United Natural Foods, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the UNFI Fiscal 2021 Third Quarter Earnings Conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. If you require any further assistance, please press star 0. I'd now like to hand the conference over to Mr. Stephen Blomquist, Vice President, Investor Relations. Please go ahead.

Good morning, everyone, and thank you for joining us on UNFI's third quarter fiscal 2021 earnings conference call. By now you should have received a copy of the earnings release issued this morning. The press release webcast and a supplemental slide deck are available under the investor 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 Dorn, our Chief Operating Officer. