Good morning and welcome to UNFI’s Third Quarter Fiscal 2023 Earnings Conference Call. All participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to Steve Bloomquist, Vice President, Investor Relations. Thank you. Please go ahead sir.

Good morning, everyone. Thank you for joining us on UNFI's third 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 strategy and 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 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 third quarter call. As you saw in our release, we reported a quarter that was below our expectations. Today, we are going to address the drivers of these results and our plan to improve profitability in both the short run and in the longer term as we strive to advance our growth and improvement agenda. Our business performance is driven by revenue growth and margins. The top line is growing. We’re making continued progress, adding new customers, and increasing business with existing customers. While we won’t lose our focus on continuing to pursue this proven top line strategy and providing a differentiated customer experience. Profitability and forecasting are where we have fallen short this year and where a great deal of our attention remains focused. Before I jump into our quarterly results, I want to step back for a minute to provide some context. Prior to my arrival as CEO, in August 2021, the company had completed the largest acquisition in its history, just ahead of the onset of the pandemic. While it was a massive undertaking to complete this transaction, the UNFI SUPERVALU combination created an unmatched industry platform and a company with significant potential competitive advantages. There remains significant work to fully capture the full opportunity for long-term value creation. In the meantime, the combination has created a complex infrastructure, partially related to the predecessor company's respective long history of M&A, which limits our ability to understand the recent volatility within our business real time. We've been working to remedy these issues, but our progress has been enabled thus far to match the quickly changing conditions. The pandemic drove vast operational complexities, including a supply chain crisis, and a highly volatile macro economy, which we're…

Thank you, Sandy, and good morning, everyone. As Sandy noted, this quarter's results were below our expectations, and our focus remains on driving sustainable profitability improvement. Today, I will focus on the drivers of this financial performance, our balance sheet and capital structure, and our updated outlook for the year. With that, let's review our results. Turning to Slide 8. Net sales grew by 3.7% in the third quarter and totaled more than $7.5 billion reflecting continued customer demand for our products, as well as elevated, but moderating inflation. Wholesale sales grew by 4%, including inflation, net of elasticity of about 8%. Sales grew across our three primary channels with Supernatural growing the largest at 12%. This includes incremental volume from new customers added over the last year, additional categories and new store openings [in] [ph] Supernatural, and increased item and category penetration with existing customers. This was partially offset by a slightly steeper decline in unit volumes relative to prior quarters, but was in-line with Nielsen's total U.S. Food volume changes, which is representative of performance for the grocery industry. Retail sales declined slightly, compared to last year's third quarter, primarily driven by lower customer counts and a decline in items per transaction, hardly offset by higher average unit retail. Some of this activity was driven from lower EBT levels as pandemic related benefits expired during the period, as well as some share shift to mass merchants as Sandy noted. Flipping to Slide 9, the adjusted EBITDA for the third quarter totaled $159 million, compared to $196 million last year. The biggest contributor to the year-over-year decline was our gross profit rate prior to the LIFO charge in both years, which declined by more than 100 basis points and led to a gross profit decline of about $50 million.…

Thank you. [Operator Instructions] Our first question comes from Mark Carden from UBS. Please go ahead. Your line is open.

Hi. This is Isabel Thompson on for Mark Carden. Thank you for taking our question. Maybe to start, you did call out some more challenges cycling, procurement gains in the third quarter. How did these shake out relative to your expectations? And how can we think about these impacting the fourth quarter?

Sure. I'll take that. I appreciate the question. This is John. So, broadly, with the way we forecasted that and what we're expecting, there still continues to be softness within the forward buy and the opportunities that are presented, as well as the magnitude of those opportunities when they do come through. We were reasonably close within Q3 on a net basis, but some of that softness that we started seeing it towards the end of Q3 as we extended it through the rest of the year is one of the contributing factors to bringing that guidance down for the rest of this year.

That's helpful. Thank you. And with the 100 million in near-term cost-outs, do you see much of that risk of cutting into some of the revenue driving initiatives, or do you simply have enough room to, you know, [turn back FX] [ph] expenses elsewhere?

Yeah, our point of view – this is Sandy. Good morning. We viewed $100 million of short-term action as principally a fiscal 2024 impact to help address some of the margin weakness that we'll be cycling in the first part of the year. And with very little impact in the rest of fiscal 2023.

Thank you.

