Good day and thank you for standing by. Welcome to the UNFI Fiscal 2022 First Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Steve Bloomquist, Vice President of Investor Relations. Please, go ahead.

Good morning, everyone. Thank you for joining us on UNFI's first quarter fiscal 2022 earnings conference call. By now you should have received a copy of the earnings release issued 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 under the Events tab. Joining me for today's call are Sandy Douglas, our Chief Executive Officer; John Howard, our Chief Financial Officer; Chris Testa, President of UNFI; and Eric Dorne, our Chief Operating Officer. Sandy, Chris 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'll now turn the call over to Sandy.

Thanks, Steve. Good morning, everyone, and thank you for joining us on our fiscal 2022 first quarter earnings call. As you saw in this morning's press release, we delivered first quarter results through a time of continued challenges across the industry, including ongoing supply chain difficulties, declining fill rates and rising inflation. UNFI is performing through this unpredictable environment by steadfastly focusing on what we need to do to make our customers successful, which will continue to be our core operating objective. Tomorrow, as I cross the four-month mark at UNFI, I continue to invest a significant amount of my time meeting with our customers, with the simple goal of learning as much as I can about their business, what differentiates their offering in the marketplace, what are their biggest opportunities and pain points and what can we do to add value to their operations. Making customers stronger is a core tenet of UNFI's mission statement, and I have a genuine passion for helping food retailers succeed. And I'm committed to doing everything possible to bring solutions that accomplish this. Our teams regularly meet with customers to introduce new items, to plan and coordinate promotions and to look forward to the next major selling event. Customers were encouraged to order early for this year's November, December holiday season and build their inventories wherever possible. We also make sure they know about the many services that UNFI offers to lower their cost structure, increase sales and simplify their operations. We've received positive feedback from our customers on the work that we did together around Thanksgiving. And now we're laser-focused on doing the best possible job to meet their needs as we move through the upcoming holidays. Further, I've initiated conversations with several of our larger suppliers, many of whom I've known…

Thanks, Sandy, and good morning, everyone. On today's call, I'll provide further color on key drivers behind UNFI's Q1 results and future growth, the trends that are impacting our industry and some insights on UNFI's operating environment. Let's start with our results for the quarter, where consolidated sales came in at $7 billion, a 4.7% increase over last year's Q1 and nearly a 4% sequential increase from the fourth quarter. It's worth noting that this is only the second time in the company's history that revenue totaled $7 billion in a single quarter. All three major sales channels experienced year-over-year growth, which was driven by two primary factors: new business wins and inflation. Modest market contraction and continued supply chain challenges were also partial offsets to these favorable sales drivers. Our strong supernatural sales were driven by winning new categories and SKUs with our largest customer, which reflects the strength of our relationship and the value we bring to their business. Independent sales channel growth was driven largely by new sales we realized from our Allentown, Pennsylvania facility, which began serving Independence in the New York Metro area in Q1. This new DC has been the largest distribution center startup in UNFI's history, and its run rate volume has quickly made it a top 15 warehouse in terms of revenue. As you'd anticipate, we've had some learnings along the way, but we are pleased with our progress and the greater opportunity to pursue enhanced customer service to existing customers and new customer growth in the New York metro market. Both in the supernatural and independent new business wins have been exceeding volume expectations, and we expect continued strong performance through the balance of this fiscal year. Our sales team also remains focused on cross-selling and we generated over $60 million…

