Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the UNFI Second Quarter Fiscal 2023 Earnings Call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] At this time, I would like to turn the call over to Steve Bloomquist, Vice President, Investor Relations. Please go ahead.

Good morning, everyone, and thank you for joining us on UNFI's second quarter fiscal 2023 earnings conference call. By now you should have received a copy of the earnings release issued this morning. The press release and earnings presentation, which management will speak to are available under the Investors section of the company's website at www.unfi.com. We've also included a supplemental disclosure file in Microsoft Excel with key financial information. Joining me for today's call are Sandy Douglas, our Chief Executive Officer; and John Howard, our Chief Financial Officer. Sandy 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 and the end of our earnings presentation. I'd ask you to now turn to Slide 6 of our presentation as I turn the call over to Sandy.

Thanks Steve, and good morning everyone. We appreciate you joining us for our second quarter call. As you've seen in our release, this was a challenging quarter for UNFI. Before I turn it over to John to share more details on our financial results and our expectations for the rest of the year, let me address our performance directly by explaining what happened? How it happened? What we're doing about it? And how it informs our strategic and operational thinking about the company going forward? During the quarter, our top line growth remained solid with more customers again buying more categories from UNFI. Clear evidence that our differentiated offering and customer centric strategy is starting to work. We remain committed to our longer term objective of above industry sales growth and positively leveraged EBITDA after we lap the procurement gains in fiscal 2022 and early fiscal 2023. All in, revenue rose over 5% compared to the prior year period, achieving $7.8 billion, the highest sales quarter in our history. However, our second quarter adjusted EBITDA and adjusted EPS were well below our expectations. As a result, we are raising our sales outlook and reducing our profit expectations and withdrawing our longer term fiscal 2024 targets. Our reduced profitability this quarter was primarily driven by a lower gross profit rate as we did not repeat the level of significant procurement and inventory gains experienced last year. Both of these gains in the previous year came during a time of significant industry volatility given the steep acceleration of inflation, continued disruptions in the supply chain and operational complexities. We also continue to experience elevated operating expenses as we're investing to service our customers, while supply chains and labor markets continue to gradually normalize. I'd like to address the lack of visibility into…

Thank you, Sandy, and good morning, everyone. My remarks today will focus on the drivers of our financial performance this quarter, the progress we made strengthening our balance sheet and pursuing capital allocation, as well as our updated fiscal 2023 expectations. Turning to Slide 8, net sales grew by 5.4% in the second quarter and totaled more than $7.8 billion setting a new quarterly high and reflecting solid customer demand and elevated inflation. Wholesale sales grew by 5.4% including inflation, net of elasticity of about 10% as well as new customers and new categories with existing customers, partially offset by a decline in unit volumes. In wholesale, we delivered widespread sales growth across our three primary channels. This includes incremental volume from new customers added over the last year, additional categories and new store openings in supernatural and increased item and category penetration with existing customers. Retail sales grew 2.6% compared to last year's second quarter, a sequential improvement from the 1.8% growth rate in Q1 driven by higher average unit retail pricing. Our retail sales comparison was especially challenging this quarter as we cycled last year's onset of Omnicron, as well as several weather events in the Minneapolis, St. Paul area, both of which added business in last year's second quarter. Flipping to Slide 9, adjusted EBITDA totaled $181 million, which is lower than last year's $220 million. The biggest contributor to the year over year decline was our gross profit dollars prior to the LIFO charge in both years, which were close to flat compared to the 5% plus sales growth I mentioned earlier. Our gross profit rate, again, prior to the LIFO charge, declined by approximately 80 basis points. The largest drivers of this decline in gross profit rate were lower procurement and inventory gains resulting from,…

Thank you. [Operator Instructions] We'll go first to John Heinbockel at Guggenheim Securities.

Good morning, Sandy, John. This is Anders Myhre on for John Heinbockel. Thank you for taking our question. To start, can you provide us with further detail into the state of the new business pipeline? Can you quantify it? And do you expect further acceleration beyond next six months? And where would that primarily come from?

Hi, Anders. It’s Sandy here. We don't disclose or quantify the new business pipeline. We generally refer to it qualitatively, but to give you a little bit more texture, we are seeing a significant amount of interest in our wall to wall services categories across conventional and natural. Our pro services, which help customers become more efficient and grow faster and our Brands Plus program, which is particularly relevant as consumers look for lower priced options. We quantify the pipeline using technology and we're able to say that it is larger this quarter than it was in recent history. And what it reflects is interest in the market in our offerings, which we are continuing to craft and execute. We have reported in past quarters that we were implementing new business in the second half of the year. That is largely implemented. One major initiative will happen in the fourth quarter. I hope that's helpful.