Our next question comes from Leah Jordan from Goldman Sachs. Please go ahead. Your line is open.

Thank you. Good morning. I was seeing if you could talk about vendor promotions a little bit more. How did they track versus your expectations in the quarter? And does your guidance make in any sequential improvement into 4Q?

Sure. This is John. I'll take that one, Leah. Good to hear from you. Yes. Promotions, they're still well below pre-pandemic levels, again, both in the percent of the items and in the magnitude of the discount. So, we are anticipating that trend is going to continue as we move through the rest of our fiscal 2023. And we'll see how the macroeconomic develops to see if there's an opportunity for some tailwinds as we move in through the rest of 2023 and into 2024.

Yes. And I'll just add that what I hear from suppliers is a generally constructive outlook to try to resuscitate unit movement in the market. And so we have an expectation that promotions will continue to grow, but so far as John said, that's been a kind of a slow lag.

Okay, thank you. And then on my follow-up, I wanted to see if you can give more detail on your capital allocation priorities. And also curious how you're thinking about the timeline of getting back to below 2.5x leverage and balancing that with all the investments you have in tech and automation along with buybacks?

Yes, sure. So, I'll start that and capital allocation still a primary focus of ours. And the way we think about that is, we think about where can we invest that cash? And we've got the opportunities to invest and grow for the business, as well as to drive those transformational improvements that we've talked about before. Those are both required investments. And then, of course, the other priority is, of course, continuing to improve our debt-to-EBITDA leverage. That's going to be challenged a little bit in the foreseeable future given the trends in our business, but the way we think about that is we're going to continue to make the right short and long-term investment decisions looking for the right returns for the shareholder, as it relates to those transformation and other investments to run and grow the business and drive the efficiencies. And then as I mentioned, to continue to focus on debt reduction and improving that debt-to-EBITDA leverage.

Great. Thank you.

Our next question comes from Scott Mushkin from R5 Capital. Please go ahead. Your line is open.

Hey, guys. Thanks for taking my questions. A decent amount to unpack here. So, I guess I wanted to start-off with retail. And, you know, obviously, the business is underperforming. It's underperforming the market quite a bit. You know, there were thoughts originally when the merger took place that it would be sold. Can you just give us a little bit of an update on where you're headed strategically on retail? And then also maybe how you improve the business?

Yes. Thanks, Scott. I'll take that. And you're right, we had a weak quarter in retail this quarter. We've been seeing some sequential top line resistance and we've got a new management team in there that's taking decisive action to resuscitate the Cub brand. The Cub brand is still the market leader in the Twin Cities. And I think our intermediate assessment here is, we needed to get more focused from a value standpoint and on a fresh category perspective and the teams take an action to do that. On the broader question of capital allocation, obviously, we don't have anything that we would publicly say about that other than it's our general focus and a part of our thinking in every aspect of the company to make sure that our uses of capital are generating the highest level of return and focus. Those are independent answers. We have a strong plan to resuscitate Cub. It is not a weak asset. It just had a quarter or two of subpar performance and we're taking action to address that.

Okay. And then I wanted to, you know, obviously move on to distribution here. And I guess, I wanted to maybe frame a little bit better, you know, what's cyclical in the business and you think will kind of add as we get into next year, and that's depressing EBITDA versus, kind of the, I'll call it, systemic. But I guess UNFI specific challenges that are pressuring EBITDA.

Sure. It's a good question and obviously a very important one to us as well. Broadly, there are a lot of environmental factors that are impacting short-term P&Ls. Last year in fiscal 2022, we saw a big upswing in value that we got as inflation to cold and our inventory was valued lower than the market price and we strategically [forward thought] [ph] and it was a tremendous source of margin expansion. And obviously, we've been down the back-end of that – this year and it surprised us in Q2. As John answered earlier, it was less sort of surprise. It's weaker than we thought it would be since that estimate, but the broader driver now is a set of factors that involve just, sort of market slowdown in the consumer, retrenching to value. There's been some market share shifts to large retailers. And in a couple of cases, in very specific senses, we've had commodities deflate, which causes another very short-term and hopefully non-recurring P&L issue as prices in the market have to go down faster than the cost basis in our DCs. So, there's a lot of moving parts as you say. Inside of UNFI, there are also some sustainable capability opportunities. I use the word turnaround from a capability standpoint. I view the sales, pro services, and brands proposition in this company to be really strong. The scale of the company, the potential to create value for suppliers and customers is as high as I've ever seen it, and I say it every quarter. The flipside is, the capability, call it, people processing systems to execute to run a supply chain to sell customers to drive value for shareholders is a turnaround opportunity of large proportion. So, I'll give you one final example, shrink. Shrink is all…

Great. Thanks Sandy for all the color. I appreciate it.

