVID-19 virus is contained as quickly as possible, and that we can return to some level of normalcy. But in the meantime, UNFI will continue to be a company that continues to do the right thing for all of our constituents. We know how important the role is that we play in the supply chain and we take that role seriously and we'll continue to operate with the utmost amount of integrity and doing what's right, first and foremost. Thanks for joining us today.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.