Yes, very helpful. Thank you. And to follow-up, you withdrew the 2024 targets. We understand that it is still early. But how do you think at least conceptually about the secular growth algo? Is this just a reset to a lower more permanent base?

Yes. The way I'd answer that is that, it's likely that we'll give guidance for 2024 at the end of the fiscal year as we normally would. But there's a lot of volatility in the environment right now and we want to see how this plays out. We remain confident that the company is very well positioned. As I mentioned, the pipeline, which drives the top line is very strong. And we'll look forward to giving investors an update on 2024 at the appropriate time.

Great. Thank you.

We'll take our next question from Mark Carden at UBS.

Good morning. Thanks so much for taking our questions. So to start, you talked about getting some more visibility into procurement lapsed towards the end of the quarter. How are you thinking about the compares over the course of the next few quarters? Should we expect to see pretty even impacts in 3Q and 4Q? How could it trend into 1Q next year? Just some additional color there would be great.

Yes, this is John. We generally don't provide quarterly guidance, but broadly the way you're thinking about it is reasonable.

Okay, great. And then looking at your adjusted EBITDA overall outside of the procurement challenges. Did you guys see any major shifts in the trajectory of your specialized services businesses, your private label operations, just some of your higher margin areas?

We continue to -- this is Sandy. We continue to see strong growth in both of those businesses with double digit growth.

All right. Thanks so much.

We'll move next to Andrew Wolf at CL King.

Thank you. Good morning. On the gross profitability, it sounded like some -- sort of follow-up to the last question. So was Q2 or perhaps even Q1, were those kind of the peak periods for holding gains and the other kind of gains you could get through buying into accelerated inflation? Just to understand externally how we could think about modeling the current -- I mean, you gave us guidance on how you think it's going to flow. But just in that -- just in terms of inventory gains, what's the early part of last year in the peak period?

Yes. Hi, Andy. It's Sandy. The inventory gain was a Q2 2022 peculiarity. You'll recall that that quarter was particularly volatile in the supply chain. We had significant vacancy changes as Omicron hit. We did everything we could with third party labor to meet our customers' needs through the holidays. And it just was probably the most volatile quarter that I've seen, at least, in my time with the company. And what inventory gains represent is, inbound or outbound, we just ended up with about two tenths of one% more inventory than we expected. And that was a positive variance on the P&L in the quarter that didn't repeat and hasn't repeated since then. From a procurement gain standpoint, the rapid onset of really extreme inflation occurred in the sixth period or the final period of the quarter. And our insight into it came as we lapped it. But -- so you can model it from that point on for about 12 months.

Got it. Thank you. And I just wanted -- on labor productivity, it seems like the trends are kind of continue to slowly improve. Are you expecting the rate of improvement to increase based on your commentary that newer workers become more seasoned?

Yes. Andy, I think the comments that John made in the script are accurate. We expect gradual improvement based on the experience base of the talent in the DCs. As we talk more about the transformation agenda, that's where we're focused on applying process and technology to make further gains, not only from an operating perspective, but also in terms of quality to our customers and capital utilization. But we think there's room for continuous improvement that we're pursuing urgently. And then we think there's room for strategic improvement as we implement the transformation agenda.

Okay. Last question for me is, on the top line, I know you have strategies that are helping penetration in new business. But the industry itself is -- your average stores down maybe mid-single digits in volume, which you mean, if nothing much changed year over year, the case ordering would be down quite a lot too. So did that weigh in on results much for the company or were some of the sales strategies able to offset that?

Well, the company is not immune from -- and our customer base is not immune from the general industry trends. Obviously, the economy is slowing down. There's a lot of focus on value and the value position retailers and number of whom we do not serve are gaining share. I think what makes up our top line as a wholesaler is customer gains, expansion in categories and then the underlying performance of our customer base. So you'd see some of our strategy as a wholesaler playing into the results. You'd see some of the underlying performance. The only other color I'd offer is that, we serve a large number of retailers and many of them are winning strongly. And innovating in their very agile independents or that way. And our focus besides earning new business is to make sure that we're doing everything possible to help our customers succeed and compete. And I think that's one of the reasons why we're earning new business.