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

Good morning. This is Ben Wood on for Kelly. Thank you for taking our questions. Just wanted to start and step back and see, can you provide us with any update as to the visibility into what's happening at the gross margin level versus given the various systems you're working on, how is your insight into puts and takes of gross margin change or improved from last quarter?

Yes. I appreciate the question, Ben. This is John. I'll start. I think the visibility is better and improving. We’ve put – as we talked about last quarter, we put the best of our FP&A group onto the process. We’ve changed our process. We've changed the data we're trying to collect through those challenging opportunities that you mentioned. So, we're making good progress. And that being said, we're still not where we want to be from a forecasting perspective. We're engaging external parties to assist us with this, looking for more of a driver based macro view of our forecast and there's still lots of opportunities for us to get better, but we've made good progress in the past few months to bring some visibility and allow us to at least provide the range that we provided today.

Great. Thank you. And then switching gears just a little bit here. Can you provide us some more details onto the volume trends to start? What was, I guess, inflation in wholesale and retail? And then across your channels, how much did new accounts impact volumes versus, kind of what was the comp volumes? And then what are you planning for the fourth quarter?

Yes. Let me make a general comment, Ben, and then let John punctuate it with a little bit more granular information. What we saw broadly was growth in sales across all of our channels. Now, the strongest in supernatural as we have a very strong relationship there, and we're expanding category participation and working very well together. It was less strong than some of the other ones. Now, those are sales numbers. Obviously, inflation is playing an important role in the sales momentum. Volume is continued to be negative in most parts of our business as elasticities are driving down units. And that's the reason why it's such a big focus across the industry to try to address that. Right now, from an elasticity standpoint, and I think my colleagues can correct me if I'm wrong here, but the return to unit growth is not happening in a linear way as inflation comes down. There's some sort of clinging weakness in units, and that seems to reflect a broader economic issue as consumers try to stretch their shopping budget. Within our channels, I see winners, and people are struggling in virtually every one. This is still a business of market positioning and execution, and we do business with some of the most innovative and successful retailers in the country, regardless of size, but clearly, within our paths, the fastest growth right now is supernatural because of new categories and their execution, but more to come. John, anything to add?

Yes. The only thing, just from an inflation perspective, just to give some numbers and a little color to that question. When we think about inflation for Q3, and this is our inflation, it's going to be somewhat similar to what you're seeing externally, but this is the inflation for UNFI. We saw that 8.2% inflation in our third quarter. And just to put a little color around that, we were at 10% for Q2. So, we're seeing that deceleration of inflation. And as Sandy mentioned, within that number is deflation in certain commodities as well. And if you look back to FY 2022, our Q3 inflation was about 8%, but the sequential from Q2 last year to Q3, Q2 was 5.7%. So, we saw that inflation rising as we moved through Q3, providing that forward-buy opportunity, as well as commodity inflation and a tailwind last year. And then we're just seeing the inverse of that this year with the deceleration of inflation from Q2 to Q3 this year.

Great. Thank you. Appreciate all the color.

Our next question comes from Andrew Wolf from CL King. Please go ahead. Your line is open.

Good morning. Thank you. Just wanted to ask on the Slide 9, the bridge to the EBITDA last year to this year. The $35 million positive benefit from the incentive compensation, is that a true-up or a reversal of prior accruals plus the quarter – not taking the quarter's accrual?

Yes. It's not taking the quarter accrual, as well as a reversal for what was remaining in our bonus accrual when we finished Q2. So, it's a combination of those two things.

Okay. It kind of linear like [15 each quarter] [ph], maybe a [30] [ph] of the reversal and 15 of not taken accrual?

Yes. That is a perfect rough math for you. And then if you go back to Q3 last year, there was actually an additional AIP expense given the performance of the company.

