Edited Transcript of UNFI earnings conference call or presentation 10-Jun-20 12:30pm GMT

Thomson Reuters StreetEvents

Q3 2020 United Natural Foods Inc Earnings Call

PROVIDENCE Jul 5, 2020 (Thomson StreetEvents) -- Edited Transcript of United Natural Foods Inc earnings conference call or presentation Wednesday, June 10, 2020 at 12:30:00pm GMT

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Corporate Participants

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* Christopher P. Testa

United Natural Foods, Inc. - President & CMO

* Eric A. Dorne

United Natural Foods, Inc. - COO

* John W. Howard

United Natural Foods, Inc. - Interim CFO

* Steven J. Bloomquist

United Natural Foods, Inc. - VP IR

* Steven L. Spinner

United Natural Foods, Inc. - Chairman & CEO

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Conference Call Participants

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* Edward Joseph Kelly

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* James Ronald Salera

Northcoast Research Partners, LLC - Research Associate

* John Edward Heinbockel

Guggenheim Securities, LLC, Research Division - Analyst

* Karen Fiona Short

Barclays Bank PLC, Research Division - Research Analyst

* Kelly Ann Bania

BMO Capital Markets Equity Research - Director & Equity Analyst

* Rupesh Dhinoj Parikh

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Scott Andrew Mushkin

R5 Capital Ltd - Founder & CEO

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. And welcome to the UNFI Third Quarter Fiscal 2020 Earnings Call. (Operator Instructions)

I would now like to hand the conference over to Mr. Steve Bloomquist, Vice President, Investor Relations. Please go ahead.

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Steven J. Bloomquist, United Natural Foods, Inc. - VP IR [2]

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Good morning, everyone, and thank you for joining us on UNFI's Third Quarter Fiscal 2020 Earnings Conference Call. By now you should have received a copy of the earnings release issued earlier this morning. The press release, webcast and a supplemental slide deck are available under the Investors section of the company's website at www.unfi.com, under the Events tab.

Joining me for today's call are Steve Spinner, our Chairman and Chief Executive Officer; John Howard, our Chief Financial Officer; Chris Testa, President of UNFI; and Eric Dorne, our Chief Operating Officer. Steve and John will provide a business update, after which we'll take your questions.

Before we begin, I'd like to remind everyone that comments made by management during today's call may contain forward-looking statements. These forward-looking statements include plans, expectations, estimates and projections that might involve significant risks and uncertainties. These risks are discussed in the company's earnings release and SEC filings. Actual results may differ materially from the results discussed in these forward-looking statements.

And lastly, I'd like to point out that during today's call, management will refer to certain non-GAAP financial measures. Definitions and reconciliations to the most comparable GAAP financial measures are included in our press release.

I will now turn the call over to Steve.

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [3]

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Thank you, Steve, and good morning, everyone. There's a lot to talk about this morning. UNFI quarterly results, how we're continuing to navigate the COVID-19 pandemic and the strategy and plans we're preparing for a new fiscal year.

But before we do that, let me say this. We stand proudly with the black community, in solidarity to address the system of systemic racism in America and the most important work of ending these injustices once and for all. We believe black lives matter.

As you know, over the past several weeks, we've seen firsthand the horrors of George Floyd's murder. In one of our largest markets and home to one of our corporate headquarters, Minneapolis, and in the aftermath and protests that occurred in other major U.S. cities. The loss of life, any life, is upsetting. When it's preventable, it's even more difficult to accept. Unfortunately, this entire event again spotlights the harsh reality, racial injustice, specifically toward black American, men and women, punctuates the inequity in our country.

At UNFI, we expect diversity and inclusion to be at the core of our DNA, in the people we employ, how we conduct our business and in our essential role supporting grocery retailers everywhere. We expect it to be at the core, but we would be misguided to tell you we are doing this perfectly today. We can, and must, and will do more.

These systemic problems of humanity will not go away until we confront them head on. That starts with speaking up, listening, acknowledging and empathy to understand. And right now, we're listening, learning and holding ongoing conversations with our associates to provide them with a chance to be heard, to share ideas or concerns and an opportunity to offer honest feedback and suggestions. We've held several of these community conversations with associates over the last week, and we'll be holding more in the coming days and weeks. Feedback from these sessions will help inform many of the actions we take.

At the core of our efforts will be our value of doing the right thing, which, on the surface, is really simple. Treat others the way they want to be treated, with respect, decency and fairness. But we know it's not that simple. As such, UNFI will be investing more resources into our diversity efforts. We'll place greater focus on and generate new initiatives to support our education, training, hiring, promoting, recruiting and retention efforts.

We'll look to align support within our associations and support coalition opportunities wherever we can to help drive meaningful change. We're forming action teams to ensure we don't lose sight of this goal: eliminate racism and foster greater opportunities for black men and women at UNFI and in America. We're creating specific, measurable metrics for each of these efforts to hold ourselves accountable. We will also work harder to get to know each other better. This will be at the core of what we do.

We're going to do our part. We will make change happen. And our pledge is to continue evolving and foster an inclusive culture of equality to create a better UNFI from the inside out, and to demonstrate how we can all do better, not through talk, but through action.