Thank you.

We'll take our next question from Leah Jordan at Goldman Sachs.

Thank you. Good morning. I was wondering if you could provide some more detail on unit volumes, how they've trended in the quarter versus the industry on a sequential basis and year over year? And also how are you thinking about volume trends for the balance of the year when you look down among your different segments?

Sure. So I think we probably all have the same syndicated facts. Food stores running about minus three, total measured channels down minus two or some of the big discounters are improving that number. And in our numbers, we reported down mid-single digit, which is really in line with the kind of customer base we serve. That's being driven, obviously, by hyperinflation and price elasticity. A little better share loss to the big formats, which is why we're so focused on helping our customers be more competitive. As we look ahead, obviously, we don't claim to be expert accountants, but what we can see and is driving our performance is that, there are significantly less price increases taking place and that should lead to lower inflation, lower inflation should result in units bouncing back and exactly how and when that happens is anybody's guess, but we would expect inflation to moderate as the year goes on and units hopefully to improve slightly.

Great. Thank you. And I just had a follow-up on your private label strategy. Just seeing if you could provide an update on that. How did growth in that category kind of track versus the industry, as well as your internal expectations? And where are you tracking to your longer term goal of potentially doubling that business?

Our private brands performance in the quarter was very strong. As I mentioned earlier, it grew double digit. We recently skilled up and put a very talented leader on top of that business. We're overhauling our strategy by kind of sharpening our brand positions and improving our [KBI] (ph) execution. There's a lot of collaboration going on with leading retailers in our system. And I would say six months into the new plan that we're pleased about the results. There's a lot of opportunity for us to continue to give our retailers a competitive edge with very well positioned brands and the early performance of the new team is very good.

We'll go next to Peter Saleh at BTIG.

Great. Thanks for taking the question. I want to ask about the vendor promotions. I think you guys mentioned you're expecting those to increase in the back end of the year. Did I hear that correctly? And are you starting to see evidence of that and is that embedded in the back end of the year guidance?

Yes. This is Sandy. We are seeing a slight uptick in vendor promotions. We expect that to continue. We're still well below pre COVID levels, but in conversations with vendors at a couple of major conferences over the last 30 days, they indicate that they're going to become more promotional, but it's gradual as the way I would describe it.

Great. And then just on the inflation, Can you just remind us again what the inflation was in 2Q 2023 and what your expectations are for the back end of the year?

Yes, I'll take that one. This is John. So for the second quarter this year, our overall inflation impact to the overall company was just below 11%, which is compared to Q2 last year was little over 11%. So just to give you that sense. And while we're expecting inflation will moderate as we go through the back half of the year, which is in our forecast, we haven't provided specific guidance around that number just that we expect it's going to moderate.

Great. Thank you very much.

We'll go next to Krisztina Katai at Deutsche Bank.

Good morning. This is Jessica on for Krisztina. I just wanted to follow-up on your comments on improving fill rates. So just can you give us a few more details on what you're seeing there? And if there's any intricacies that we should think about? Thank you.

Yeah. Krisztina, this is Sandy. Fill rates are about 12 percentage points better. This in the second quarter than they were last year, which is a significant improvement. There continue to be categories that are stressed and parts of categories that are stressed. And we're still a ways away from where we were pre COVID, but we certainly see them improve year over year and sequentially from the first quarter.

Thank you.

We'll move next to Kelly Bania at BMO Capital Markets.

Hi, good morning, guys. This is Ben Wood on for Kelly Bania. Thanks for taking our questions. I wanted to step back and just look a little bigger picture at the inventory gains. Do you believe that the significant inventory gain headwinds is something that's being felt across the broader distributor landscape and among your competitors? And is there any risk that this kind of lower profitability reset spurs a less rational competitive dynamic?

Yes, Ben. Specifically to the inventory gain, that was a second quarter issue last year for us that impacted about two tenths of one percent of our inventory and we have not seen it repeat since. So I wouldn't think that's a broader issue. It just was a function of the supply chain volatility in the quarter. And really the broader picture here is a kind of analytical miss on our part as hyperinflation began last year without the experience of that scenario before we missed the cause of it going up. And therefore we just didn't have the right forecast for this year. The competitive environment, obviously, is very competitive, but it doesn't -- and it hasn't increased or decreased and really if you look at Slide 6 of our deck, what you see is that, our operating margins as we sort of head out of the COVID era are right on what they were beforehand. We just enjoyed a lot of growth, which we both earned and also seen as a part of inflation. So I wouldn't describe the competitive environment in a really different way than it has been and we would expect it to be.