Got it. So, I guess what's really perplexing me the most is that helps explain some of the sequentially lower EBITDA in Q4, but the range is pretty wide, but even at the high-end, that $35 million doesn't explain all the sequential slowing. So, could you just, kind of – what's going on with the business and the macro backdrop where the Q4 is projected sequentially, even if we exclude the – take out the accrual, the comp accrual in Q3, [and why] [ph] you're looking for further sliding in the EBITDA run rate?

Yes, I'll take a shot at that, Bill. I think the way that we looked at the fourth quarter was taking a case that reflected the momentum from the third quarter at the low end as we saw certain things like deflation start to accelerate in key categories and project that forward and then taking some of the more top-line focused actions that we have in the market and anticipating them starting to bite, and that got us to more of the top-end. The broader, sort of, what's going on story in the market is, I think there's a general tightening of the market. We are seeing some share movement from all other to the big discounters and clubs, and they're competing to try to take advantage of the opportunity. We, on the other hand, led by our private brands program as the, sort of key focus area, are working to give our customers the best possible weapons to compete on the back-end, but there's down-trading going on as a result of all that. And so, if you saw a return to stronger promotional activity from vendors, you'd start to see us inch higher as sales rebounded a little bit. After you saw everybody, sort of dig in for the summer, you'd see performance more near the low end of the range, and there's nothing more significant going on than that.

Okay. And I just want to follow up, Sandy. On the promotional cadence with the vendors, I think you said earlier, it really hasn't shifted much. And I'm just – if they're – are they content to see their market share shift into different channels, so they're indifferent or do you expect that there's going to be some change in that promotionality?

I was with a lot of them yesterday. We have a big event to raise money for the UNFI Foundation, which is all about food and security and a big part of what we do. And we got a bunch of vendors together, and we talked about the business. And to the vendor, their narrative is, they're getting focused on growing units again. I didn't hear one vendor that gave me a different narrative than that. When [indiscernible], when we got into the dollars and the specific actions, they're different. There are some that are already in motion. There are others that are really talking about it. They're seeing the share data, and they're seeing the way the market is changing. And of course, when they're hanging around of someone who represents a lot of independents, they're talking about accelerating independent growth. And I think it's in their interest and our interest for independents to lead growth in this market, because it creates diversity in the channel and it's good for building brands in different places and in different towns and merchandising environment. So, we've got the story what we hope happens as we get to follow through. Certainly, that's what people are saying, and we expect that more and more of that will happen as we go forward.

Great. Thank you.

Our next question comes from Peter Saleh from BTIG. Please go ahead. Your line is open.

Great. Thanks. Just a couple of questions on my end. First, coming back to the conversation around shrink, it just sounds like we're hearing more and more about shrink lately from many other operators. Just curious, can you just give us a sense of really what's changed over the past maybe 3 months to 6 months that shrink has just gotten more material of an issue? Just trying to understand the dynamic that's going on.

Peter, at this stage, there's multiple factors that have impacted the degradation in shrink. At retail, you've heard from others that there's higher incidence of theft, and the practice of managing that at the retail stores become highly complex from a workplace safety, as well as managing shrink perspective, actions being considered or how late we stay open, different local, local, local solutions to the problem. But I think that's a big part of the retail degradation inside of DCs. There's a lot of return to the basic disciplines that drove good DC execution in the past that are part of the solve here. The last couple of years, DC environment has been a get-through-the-day environment, who can we get to come to work environment. As that settles down and the training manuals are updated and the training disciplines are implemented, we expect to see all kinds of different metrics in DC execution improve. And then finally, we're using technology in a new way to track orders and to make sure we drive for higher levels of order accuracy and then return – speed the offset of credits to customers when we're not accurate, but not over-credit customers based on historical trends. And so, I just sort of summarized a much more complicated multifactorial problem, but we have the – from a management-focused standpoint, reducing shrink is our Chief Operating Officer, Erin Horvath's Number 1 priority, and she convenes a cross-functional management team through action planning every week. And it's my expectation that whether it's procurement shrink or lingering PPE inventories or working through the different types of products that tend to be more shrink-sensitive on the procurement side, all the way to DC operations, technology, all the way to execute through retail, that you'll see improvement in those numbers in the weeks, months, and years to come.

Great. Thanks. And then just on the consumer side. I think I heard you say consumers are retrenching to more value, and maybe you're seeing with some smaller basket sizes as well. Can you just elaborate a little bit on some of the detail that you're seeing there? And when did that kind of shift start? Is that a more recent occurrence or has that been going on for the bulk of [this year] [ph]?