Before we discuss our third quarter results, I wanted to first offer my sincere thoughts and prayers to all of those affected by the COVID-19 pandemic, and my gratitude and appreciation to our nation's health care professionals, first responders, essential workers, including all the incredible UNFI associates, who have done amazing work during these unprecedented times. Their safety and well-being has been, and will always be, at the forefront of everything we do. I am so proud that UNFI was one of the first companies to adopt a $2 per hour temporary state of emergency bonus for our direct labor associates; that we provided tremendous flexibility towards attendance policies and productivity expectations during the most impacted times of the outbreak; and that the safety and sanitation measures we've taken in our distribution centers and retail stores have kept our associates safe.

In addition to supporting our associates, UNFI has now donated more than 6 million pounds, equal to an estimated 150 truckloads, of food and essential items to food banks across the country, and we've committed over $1 million to philanthropic organizations, helping those impacted by the pandemic, in addition to the funds previously committed through the UNFI Foundation. And information about the foundation can be found at unififoundation.org.

COVID-19 has changed everyone's life and radically altered where and how food is purchased and consumed. At the time of our last earning calls, in March, more than 50% of dollars spent on food went toward consumption outside the home, including full and limited service restaurants, hotels, recreational attractions, in schools and colleges. Fast forward 3 months and the landscape is dramatically different. As we all know, there has been a significant shift towards food consumed at home, with some estimates placing the potential shift this calendar year at approximately $100 billion.

As you know, we pre-released third quarter results on May 12, and issued a complete financial statement earlier today, which were substantially unchanged from last month. Our third quarter results reflect the demand shift I spoke to. In March, midway through the quarter, we saw a significant jump in demand as consumers began loading their pantries with outsized purchases of items such as toilet paper, sanitizers, pasta and canned soup. While our third quarter results did benefit from this pantry loading, net sales continued to increase at a double-digit pace over the remaining weeks of the third quarter, and this trend has continued into the early stages of the fourth quarter as well.

Through the first 4 weeks of the quarter, wholesale net sales were up roughly 11% compared to the same period last year. These results demonstrate the power of our business model and our success building out the store. We experienced strong double-digit growth throughout our portfolio and are on track for over $175 million in cross-selling revenue this year as our customers continue to recognize the benefits of consolidating purchases with UNFI and our industry-leading 250,000 item SKU count.

Today, we provide real value through industry-leading capabilities across all categories, including produce, protein, general merchandise, health and beauty, services, and so much more, all with the benefit of scale.

Another point that differentiates UNFI and contributed to our strong sales growth was the performance of our Brands+ business, where sales were up 26% for the quarter compared to last year. During recessionary periods, consumers are more likely to turn to private brands to stretch their food dollars. And we believe that our selection of conventional and better-for-you products, which represent more than a $2 billion business on its own at retail, is unmatched in the industry. This is supported by Nielsen data that shows March and April growth rates for UNFI's private brands has been consistently higher growth rates than other retailer-owned private brand programs across the U.S.

We've seen great success with our Essential Everyday, Wild Harvest and Field Day brands where our growth rates in many key categories have been double or triple that of the category total. With examples, including soup, frozen vegetables and household paper products.

Overall, the progress we've made on our Build out the Store strategy and our initial cross-selling success has fundamentally changed the relationship we have with many of our customers, who, more than ever, look to UNFI's scale and variety to help them best meet the needs of their shoppers.

Our 12% sales growth in the third quarter includes the impact of headwinds from lower inbound fill rates, as suppliers across multiple product categories were unable to meet the significant increase in demand in the quarter. And while we do expect fill rates to gradually improve as we move through the fourth quarter, we do not expect them to return to pre-COVID levels until fiscal 2021.

Our unmatched size, scale and geographic footprint allowed us to support the strong increase in sales with our existing infrastructure, driving fixed operating and administrative cost leverage to increase our adjusted EBITDA margin from continuing operations by nearly 25 basis points. Our $222 million in adjusted EBITDA included approximately $25 million in COVID-19-related costs, for safety protocols, procedures, additional third-party labor support to handle the increased volumes as well as pandemic-related incentive payments to frontline associates.

Our synergy and integration initiatives also contributed to our strong results this quarter. UNFI is also investing in a variety of ways for anticipated future growth. We're midstream on updating our ordering technology and customer portal, which will make it easier for our customers to interface with us for promotions, ordering, billing and other aspects of our relationship. We've also seen a dramatic uptick in customer inquiries for our turnkey e-commerce solution for brick-and-mortar stores, likely driven by data that suggests more than 40% of recent online grocery users were first time shoppers. Our offering leverages the historical e-commerce platform investments we've made that can have a customer up and running with a variety of web and mobile device offerings in a relatively short time, which is attractive for those customers looking to now provide an online offering to their consumers.

We believe our investments to date have positioned us to deliver continued growth in the e-commerce space. We're also continuing to invest in optimizing our distribution center network, including automation, where appropriate.

Next, let me talk about our retail banners, Cub and Shoppers. Last month, given the state of the M&A markets, I said we'll likely be running some Shopper stores for an additional period of time, and that same thinking applies to Cub. As an interim step, we're in the process of separating Cub from UNFI, which means Cub will operate more as a freestanding entity than it does today, with its own dedicated resources once the separation is complete.

Historically, we've supported Cub with shared resources that include associates splitting their time between Cub and other parts of the business. This should accelerate the diligence period and allow for a more streamlined process when we market these banners for sale. We've also decided to take a pause on the sale leaseback of Cub's owned properties. To maximize the value of the banner, including its own real estate, we've pushed these potential transactions 24 or so months into the future. As a result, beginning in the fourth quarter, we'll move Cub and certain Shopper stores into continuing operations, which John will discuss shortly.