Great. Thank you. And then just another quick one from us. I think you mentioned that you're seeing some share loss to certain of the bigger players by your customers. Can you just walk us through the competitive positioning of your customers and your retail? Maybe how they are aligned to mass and value players? And then what might you be messaging to them going forward to focus on to take the share back?

Sure. We serve 32,000 food stores, so very wide set of positioning from large natural to very, very strong ethnic position retail in the number of key markets that don't report to IRI and Nielsen, so they don't get counted in that share calculation. And so, their strategies to win vary by their positioning. What our job is as their back end is to have the tools and resources at the ready that allow them to win, to buy right for them, to get them items that are sharply priced, supplier promotions and services that allow them to streamline their operations, be more competitive and profitable. And we collaborate with them on strategy, but they drive it. Our job is to serve it. And independents are very widely and capable and innovative and many of them are gaining share, but there is a significant trend in price competition from the big players. And right now in this economic environment, it's working for them on the margin. That's just the general state of play.

Great. Thank you.

Next we'll move to William Reuter at Bank of America.

Good morning. I just have two. The first is on the change in the outlook regarding inventory gains and forward purchase opportunities. Are there any investments in systems that are going to be required to have greater visibility? Or is it just that the environment moved very quickly in terms of what those purchase opportunities were?

Yes, this is Sandy. One of the things that I've seen since I joined the company is an opportunity to address system maturities and modernization. And we've been building a plan for the last six months to take advantage of the opportunity to finish the integrations of past acquisitions that modernize our tech stack, establish a common data architecture so that we could begin to realize the full benefits for our customers of the extraordinary capabilities we have around the country. And in the middle of that is an opportunity to get much more effective and granular in real time analysis, which would have really helped in this situation. So we were in the process of building that plan. And as I mentioned in my comments, the Board approved it and we're moving forward. So think about it as people processes and systems deployed to build the analytical competence of the company. Some of that cost nothing. Some of it will involve investment that will be done in a very disciplined way. But the net effect of it is that we expect to have a more granular and real time view of our metrics and we expect to deploy all of that capability for the benefit of our customers and more efficient operations.

Got it. And then my second question, you mentioned the broad different baskets or groups of customers that you do serve. I would have thought that in the current environment, maybe natural and organics would do a little bit better than traditional grocery, because traditional grocery maybe experiencing that trade down to dollar stores, et cetera, that you mentioned. Are the natural and organic customers doing better than our more traditional grocers?

Some of them aren't, and I'm not trying to give you a huge answer. It varies. We're seeing some of our natural customers do extremely well. And in some cases, they're giving us more to do for them which makes it look even better. And you can see that in our results. But there is a bifurcation generally and some of the natural customers are taking full advantage of it. Some of the more conventional retailers are doing very well because of the diversity of their offer, their foodservice offer. So it varies really across the board based on the capability of the customer.

Great. That's all for me. Thank you.

And your last question comes from Scott Mushkin at R5 Capital.

Hey, guys. Thanks for thanks for squeezing me in here. So I kind of say that I'm a little bit confused and maybe it's me, but I think you guys said the inflation rate year over year was a little over 11% last year, a little under 11% this year. So why wouldn't the forward buy opportunity still be there given the fact that you're still going up 11%.

Hey, Scott. It’s Sandy. 11% is the year over year inflation. The forward buy opportunities happen in much narrower circles. Suppliers are obligated in one format to give us 60 days and the other 90 and the forward buy impact happens in that cycle. And what we're seeing right now is, while the accumulation of all the price increases that have happened in the last 12 months add up to significant year over year price inflation. The number of price increases that are happening now is reduced by about two-thirds from last year and that significantly impacted P6. And when we lapped it, we were able to understand it analytically. And as we look ahead, it was more impactful than we had expected. And that's what we've now applied to our second half guidance.

That's what you said. I thought it was me and it was. So the second question is, I mean, did you guys just not have the systems in place to understand how much forward buy you were doing?