Thank you, Chris, and good morning, everyone. On today's call, I'll cover our first quarter financial performance, balance sheet, capital structure and comments on our fiscal 2022 outlook. As Sandy and Chris both said, we're encouraged by our operating performance this quarter and the start to fiscal 2022. Sales for the first quarter totaled $7 billion, a 4.7% increase compared to last year's Q1. Adjusted EBITDA increased nearly 19% from $159 million to $189 million. First quarter gross margin rate increased 38 basis points compared to last year's first quarter. Our wholesale margin rate was impacted by this quarter's elevated inflation as well as the continued benefits from our Value Path initiatives. First quarter operating expense rate declined 20 basis points compared to last year, driven by the favorable leverage from higher sales and lower year-over-year costs when comparing last year's cost related to the consolidation in the Pacific Northwest, against this year's start-up costs for our DC, supporting the New York metro area. These were partially offset by higher operating costs in our supply chain, including transportation costs, part of which came in support of our customers during the temporary and voluntary closure of our Centralia, Washington distribution center, the first week of the quarter, as well as investments in adding and retaining labor to better service our customers. As we've stated before, one of our goals is to grow adjusted EBITDA faster than sales. And this quarter's 19% growth in adjusted EBITDA on a 4.7% increase in sales exemplified just that and translated to a 32 basis point year-over-year expansion in our adjusted EBITDA margin. Our GAAP earnings per share totaled $1.25, which included $0.28 in net favorable items. This includes our GAAP tax rate, which benefited from employee stock award vestings as well as the release of…

[Operator Instructions] Your first question is from the line of John Heinbockel from Guggenheim.

Thank you, guys. Let me start with, do you have any way of telling relative allocation and fill rates versus various competitors and retailers, right? Because you would think you should have a better allocation than smaller distributors and smaller retailers. Do you have a sense of that? And then can that drive new customer acquisition right in the short run here, because you have product and others don't, or is that too optimistic?

Yes. Hey, John, it's Chris. So it's impossible for us to tell what's going on with CPG allocation of products. What we do is we work with them every day to make sure that we're securing our fair share of supply. And given our scale and given that we're the top one, two, three customer for many of the CPGs, we get more product, right, on a straight allocation basis. So that is what the CPGs are telling us. As far as acquisition of new customers, that is an attractive selling point, in addition to since COVID hit almost 20 months ago, it stressed the supply chain. And what we have found is that, our customers are looking for alternatives in this stressed environment. And what we found is UNFI is an attractive alternative, not only because of the product availability that you asked about, but also just the consistency and the size and the scale of the network. So that’s been helpful for us to attract new customers.

And if you think about the pipeline you referenced, right? So it's the biggest you've had. I don't know if that's a number of folks you're having conversations with or volume that they represent. But if you think about the composition of that, so maybe speak to that, but also the composition, large versus small, conventional versus more specialty or even maybe non-food retail, what does the composition look like?

Sure. So first, to answer your question, it's the volume they represent. So that's how we're measuring that. Look, we are tracking hundreds of opportunities. And if you think about what UNFI sells, with over 300 SKUs with a deep fresh portfolio, with the deep conventional portfolio, with the deep natural portfolio, brand services, there is really no single competitor out there. So the customers -- the potential customers in the pipeline are really ranged from the large national customers. They range from customers with captive distribution, looking for alternatives. There are also a lot in hundreds of local regional customers as well. So it really is the range, John. And we still look at that $38 billion opportunity with existing customers as white space, as well as the $78 billion opportunity with new customers. So it's -- the pipeline represents a fair amount of both.

And one last real quick one. The Key Food will get to the $1 billion run rate win. And I guess in the first quarter, what might Key Food have been running at? $100 million plus or something like that?

So we don't disclose how much we do with each customer, but we won't realize the full volume of the Key Food until fiscal 2023. It has ramped up throughout the year, but we won't get the full volume until 12 months next year.

Okay. Thank you.

Sure.

Your next question is from the line of Scott Mushkin with R5 Capital.

Hey, guys. Thanks for taking my call. Great work given the environment. So I guess that's the first thing I wanted to ask about is, obviously, it's really hard right now operating. We saw in the Campbell's call, and they were talking about how difficult to run some of those plants. So I was wondering if you guys could talk about what your expectation is. I know there's a lot of pressure points in the quarter you just reported. How are you thinking about the next couple of quarters as far as availability of labor, just the challenge of running your network? Is it going to lessen or is it going to remain the same?