As I mentioned earlier, sales to date in our fourth quarter remains strong, and we believe people will continue to eat more at home than they did 6 months ago for several reasons which should drive favorable trends for UNFI.

First, beyond the question of "Are restaurants open?" and "Am I allowed to eat out?" is the question, "Do I feel comfortable doing so?" We believe there is, and will continue to be, a degree of hesitation for eating at traditional sitdown restaurants. A recent survey by Piper Sandler found roughly 2/3 of respondents planned to cook more at home post-COVID, with an average of more than 4 additional meals per week.

Second, we expect we could see a recession last for 12 to 24 months, and UNFI has historically done well during recessionary periods. Our Brands+ business should continue to perform well given the lower price point and differentiated value of these products.

Third, many businesses have now extended work-from-home plans, meaning many of us will continue to eat more meals prepared in our own kitchens as we work, where we sleep.

And finally, our customers, both new and old, have responded to our new business model, combining natural and conventional with new opportunities and the strongest pipeline we've had in years. We are one company providing retailers with the most sophisticated services, the broadest product offering and an unmatched network of distribution centers.

Let me summarize the importance of our third quarter results and updated outlook for fiscal 2020 and provide some thoughts on fiscal 2021. Sales in the third quarter grew to $6.7 billion, up 12% versus the prior year. Adjusted EBITDA was $222 million, up 32% versus last year's third quarter. Adjusted EPS was $1.40, up 130% or $0.79 versus last year's third quarter. And based on the trends, we believe the momentum will continue, and fiscal 2021 will be better across these key metrics.

We've also paid down over $300 million of net debt and closed the quarter with $1.2 billion of liquidity. We are continuing to review our fiscal 2021 budget and look forward to providing more detail in September.

Our 25,000 associates, and especially those working on the front lines, are incredible. Since COVID first appeared, we've remained open, we've protected our teams, we've paid our front-line associates incentives with more flexible programs, and we've hired over 3,000 new team members. This work has been and continues to be truly remarkable. We expect to finish the year with a strong fourth quarter, as reflected in our raised guidance for adjusted EBITDA as well as adjusted EPS.

With that, let me turn the call over to John.

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John W. Howard, United Natural Foods, Inc. - Interim CFO [4]

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Thank you, Steve, and good morning, everyone. I will cover our third quarter financial performance, balance sheet, capital structure and updated outlook for fiscal 2020.

Let's start with sales for the 13-week third quarter, which totaled approximately $6.7 billion, up nearly 12% versus last year, driven by COVID-19 demand, cross-selling revenue and strong private brand performance.

Sales in the supermarket channel, which represents nearly 2/3 of our volume, increased by 15%. Beyond the COVID-related demand, we believe this increase reflects shifting consumer preferences towards value in this time of crisis as well as an acknowledgment of the relevance, importance and trust of the local grocer.

Our supermarket channel results include sales to customers with captive distribution facilities that have been pressured by the uptick in volume, reflecting the value UNFI brings to a broad range of customers.

Supernatural sales were up over 16%, continuing its strong recent trends and expanded by COVID-19. Independent sales, representing 10% of total net sales, were down about 3%, including a 900-basis point headwind from the customer bankruptcies we have discussed last quarter. The growth in this channel, adjusted for the bankruptcies, was impressive given the pantry-loading and value-seeking behavior that we believe favor the conventional supermarket.

Finally, our other channel was down 3%. And included in this total is the strong growth from our 2 largest e-commerce customers, which was more than offset by declines in our foodservice sales and military sales.

Third quarter gross margin of 12.85% declined approximately 37 basis points from last year's gross margin rate. The decline was driven by a product mix shift towards lower-margin products as well as a decrease in vendor funding as manufacturers became less promotional, which was partially offset by lower levels of shrink compared to last year. Cost inflation in the third quarter was approximately 1%, down slightly from last quarter.

Third quarter operating expense was $774 million or 11.61% of net sales compared to $738 million or 12.37% of sales last year. The 76-basis point decline was driven by strong expense leverage on the fixed and semi-fixed portions of our operating and administrative costs as well as the benefits of our synergy and integration efforts.

Third quarter operating expense includes roughly $20 million in COVID-19-related expenses. Including another $5 million in discontinued operations, we spent a total of $25 million in the third quarter in COVID-19-related expenses to promote the health, welfare and safety of our associates.

Our double-digit growth in net sales, combined with improved leverage in operating expenses translated into strong profit performance. Third quarter consolidated adjusted EBITDA was $222 million, an increase of 32% versus last year. Our third quarter sales includes $58 million of adjusted EBITDA from our retail banners, an increase of $24 million compared to last year's third quarter.

Our adjusted EBITDA margin rate from continuing operations increased 23 basis points versus last year. Third quarter net interest expense was $47 million, a decline of $8 million from last year, driven by lower average debt balances and interest rates compared to last year. The effective borrowing rate for the third quarter was approximately 6.4%, up slightly from the second quarter as a result of lower ABL balance, UNFI's least expensive debt instrument.

Q3 GAAP EPS was $1.60 per share, which included the following items. First, we incurred restructuring, acquisition and integration-related expenses of $0.19 per share. Second, we took another $0.19 per share charge for store closure costs and charges within our discontinued operations. And third, we had $0.03 per share in expenses related to exiting certain sites in our surplus property portfolio.

More than offsetting these expense items was a $0.61 per share benefit on the tax line that included the impact of the CARES Act, and to a lesser degree, the tax consequence of the 3 items I just mentioned. The GAAP tax benefit from the CARES Act resulted from our ability to now carry net operating losses back to tax years with statutory rates higher than the current rate.