Great question. Our systems, the way they're structured now, do a very good job of aggregating DC data each period and they do it accurately and it's very controlled. However, the granularity of that data and the real time ability to analyze it is not strong. And if you recall in the second quarter last year, and again, I'm just giving this to you the way we experienced it. Second quarter operating environment was crazy and we reacted to it like many others did by renting people and doing whatever we could to try to service customers. I mean I mentioned last year that our vacancy rate went from about 9% to 20% in seven days right before the holidays. And so that was where our focus was. And while margins started to pick up in P6 due to forward buying, the operating expense side of our business grew and we had lots sales and no EBITDA growth in the second quarter last year. And so as the year went on, margins continued to improve as a result of forward buying, but the company's focus was largely on making sure that we were operating properly and as efficiently as possible. And we missed it. The other thing I would say and this is as it happened, the macro nature of the systems in the way they worked, worked very well with an experienced management team that had experienced the trends over time. And the one scenario that none of us had was the rapid increase of extreme inflation. And so, the questions that we would have asked were not as natural and that just led to us missing it until we lapped it. And once we lapped it, we saw clearly that this is a big driver. Nothing makes a bad forecast good. It's simply bad. But what it doesn't mean is that the company is really in a different place after it gets through it. And then that's what you saw on Slide 6. But that's how we missed it, why we missed it and I don't know if you have a follow-up question.

Scott, this is John. Your question made me realize that I misspoke in my inflation response. So I want to correct that data. So our Q2 inflation that I said was just under 11% is correct. When I said just over 11% for Q2 last year, that was Q1 of this year showing that sequential deceleration that Sandy was talking about. Q2 last year was just under 6%, but the key is exactly what Sandy highlighted that sequential deceleration. So I apologize for that. When you asked your question, you made me realize I gave the wrong data point.

I appreciate the clarification. So then the last thing is we look at this business, My guess is, obviously, pulled your guidance. It seems like expense growth remains an issue across not you guys, employee costs, all this and maybe gross margin as you kind of look at it right now, it's going to be -- can take time to kind of build that as the efficiencies and other things come in. Is that the right way to look at this?

Yes, Scott, the way I would look at it is and I'll just kind of walk down the P&L for you. The top line is really strong. And the margins that we're getting from customers is solid. As I travel around the country and meet with customers, and I've been in 30 or 40 of them in -- of those meetings in the last 30 days. What we're working on for customers and being driven by customers is resonating and we're getting good feedback about our improvement for them and the relevance of what we're bringing to help them succeed. So I feel really good about the top line. And margins generally flow as a function of that value. And customer mix shift here or there or retail's margin shift into wholesale, those things will move around a little bit. But basically, we're steady there and therefore the top line will convert. The area where we're elevated and if you go back to fuel the future, one of our KPIs was to be 10 basis points a year down in our supply chain expense and obviously that's gone the other direction. And that's the opportunity we have and we made the decision to make sure we were taking care of our customers as best as we possibly could and then work on efficiency from that position. And I started talking about the improvement agenda a few quarters ago and that's now taken the form of a detailed transformation plan to attack that. And we believe there is a set of very common sense proven approaches that we can take that will and further increase our quality to our customers, but then also drive efficiency in the way our system operates. Efficiency in our operating expenses and efficiency in our capital. And while some of that will be achievable with discipline, and therefore be very high returns. Some of that will require investments in technology and automation where we'll have very disciplined returns. But that implementation is the center of our transformation plan and we look forward to giving the Street more details as we go forward.

Perfect. Thanks for taking all my questions.

Thanks, Scott.

And that does conclude the question-and-answer session. I'll turn the conference back over to Sandy Douglas for any closing remarks. Sandy Douglas Thanks, operator. And thanks to everybody for joining us this morning. While I'm not pleased with the results that we reported today, I remain highly optimistic about UNFI's ability to create value for our customers, suppliers, associates and as a result for our shareholders. I hope you've heard and take away from today's call that we are on a path to transform UNFI from the bottom up with an enduring focus on serving our customers in the best manner possible. We believe our focus on continuous improvement will lead to growth and perpetuate the flywheel effect that I've described in the past and generate solid returns for our shareholders. For our customers and suppliers, we thank you for your continued partnership and the business we do together. For the 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, we know this is a challenging quarter, but we thank you for the trust you placed in us and we will work diligently to deserve that trust. While we have a lot of work to do, I remain extremely optimistic about the value creating potential in front of us given our unique and unmatched customer value proposition. Customer feedback and contract renewals support this thesis. Our technology and operating capabilities represent meaningful improvement opportunities and we will invest in a disciplined, timely and appropriate manner to capture the immense benefits that they represent. We know we have work to do and we're doing it. We look forward to updating all of you again after our third quarter.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.