Yes, Scott, this is Sandy. I think our outlook is essentially realistic. It's very hard to predict what's around the next corner. As Chris said in his remarks, we've made some improvements in terms of our net openings in our fulfillment system, and we're doing that by intensifying our recruiting, but also working on simplifying the associate experience as well. And we talk to suppliers, they continue to believe that they're going to have constraints around their supply environment. And so our general expectation is that we're going to have to stay agile. We're going to have to stay customer-focused and that the environment will continue to be difficult.

And staffing levels are okay right now. I'm just looking at the cold cases are going through the roof. I mean are you able to staff?

Eric, why don't you take that?

Yes, Scott, we are and we're actively enforcing our protocols around COVID, whether it's mask wearing, social distancing. And we continue -- we've offered incentives for vaccinations. We're encouraging and educating our staff around the benefits of vaccinations. And as Chris referenced, we closed our headcount gap by 30%, and we're continuing to work on that. And associate-friendly programs like Flex Shift is really starting to take hold. We're seeing almost 4% of our total hours with those associates, and it's growing every week. So we are focused on it. We're going to stay focused on it and work our way through it.

Then my follow-up is much more of a longer-term question. I mean, I know the thought process is we're going to do more consolidation of the distribution networks. I don't think you mentioned it, maybe I missed it, but I was wondering where we are in that process? Like how are you guys are thinking maybe out the next couple of years on that item?

Yes. Scott, I'll take this again. It's Eric. We are actively looking at that, but we are focused on meeting our capacity needs for the here and now. So we have looked at expansions that we have underway, obviously, with Allentown coming online and adding 1.3 million square feet to service the New York market, and we continue to invest -- strategically invest in automation. We've got two new automated systems on the West Coast that we've talked about in Richfield and Riverside. We're expanding our Carlyle, PA automation system, and we're looking at other strategic expansions around the network. So I think this is very much a dynamic situation based on our growth and meeting the pipeline that Chris referenced, making sure that we can continue to stay flexible and agile as the business comes on.

That’s perfect, guys. Thanks very much. Appreciate it.

Your next question is from William Reuter with Bank of America.

Good morning. On the Allentown distribution center, have you talked about how much of that capacity is going to be used by Key Foods? And you've been hoping to get additional customers in the New York metro area. How has that process gone so far?

Yes. So, we are focused on that startup. Any start-up that you have for any warehouse, you want to build gradually and work out the kinks. As I said, we've had some expected challenges there, but we're really proud of the progress. And we're just focused on servicing the business we have there. And we will – we do plan to continue to add to serve that very attractive in dense marketplace in the near term.

Okay. And then in the prepared remarks, you talked about limited product availability and how that's reducing promotions. Can you talk a little bit about how the balance of this -- I guess, how this is negatively impacting margins versus the positive of inflation?

Yes. So, I'll say this is, first off, the fill rate, we're still growing over $300 million in the quarter year-over-year and the fill rate was only up slightly. So, there's plenty of product and supply out there. It just might not have the SKUs and everything that our customers want because of the supply restriction. So, we're selling a lot of products. We're doing everything we can to keep our customer shelves filled. Regarding promo, we are seeing it come back as far as activity. Our merchandising team is working closely with suppliers to make sure that we're getting the best promos for our customers, doing everything to mitigate price increases. And we did see a year-over-year increase in promo activity. The fill rate and less new SKUs is a headwind. But overall, we're actually – our promo expectations were in line with what we thought was going to happen for the quarter.

Okay. And then lastly, if I could just sneak one in. With regard to the one facility that was shut down in August, it's now fully operational. Are there any facilities that are getting levels of COVID transmission that you're concerned you may have to shut them down again?

Bill, this is Eric. No, we have not seen that. And again, I'd reinforce the protocols that we have in place. We've been maintaining mask wearing in all facilities, social distancing. We continue to offer incentives for vaccinations and encourage our associates to get vaccinated. So, we're monitoring. We have a really robust program in place to monitor and we're continuing to just see the normal trends across the country. So, nothing alarming that we would communicate.