In total, these adjustments net to a $0.20 reduction to our GAAP EPS, bringing adjusted EPS to $1.40 per share. This is a $0.79 or 130% increase from last year's third quarter adjusted EPS of $0.61.

Given the significant increase in volume running through our distribution centers and our focus on the health and safety of our associates and strong operating performance in light of unprecedented increase in demand, we had a lighter-than-normal quarter in terms of capital expenditures, which totaled $34 million or approximately 50 basis points as a percent of net sales.

We are pleased with the strong net debt reduction we achieved this quarter. Total outstanding debt and finance lease obligations at the end of Q3 net of cash and cash equivalents was $2.66 billion, the lowest quarter end amount since the acquisition and a decrease of $302 million compared to the end of Q2. The primary drivers of our debt reduction were strong cash flows from a reduction in working capital and increased earnings, partially offset by a $94 million increase in our long-term finance lease obligations from the addition of a finance lease for our second distribution center in Moreno Valley. The Moreno Valley finance lease addition is part of a strategy we're working on to lower our long-term occupancy costs for this facility.

We ended the third quarter with a total liquidity of approximately $1.21 billion, which is the sum of the unused capacity under our $2.1 billion revolving ABL facility plus cash and cash equivalents. Overall, we're pleased with our third quarter results and look for another strong quarter as we finish the year.

Turning to our full year outlook for fiscal 2020. We withdrew our prior guidance in our May 12 prerelease, given the strength of our year-to-date financial performance. The new guidance we issued today represents our current thinking on how we expect the year to finish, recognizing that these remain highly uncertain times. Our updated guidance also reflects changes to how we'll be reporting results for Cub and certain Shoppers stores that will be moved from discontinued operations to continuing operations as a result of our plan to delay moving these assets, as Steve discussed. These reporting changes will be reflected when we report fourth quarter and full year results later this year.

Let me briefly walk through these changes before getting to our guidance. First, discontinued operations did not go away. Rather, the results reported in discontinued operations will only be for stores that have previously been disposed of or which we currently expect will be disposed of in the near future. What moves to continuing operations is the entire Cub banner as well as those Shoppers stores that will run for up to 24 months.

Second, how we report net sales will change. Since we acquired SUPERVALU and its retail operations, we've only included the wholesale sales to Cub as part of net sales. This was because our intention has always been through sell Cub with a supply agreement. In the fourth quarter, we will recast prior periods whereby the wholesale sales to Cub and certain Shoppers will be eliminated. And on a consolidated basis, we will now report the retail sales from these stores. This estimated impact of this change will increase total annual sales for fiscal 2020 by approximately $1.2 billion.

Third, our statement of operations, or P&L, will be restated to include the gross profit and operating expenses of Cub and certain Shoppers stores in continuing operations, both of which were previously included in the income from discontinued operations net of tax line.

Continuing operations will also include annual depreciation and amortization expense for retail assets, which were not previously being depreciated, given they're held for sale status. For modeling purposes, this will increase fiscal 2020 annual depreciation and amortization expense by approximately $23 million for retail assets, which were not previously being depreciated. This will not impact consolidated adjusted EBITDA, but will reduce adjusted earnings per share by approximately $0.30 for the full year fiscal 2020 results.

Our GAAP results will also include an additional $25 million of depreciation and amortization expense related to fiscal 2020, which equates to a total of $0.70 per share. The balance sheet will change as well with most short and long-term assets and liabilities of discontinued operations moving out of those 4 lines and into the appropriate lines on the balance sheet. For example, the land, building and equipment associated with our Cub stores will move out of long-term assets of discontinued operations and into property and equipment net.

Including the estimated $1.2 billion increase in net sales from moving retail into continuing operations, we now expect fiscal 2020 full year sales to be in the range of $26.4 billion to $26.6 billion. At the midpoint, this reflects an implied fourth quarter wholesale sales growth rate of about 9% over last year on a comparable 13-week basis when excluding the $451 million benefit of last year's additional week from the 53-week fiscal year. We expect full year adjusted EBITDA to be in the range of $655 million to $670 million. At the midpoint, this would be approximately a 22% growth rate over last year's fourth quarter on a comparable 13-week basis.

This adjusted EBITDA translates into an adjusted EPS range of $2.30 to $2.50, which includes the estimated $0.30 per share of additional retail depreciation expense for fiscal 2020. Finally, both our press release and Slide 13 from our supplemental slides show this guidance as well as what the implied guidance would be on what I'll call our prior basis with all retail and discontinued operations.

Our capital spending has clearly slowed as a result of COVID-19. As a result, we now expect to spend less on CapEx than the 90 basis points of net sales I guided to last quarter. This is the result of both lower spending in this environment and stronger sales.

We're currently expecting to spend about $190 million for the full year. We don't believe this lower spend level has or will negatively impact our operating performance. Our Q3 year-to-date debt reduction totaled $333 million, an amount that does not include the majority of proceeds from the asset sales included in our prior guidance. We closed on the sale of our Tacoma distribution center early in the fourth quarter and expect to receive cash proceeds in the first half of fiscal 2021.

We're pleased with the cash being generated by Cub and happy to have the flexibility to sell Cub's owned real estate at a more advantageous time. We made great progress on reducing leverage in the quarter as the face value of net debt relative to trailing 12-month EBITDA fell to approximately 4.3x, nearly a full turn less than the 5.2x at the end of the second quarter.