I believe it's sort of increasing gradually, but from our perspective, we have had a priority on our private brands program for several years. Last fall, we skilled up the leadership of that group. And this year, we have two or three major program initiatives in the field with our customers around known value items, around reconsidering the price positioning of the product offer. We're actually focusing on a narrower set of brands to make sure that the value impact is as strong as it possibly can and can be. And our customers are embracing it and implementing it. And we're seeing significant unit improvement. And I would say, it's in the top 5 focuses of the company to make sure that our retail customers have the best private program that they can have to compete against the lower private label programs that they're seeing from some of the bigger retailers in the country.

Thank you very much.

Your last question comes from William Reuter from Bank of America. Please go ahead. Your line is open.

My first question, as you talked about renegotiating some of your contracts with customers and suppliers to make sure that those are profitable, do you have a sense for how much unprofitable business there may be today? And what the benefit once you are able to get better visibility into all of the promotions and dollars that are shifting across those programs? Do you know what that benefit could be?

[Peter] [ph], this is a part of a four-part plan that I mentioned in my script about really looking at a much more granular way at our budgeting and how we're using the resources of the company to drive results and value, SKU management, as well as streamlining our administrative structures and particularly at the senior levels look at layers and spans of control to try to be as efficient and agile and fast as possible. From a commercial contract review perspective, it's been my history that in a company like ours that has thousands of those kinds of contracts, there's an opportunity to look at them individually and holistically for compliance, for terms that are no longer relevant, for ways in which both the customer and UNFI on the downstream side or the supplier and UNFI on the upstream side can work together to make a situation better. And I mentioned that, that four-part plan has a basket level opportunity of approximately $100 million, mostly to impact fiscal 2024 to address some of the run rate margin and forward-buy issues that we have in fiscal 2024. And we'd expect those components to contribute importantly to that. I don't think we'll disclose the individual amounts, but there are material opportunities. And there are things that will be good for our customers and our suppliers because there are things on both sides that can be modernized to make us faster and easier to work with, grow faster, but at the same time, more profitable.

Great. By the way, my name is Bill or William, not Peter. My second question, the $100 million of cost savings, can you give us some of the buckets of where we're going to be seeing those come through the P&L?

Well, a couple of them will show up in margin and a couple of them will show up in SG&A.

Okay. I guess, I was wondering if you could share a little more detail on the components? If you've been able to figure those out at this point or is it still too early?

If you're talking about amounts of the items, we won't disclose that. If you were looking at where in the P&L – commercial contract reviews will largely show up in margin. There's some cash flow components there relative to payment terms. There's a piece of that, however, is operating expense because we'll be looking at order quantities and order frequency. So, as you can tell, it's a comprehensive opportunity, as the, sort of more granular budgeting is across the P&L to make sure that every dollar that we spend is useful against the plan that we have. My experience is, is that a lot of times when people budget based on last year, the existence of a spend argues for its persistence, and we have a process here that we've implemented that generates good relief of those investments that are no longer relevant. And so that process goes across the P&L. SKU rationalization will improve margin and operating expense, better aligning DC space with the velocity of the SKUs that we carry and eliminating wasted space and wasted capital. And then the streamlined administrative structure will come into SG&A mostly. I hope that's helpful.

That is helpful. That was kind of exactly what I was getting at. All right. Thank you.

Thank you.

We are out of time for questions today. I would like to turn the call back over to Sandy Douglas for closing remarks.

Thank you, operator, and thanks to everybody for joining us this morning. While our recent results have been challenging, I remain confident in the longer-term outlook and prospects for UNFI. As I said earlier, we're disappointed, but not discouraged by the past few quarters and are working to improve profitability and recapture the shareholder value that has been lost. As I stated on our second quarter call, our transformation agenda will be a multi-year journey with the sole goal of improving key capabilities, so we can better serve our customers, suppliers and associates, while being a good steward of the planet and creating value 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 special 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 period, but we thank you for the trust you place in us. And we are working diligently to deserve that trust. We know we have work to do, and we are doing it, but we are doing it in a disciplined and methodical manner and at a pace that balances urgency with thoughtfulness, an attitude of doing the work that needs to be done in the highest quality manner. We look forward to updating you again after the fourth quarter.

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