Great. Thanks a lot and good luck.

Next question is from Bill Kirk with MKM Partners.

Good morning, everyone. More so than normal, it sounds like customers ordered early for the holidays and maybe expanded their inventories. So, I guess how big of a benefit was that, or how abnormal was that inventory load relative to other like periods? And does it reverse out here in later in 2Q? Do their inventories come back down at your customers?

Bill, this is Chris. I think you're talking about for the November and Thanksgiving season and the December season. So, this is always – this quarter, Q2 that we're in right now, always represents our highest inventory build because of the inventory – sorry, because of the holidays. So, it's in line with what we've seen for prior years. Nothing dramatically lower, nothing dramatically bigger. As far as the order early, I mean, we started talking about Thanksgiving in July. And that was just to work really closely with our customers and our suppliers to make sure we had those high-demand items on their shelves. So we feel pretty good about our performance in Thanksgiving. There's always opportunities to do better and we're focused on the December holidays right now.

And kind of as a follow-up. Did you see retailers who normally rely on their own captive distribution? Did you see them lean on your services more in the period? And if they were, because maybe they were having some of their own supply chain restrictions, but if they leaned on you more, do they stay, or do they go back to their normal sourcing systems?

Bill, this is Sandy. I'm going to make a strategic point, and then I'll turn it over to Chris to answer your question. I think one of the things we've been paying attention to is making sure that we take care of our customers that exist while we think about growing new customers. As Chris said, the pipeline is very rich and robust of all types of customers, and you described that. But what matters to us every day is that the customers who trusted us before will get the best possible service. And then we add customers, as we have the capability and capacity to do it. And so, Chris, you can get into the detail. But I think the point I want to reinforce is, how loyal we are to the customers who've been loyal to us.

Yes. Just to add to what Sandy said, we have not seen a retraction from that new business gains from captive customers. That is actually, if anything, it's gone the opposite direction.

Okay. Thank you, everyone.

The next question is from Eric Larson with Seaport Research.

Yes. Thanks, everyone. Thanks for the question. So I would like to dig a little bit more, maybe just a question for Chris, into the promotional environment, obviously, the manufacturers are taking prices up aggressively, looks like they might even need another round due to higher costs. So traditionally, that's been a good profit center for you, as they increase their promotional discount rates during promotional periods. So has that kicked in fully yet here, Chris, or do you still expect increased benefits going forward on that?

So, I will say that it has not kicked in fully. And although, we are getting those promotions, to your point, that behavior is staying consistent. What's preventing it from fully kicking in is the product supply, right? So, I mean, if you think about promotions, promotions are based on transactions and number of transactions. And when you have less SKUs, when you're on allocation, when you're not launching a new product, those transaction levels are lower. The promotions are there, the programs are there, but I would -- to your question directly about fully kicking in, no, I don't think it has. I think there's been some headwinds because of the product availability issues that we're having.

Okay. Thanks. And a little bit more detail kind of on fill rates. Obviously, product availability as part of it has -- any other part of the supply chain been an issue either? I think you mentioned a little bit about transportation. But is it like 90% just product availability on fill rates, or are there other constraints in your supply chain that are restricting that fill rate completion?

No. Our fill rate is a reflection of our inbound fill rate from our suppliers. And there's no surprises there. It is labor, it's availability, transportation, it's raw materials, it's all the macro environment factors that you've been hearing about and actually we spoke at in the last call. So there's really nothing unique to our environment. Our supply chain that's hindering fill rate, it's really about inbound.

Got it. Okay. And then my final question, I think, is for John. John, I think you talked a little bit about this at year-end. Your $300 million of CapEx spending, I think if I recall correctly that, that is still a little bit of an elevated spending rate for this upcoming year. Is that the case, or is $300 million more of kind of what we should expect going forward?