With that, let me turn the call back to Steve.

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [5]

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Thanks, John. As I close my prepared remarks, and to reiterate what John and I said, we're looking to finish this fiscal year strong, as reflected in our updated guidance.

I spoke earlier about the reasons we believe sales will remain elevated for many months, the foremost being the recession we're likely heading toward and the heightened unemployment rates across the country. This will be reflected in the strong fiscal 2021 for UNFI, which will show incremental growth over a very strong 2020.

We continue to believe that UNFI is the best positioned food wholesaler in North America. While COVID-19 pandemic has presented operational challenges, it has also provided a platform for us to demonstrate our true potential. UNFI has not changed, but the customer perspective of us has. COVID-19 has provided a platform for us to showcase the value of our people, our scale and our product diversity.

Our customer conversations have drastically shifted, from justifying the acquisition, to displaying and capitalizing on the benefits of it. Our strategy is adapting to realize the full potential of the current opportunities and to further position UNFI for success beyond this period of incredible demand. We're more optimistic toward our future than ever before and look forward to updating you on our progress and accomplishments.

We'll now take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Scott Mushkin with R5 Capital.

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Scott Andrew Mushkin, R5 Capital Ltd - Founder & CEO [2]

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So Steve, I was hoping to talk a little bit more about long-term margins and just get a feel for where you guys think that can go over time? And how you get there?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [3]

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You're talking about operating margins, Scott?

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Scott Andrew Mushkin, R5 Capital Ltd - Founder & CEO [4]

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Yes, operating margins and EBITDA margins.

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [5]

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Yes. I mean, I think we are doing a lot of work, finishing up the acquisition of SUPERVALU. We're still well on target to go beyond the synergies we had originally articulated.

And as we look into the out years, we think that there's also more work to do about towards expense reduction, network optimization and continued kind of activities that would just make us more efficient in the warehouse.

I think, obviously, we're going to have a really good year this year. Some of it supported by COVID. But as I think about the current year, I think that it really proved out the acquisition of SUPERVALU, which I think we had a rough time with it in the beginning for a lot of reasons, not the least of which being the investor community. But COVID and the accelerated volume certainly proved out the fact that retailers want to buy protein produce, general merchandise, conventional, natural and everything else from one source of supply. They also, from an independent perspective, want services. And for those that follow -- had followed SUPERVALU, SUPERVALU had a pretty nice built out services building business, and we're moving mountains to make it even bigger.

I think we've used the example of payroll. As an example, we cut over 60,000 payroll checks a week. We have 25,000 associates. So we're doing payroll for a lot of independents. But we're also doing a lot more than that, whether it's planogram, data, e-commerce and obviously, the services business is much higher-margin than wholesale. And so over time, we'll put a lot more resources towards the growth of the services business.

So I think it would be unfair for me to comment about where the margins go. We'll certainly provide more color on that as we close out what has been a really volatile year, in a good way.

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Scott Andrew Mushkin, R5 Capital Ltd - Founder & CEO [6]

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And my follow-up question is more short term. Obviously, revenues were really strong. But they did seem to be just slightly shy of what some of the other people in the industry are seeing. So I was wondering if you could maybe shed some light on that? And maybe what's driving that? And does that change as we move over the next few quarters?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [7]

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Yes. I mean, the only thing that's -- that we obviously have talked about is we did have a pretty significant series of bankruptcies just before COVID hit. And so my guess is if you adjust those bankruptcies back into the numbers, we are right where the industry is seeing the growth. What I will say is we've done a remarkable job at seeing that revenue growth fall to the bottom line, and that's just as a result of integration, synergy and a lot of discipline, despite having spent $25 million on doing the right thing with our teams and keeping them safe and paying incentives and so on and so forth.

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Operator [8]

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Next question comes from Edward Kelly with Wells Fargo.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [9]

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Steve, I was curious if you could provide a bit more color on what you're seeing so far in the quarter, current quarter? And what it's saying about sustainability of food at home demand as states reopen? And specifically, I'm kind of interested in color that you may have on states that have opened earlier and what your trends are looking like there?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [10]

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Yes. I mean, I can talk generally. I think we said in the script that the first couple of weeks of the fourth quarter have continued to show growth at around 11%. We certainly believe that the amount of meals that are eaten at home versus away from home are going to continue in a pretty significant way. I think most people are still going to be reluctant to sit in a restaurant for any extended period of time. That's part 1. Part 2 is COVID is not over. There are many states that have very high rates of infection. And as long as that continues, and we have every reason to believe it's going to continue until there's a vaccine, there's going to be just pressure to continue to eat more meals at home.

The second part of it is we're clearly in a recession. We certainly feel that way. And history has proven many times over that during a recession, our business tends to do very well because people are much more careful about where they spend their dollars, and that just means more meals at home versus away from home.

So I think we made a general statement that said, we expect the demand to continue and we expect 2021 to be better than 2020. And we'll provide more clarity on where we see 2021 in September as we finalize the budgets.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [11]

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And then just a follow-up. I'm curious on the cross-selling and the ability to drive additional sales. Obviously, this period probably creates more dialogue between you and your customers. Could you just provide a bit more color on how you're capitalizing on that? How does the $175 million compare to what you've seen in prior quarters? Just curious generally about the traction on the cross-selling.

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Christopher P. Testa, United Natural Foods, Inc. - President & CMO [12]

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Ed, this is Chris Testa. I'll take that question. Yes. I mean, look, if you look at the $175 million, that's our run rate for the year. Our Q3 accelerated because we did a couple of things. One, we put 1,500 to 3,500 natural, fast-moving natural SKUs into the conventional system, which means all those customers that wanted natural products could order them through their existing system, their existing promos, their existing invoice, their existing truck and so forth.

So we did that right before COVID. Obviously, COVID accelerated that penetration. What is ahead on the cross-selling is sort of the next level of we're taking cross-stocking and moving it to actually replacing captive distribution or replacing conventional or natural distribution with our partners that are using our competitors or, again, captive. So we expect that run rate to continue to accelerate through the balance of the year and into '21.

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [13]

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And one thing that we learned throughout all of this is we tend to be pretty hard on ourselves. But we actually know distribution, and we do it really well. And when you throw a little volatility into the system, you get a lot of people coming to UNFI for help. And whether it be for natural or conventional, or general merchandise, or certainly, produce and protein, and we did provide a lot of help, and we'll continue to provide a lot of help to even the largest retailers who rely heavily on us and continue to rely heavily on us for product throughout the system. And we just would not have been able to do that had we not done the SUPERVALU acquisition.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [14]

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And just one last one for you on the integration. Can you just talk about how COVID has impacted the timing of the integration and synergy capture, if at all?

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Eric A. Dorne, United Natural Foods, Inc. - COO [15]

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Sure, Ed. This is Eric Dorne. Our integration, we did pause slightly to handle the surge in volume, but we have reenergized those efforts. We have learned how to do it in a virtual environment to maintain the safety of our associates, and we are full steam ahead right now. So we anticipate no big implications from COVID, and we're moving it forward.

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Operator [16]

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Next question comes from John Heinbockel with Guggenheim.

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [17]

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Steve, two questions. If you look at double-digit top line growth, how much of that is coming from average drop size increasing, right? Is that the bulk of it? And then, secondly, if you look at the growth that you think you're going to continue to see, where are you with capacity? And are you particularly tight in some places? And if you are, how do you alleviate that?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [18]

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Yes. So let me answer the second one first. So again, one of the beauties of acquiring SUPERVALU was it gave us capacity in a lot of distribution centers around the country. And so generally speaking, we're in pretty good shape from a capacity perspective. And the amazing thing that COVID did for us was demonstrate that we could actually do more by DC than we ever thought possible, and while keeping everybody safe with really rigid protocols. And so I would say, generally, we're in really good shape from a capacity perspective. And a lot of that has been driven by the addition of the SUPERVALU distribution centers in the core markets. And we've been moving business around in order to make that work.

As far as the drop size, as you might imagine, our world, distribution, the bigger the drop size, the more you're putting on a truck, the more efficient everything becomes. And that certainly was the case and continues to be the case. As you cube out the trucks, you wait out the trucks, trucks are traveling less distance, and that's a great call out.

As far as how much of the growth was associated with just an increase in drop size, I'm not sure we've ever considered that question, but it's a good one.

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [19]

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And then just your comment, 2021 being better than 2020, is that sort of absolute better? Or do you -- is it even remotely possible that the growth rates could be similar or better if we stay in a recession as you suspect?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [20]

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Yes. So look, I understand the question. We can't go there yet because we just haven't finished the complexity of the 2021 budget. And everybody is in the same boat trying to figure out what 2021 is going to look like once you adjust for the COVID effect.

But what we do know is we see SG&A, we see costs, we see productivity. So we know that on an absolute basis, when comparing '21 to '20, the numbers will be better. To what degree? I don't know yet. But I think it's important to call out that we're not going to see a number in '21 that's less than the number in '20 and blame it on COVID. That is not going to be the case for UNFI in 2021.

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Operator [21]

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Next question comes from Karen Short with Barclays.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [22]

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Steve, I wanted to see, actually, if you could give the actual cadence of growth, top line growth in the quarter? And then I ask in the context of the 11% into the first 4 weeks of the quarter because I know there's a disconnect on top line for you versus top line at food retail just because CPI is kind of in that high 4% range versus the inflation that you called out in the 1% range. But I guess not to diminish what you've accomplished, but the top line in the first 4 weeks does seem lower than what I would have expected, and then the top line range for the full quarter seems a little lower than what I would have expected?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [23]

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Well let me answer the first one. Let's keep in mind that, first of all, we're a $25 billion business, so 11% or 12% growth is a staggering number, staggering. And so the second thing that I would call out is one of the things that's just really painful right now is fill rate. Supplier fill rate is very low on both natural and conventional. And that's just a terrible lost sale for us and for the retailer. And the fill rate is certainly the lowest that I've ever experienced by -- or seen by 1,000-plus basis points.

Now I think we're going to see improvement because the manufacturers align with us, and they're aligned with the consumers and everybody wants it to get better, and we're going to make it better. The other thing that's making the top line artificially less is that the largest manufacturers have discontinued, on a temporary basis, thousands of items to focus solely on producing the ones that consumers need the most. And so that will also start to come back as the overall growth rate stabilize and manufacturers can get back to some state of normalcy.

What will also come is the retailers are going to demand promotional allowances to put those products back on the shelf, which will also have a benefit to us. So I think it's a long way of saying that fill rate is the #1 driver to sales right now. If you add back the 2 bankruptcies that we had just before COVID, I mean, that's 900 basis points by itself. So we're right there in terms of overall growth. Actually, the 900 basis points does not quite -- the math of doesn't work quite that way.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [24]

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Well yes, it's just 900 basis points on that segment, right?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [25]

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Correct. Correct. But more importantly to me is that the growth certainly continues and look at what we've accomplished on the bottom line, which, again, was a lot of work. It didn't come easy.