Yes. What we've said -- I appreciate the question, Eric. And what we've talked about on that is being roughly around that 1% of sales, and we put in for our 2022 guidance the $300 million. And just as a reminder, as I said in my script, that's excluding the financial reporting aspect related to how we're going to monetize Riverside, because it will give you the impression that's driving that up much higher. But that $300 million, we're still targeting that $300 million of cash CapEx for FY 2022. We haven't brought that down yet. We're seeing some similar supply chain challenges on some of the projects. But we're continuing to keep that $300 million out there and doing everything we can to make those investments line up with our customer focus.

Okay. Thank you, everyone.

[Operator Instructions] Our next question is from the line of Greg Badishkanian with Wolfe Research.

Good morning. This is Spencer Hanus on for Greg. Can you talk about your expectations for inflation for the full year? Should we expect the 1Q run rate of 2.5% to 3% to be a good proxy for the full year? And then how much of a sales headwind were the lower fill rates in the quarter? And just how does that flow into the full year guidance that you should see a really significant benefit from the higher run rate inflation?

So, Spencer, I’ll take the first part of that as it relates to the inflation. As I mentioned, we did raise our view on that from the 100 bps. And that 250 to 300 bps is how we're thinking about certainly in the near-term. But as I mentioned, there's also some of this corresponding offsets related to the supply chain and other challenges that we're seeing that will keep that sales in line with where we provided our original guidance.

And then just as far as the fill rate impact on sales, so I'll say this, look, fill rate was up slightly year-over-year, and sales were up over 4.5%. So we – we have products, and that we work with our customers to sell when we don't have the products, exact products they want, right? So namely, replacing in-stock SKUs from our brand portfolio, which typically has a 5% to 10% more favorable fill rate than national brands. We look for alternatives for our products that are going to be in stock longer term. So we're generating the sales for those out-of-stock and constricted items. The exact headwinds is -- I can't put a number on that. I don't think anybody can because we work so hard with our customers to control the controllables, right, to find the products, to keep their sales full and make sure that we're getting the revenue from whatever we have in our warehouses.

Got it. That's helpful. And then just a follow-up on the DC consolidation question. Do you still think that the plan laid out by Steve make strategic sense? And how long would you expect the consolidation plans to be pushed out? Is it 6 months, 12 months, 18 months? Any color there would be helpful.

I don't think, Spencer, we would put a time frame on it as we're trying to stay agile here and leverage our capacity to service the customers that we have and that we're acquiring. So, I think that this is very much a dynamic situation, and we're going to continue to leverage our building. And as we add new customers that profile will really change. So, I think more to come on that as we move forward.

Thank you.

The next question is from the line of Peter Saleh with BTIG.

Great. Thanks for taking the question. Congrats on the quarter. I just wanted to come back to the conversation around labor and the changes you guys have made to the employee, I guess, compensation. I think you guys mentioned there was a 30% reduction in – I think it's the GAAP versus headcount gap that you guys are expecting. Maybe can you elaborate there? And then just – have you seen any changes in your turnover rates? Have those come down as you've made changes to the compensation structure? Thank you.

Yes. Peter, this is Eric. The 30% that we referenced is the gap of associates we need to service our business versus what we had. So, we closed that gap by 30% by doing a variety of things, all of which focused on the associate experience, the lifestyle inside the buildings. We're striving after work-life balance, reducing over time, increasing flexibility. So, it's really not just about wages that we've adjusted. We're going after more than that. And other things like early wage access is an innovative program that we've put in throughout the network. We revised our success share plan for inside the DC. And we've also modified our health benefit options to all associates. So, this is more than just wages and we're optimistic on what we're seeing. And again, this is a focus for us moving forward through this challenging time.

Great. Thank you for that. And then just lastly on the leverage. I know it ticked up a little bit here. Can we expect – or what's the timing you guys anticipate to get to call that 2.5x leverage? Can we anticipate that you might get there by the end of FY 2022, or is this more of a sometime in '23 target?