As far as the cadence of growth, I think we've talked about this before. And basically, we saw the growth happened first in natural. So I think that was right around mid-March, some -- well, John or Chris can probably correct me there.

But -- and then about 3 weeks later, we saw it start to ramp up on the conventional side, and then it's been strong ever since. Convention -- unnatural has come off a little bit. Conventional has stayed high.

Chris or John, anything else you want to add there?

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Christopher P. Testa, United Natural Foods, Inc. - President & CMO [26]

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No, that's about right, Steve. It started in natural and the coasts. And then by mid-March, it was across all DCs, all customers, high double-digit growth.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [27]

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Okay. And then I guess, just going back to Ed's question about what you're seeing in terms of the country and locations or states that are reopening or further along in the reopening process, is there anything to point to in terms of differences in top line in those markets versus the ones that are still kind of behind on that?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [28]

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I don't think so. John? Chris?

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Christopher P. Testa, United Natural Foods, Inc. - President & CMO [29]

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Yes. I mean, it's a great question, Karen. It's -- and we're really early on in the period here and there are so many fluctuations. We had a lot of store -- had 150 curfews in place for the last couple of weeks in certain cities. So trying to factor in the impact of that, stores closing early. So it's really dynamic. It's hard to watch. It's hard to look at the month of May and really draw any conclusions about the impact of states reopening. I will tell you that in general, the demand in May was fairly equal to that in April.

As Steve said, our ability to turn that demand into sales, really, the biggest headwind right there is supplier fill rates. But in general, the raw demand has remained consistent through the month.

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [30]

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Yes. And that's a good point over the last, I guess, it's just over a week, maybe a little more than a week. We've had a lot of stores closed. We've had to reroute delivery times because of the protests that are going on.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [31]

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Right. That's fair. Okay. And then just wondering, to switch gears. I know it's been all hands on deck for obvious reasons. But any update on the supernatural contract? It's just -- obviously, there's -- you may have been distracted on that front, but any color that you can provide in terms of those conversations?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [32]

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Yes. I mean -- I'll take that one. I mean, listen, everybody's got to remember, this is a contract that goes out to 2025. That's 5 years from now. We don't have another contract that has 5 years' worth of life, number one. Number two, I have no doubt that the contract will get done. Obviously, we've taken a break. They've taken a break. We've had to put our attention elsewhere. And usually, we start talking about the contract extension 4, 5 years before the termination, and that is going to proceed normally.

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Operator [33]

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Next question comes from Rupesh Parikh with Oppenheimer.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [34]

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So just going back to your Q4 implied top line growth. The trends right now, I think you mentioned, are running plus 11% for the quarter, but your guidance implies moderation. Is that just conservatism at this point in terms of how you guys would think about Q4?

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John W. Howard, United Natural Foods, Inc. - Interim CFO [35]

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Yes. No, I wouldn't call it conservatism, Rupesh. I think what it ties into is the topic that Steve and Chris have mentioned, which is the fill rate assumptions and our ability to get those back to a normalized level.

The demands are staying high. It's just trying to get the fill rate back up where it needs to be.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [36]

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Okay. So has the fill rate -- has it deteriorated? Has it gotten worse, the fill rate? Or maybe you can help us understand what's happening with the fill rates?

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John W. Howard, United Natural Foods, Inc. - Interim CFO [37]

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It stayed roughly the same. We just had -- certainly, in Q3, we had wonderful success translating all that into sales with the fill rate the way it was. And then it's -- as you might imagine with the demand out there. For the suppliers, it's tapered off a little bit, and it's staying relatively flat, and we've seen it actually tick back up in the past week or so. So we're hoping that continues.

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Rupesh Dhinoj Parikh, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [38]

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Okay. Great. And then one more quick follow-up. Just on the independent channel. So you guys called out a 900-basis point impact related to the bankruptcies. Is that the right way to think about the headwind until we lap the bankruptcies?

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John W. Howard, United Natural Foods, Inc. - Interim CFO [39]

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I think, roughly, it is. It will vary a little bit with some seasonality. But roughly until we get into the laps in Q2 next year, I think that's the right way to think about it.

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Operator [40]

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Next question comes from Chuck Cerankosky with Northcoast Research.

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James Ronald Salera, Northcoast Research Partners, LLC - Research Associate [41]

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Jim on for Chuck. First of all, congrats on the great quarter. I wanted to touch on margin, both top line and EBIT margin. You guys had mentioned you see the vendors pull back on some of the promotional spend. Do you see that returning whether over the next, I will say, like 6 to 9 months, as some of the restrictions start to ease up and maybe some of the food away-from-home trends normalize? Do you think the vendor dollars will be back in the channel?

And then similarly, on the EBIT margin, I know you guys have invested a lot in employee wages and procuring PPE and the sanitation cost. Do you see any opportunity to leverage that kind of moving through the fourth quarter into the beginning of 2021 where maybe volumes still stay elevated, but you have a chance to pull back on some of that spending?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [42]

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Yes. So I'll start that one, Jim. So the vendor dollars will certainly return as there is the ability for the vendors to actually produce the product and get it delivered out into the marketplace. There will be a time when the retailers are going to demand promotional activity to replanogram those products and get those products promoted, whether it be through end caps or buy one, get one free. But it's just the way the industry works and it's likely that, that promotional spending will return, and that will be a nice tailwind for us.

From a perspective of wages, we had $25 million of cost that we happily spent in the quarter. That will begin to dissipate as the incentives go back to normal, as the productivity returns. And we're in the process of doing that right now. So you'll definitely see that happen throughout the next couple of quarters. And we'll only do that when we know our people are safe, when we can make sure that we have the building staffed appropriately. And that's when we'll make the decision. We certainly believe that we're there today. We're watching the outbreak of COVID very carefully. But I absolutely believe that moving into the fourth quarter, the latter part of the fourth quarter and into next year, those costs will dissipate.

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James Ronald Salera, Northcoast Research Partners, LLC - Research Associate [43]

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Okay. And as a follow-up to that, I know you had mentioned earlier you might have some concerns about whether a resurgence of COVID or some of the states that have reopened having kind of elevated levels. Do you guys have built in kind of a snapback for the wages to go back to where they are right now with the bonus pay? Or is there any way that we should look at that? Or will you just keep them where they're at right now, and then only back them off when you're certain that there isn't going to be any sort of resurgence?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [44]

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No, there's no automatic snapback. We expect, like I said earlier, when we feel that it's safe and that we have an adequate amount of people in the buildings, then throughout the distribution centers, we will remove the incentive and put back all the productivity standards.

As far as whether we get a spike in a DC, which we will, I don't know that, that would be enough to trigger incentives generally across the country. But we'll have to wait and see how it goes.

I think the way we're thinking about it, Jim, is we're going to take off the incentives and the productivity standards when we feel the time is right, when it's safe and there's enough people in the building, and we're pretty close to that point. Now a lot of retailers and wholesalers have already removed it. We just haven't done it yet.

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Operator [45]

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Final question comes from Kelly Bania with BMO Capital.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [46]

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Just wanted to talk a little bit more about retail and the decision to delay that. Just -- can you give us some more color on what your thinking is? And why -- what you're seeing in the M&A market that makes you think it's going to be delayed so long?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [47]

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Yes. Kelly, I'll take that one. I mean, as you might imagine, the M&A environment for retail is just poor. Not a lot of transactions happening, especially of really healthy companies at multiples that, I would say, a shareholder in UNFI would be comfortable with. And so that's number one.

Number two is when you look at the results of our retail banners, our teams have just done spectacular work. They're an important part of the communities. The communities rely on them. And so they're just -- they're doing really well. And so we don't want to own retail forever. We've said that publicly. But we just don't feel like in the best interest of our shareholders, it's just not the right time to do it. We'll wait until there's stability in the market and there's demand for really healthy retailers, and in the case of Cub, with #1 market share.

Now it's not the right time to disturb the communities and everything that's going on with the retailing of food.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [48]

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So I guess in that vein, can you understand us -- or help us understand then how healthy those businesses are? You're talking about $1.2 billion in retail sales. I'm not exactly sure how much Shoppers -- or how many stores are staying or going for Shoppers into discontinued ops versus continuing ops. What kind of same-store sales those businesses were trending at? How they are now? And just -- how can we think about what -- the health of those businesses?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [49]

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Yes. So John will give you some color in a second. We have a couple of Shoppers stores, a handful of stores that have yet to be sold, but they will be sold. We're just finishing up some of the work to do so. The rest of them will be kept and be operated up underneath Cub. So Cub will actually provide the infrastructure.

And to give you some clarity, we're in the process of separating retail entirely from UNFI. Right now, it's complicated, as you know. And we think it's probably going to take a better part of, might say, 9 to 12 months to fully separate the 2 companies.

But I think we can give you some color. John, do you want to take a swag at it?

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John W. Howard, United Natural Foods, Inc. - Interim CFO [50]

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Yes. Kelly, I'll tell you how I think about it. If you just looked at that combined retail business of Cub and the Shoppers stores that we're going to move to continuing ops, they do roughly $2 billion a year of sales, might be a little bit more this year with some of the COVID activity. But they do roughly $2 billion a year. And the reason the $1.2 billion is called out is because there are some of the intercompany sales from our warehouses to those retail stores that we have to eliminate. So that net increase will be roughly $1.2 billion, give or take.

And then just thinking about the earnings, I think if you just looked at a sort of a normalized view of a 5% EBITDA margin, I think that will give you at least a -- gets in the ballpark of how we think about the earnings for that company. And the other thing, just to build on Steve's comment, as we think about carving out Cub, making it stand-alone over the next 9 to 12 months, we're also proactively looking for MEP solutions so that we can make that chain even more marketable when we get to that stage.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [51]

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And I guess just the last -- this is helpful. But the last one on this, do you anticipate investing in these stores over the next 24 months?

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [52]

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Yes. So we certainly have a cadence of store renovations that we will continue to do. We're also investing in technology to update their technology platform, to give them better access to data, among other things. So there is some nominal spending that's going to take place in retail, certainly over the next 2 years until we sell it.

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Steven J. Bloomquist, United Natural Foods, Inc. - VP IR [53]

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I think that's the end of the call. So I wanted to thank everybody for participating. If you have any follow up calls, I will be in my office today. And with that, we will talk to you with our fourth quarter.

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Operator [54]

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This concludes today's...

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Steven L. Spinner, United Natural Foods, Inc. - Chairman & CEO [55]

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Everybody, have a great day.

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John W. Howard, United Natural Foods, Inc. - Interim CFO [56]

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Thank you, everyone.

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Operator [57]

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

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