Yes. So what we've put out there, Peter, is we talked about getting to the 2 to 2.5 range as part of our Investor Day, which would be the end of FY 2024 for us. And certainly, we'll be doing it on a gradual basis. We're forecasting being in below 3x at the end of this fiscal year. And we're anticipating, at this point, continuing that trend to get to that 2 to 2.5 range by the end of FY 2024.

Thank you very much.

Appreciate the question.

I think we've answered all the questions in the queue. So -- I guess we had one more come in. Why don't you bring that in for us?

And the next question is from Edward Kelly with Wells Fargo.

Yes, hi guys. Good morning. Could you just talk a little bit about the rate of labor inflation that you are currently seeing and expect going forward, both from like a driver perspective and warehouse perspective? Foodservice has been ramping, hiring. Wondering what's been happening with sort of market pressure there and your expectations around that?

Yes. This is Eric. I'm not sure I'd put a number to it. But as Chris referenced in his script, we've made market adjustments, and we'll continue to make market adjustments as things continue to evolve here. And as far as drivers, specifically, we've put different programs in place for our drivers, whether they're premiums or sign-on bonuses. And we feel very confident with our associate profile here on drivers that we offer a different experience than other players in the market, and we're going continue to leverage that as we move forward.

Ed, this is Sandy. I think what I'd add to that is that market competitive is the key, and then where we're trying to differentiate is through the different lifestyle and employee-friendly programs. There's a whole lot of effort going on across Eric's organization to get closer to our team and to make UNFI a better place to work. And through that, to be able to take market competitive investments, which is all about customer capability, but leverage it to get the most value possible out of every dollar spent.

Okay. And then can you just -- I don't know, is there any update on retail and the strategic outlook for that business? And how it fits within UNFI over the long term?

Yes. No, happy to answer that. This is John. Like we talked about at Investor Day, we are going to continue to optimize retail. We've got an outstanding leadership team that is in place there, spearheaded by Mike Stigers. And he -- that function that, that segment has been performing outstanding, both the Cub banner in the Minneapolis market as well as the Shoppers banners on the East Coast. And our approach to that is that, can continue to optimize, which means we're going to run, we're going to invest, we're going to grow, and we're going to do all the things that you would expect us to do with an asset that we own. And at the same time, what that means is, if an opportunity presents itself to monetize it at an appropriate value, we're happy to consider it. But under the leadership that we have and the results that they're producing, we're going to continue to optimize and grow it.

Yes. And it's Sandy, again. What I'd also add is it's a great place for us to learn. Our retail leadership team gives us really direct feedback about what they need and what programs, services, brands and other things we can do to serve them better. And that visibility is very helpful to us.

Okay. And then, just lastly for you. Related to the change, you mentioned change with captive distribution and making inroads there. Can you just provide a bit more color on that? How much of that is just people are looking for product right now versus you building a more sustained relationship in that area?

Ed, it's Chris. I think it's more than just product supply, I think, there's retailers with captive distribution that are looking long term and considering their own capital investment versus leveraging UNFI's network. And given the scale of our network, we can provide an attractive option to them rather than investing on their own. And I think generally, that's where it's coming from.

And I think also, this is Sandy. Serving captive retailer is not new. I mean, it could be category-specific natural products, different kinds of items that they want to have, innovation, et cetera. And so it's a growing part of the business, but it's not a new part of the business.

Great. Thank you.

Okay. Thank you, guys, for joining us today and for joining us this morning. I hope you've heard and take away from today's call that UNFI is growing and improving within a challenging and unpredictable environment by steadfastly focusing on what we need to do to make our customers successful. As I said on the last call, our job is to help our customers and suppliers compete, grow, serve their customers and add value to their businesses across our network. Our success depends on repeating this day in and day out, and I'm pleased with how well we're doing, while being challenged by significant opportunities for ongoing improvement. For our customers, we thank you for your continued partnership and the business we do together. And for our suppliers and UNFI associates listening today, our thanks to each of you for everything that you do for our business, our customers, our communities and each other. And for our shareholders, thank you for the trust you put in us through your continued investment in UNFI. Thanks, everyone.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.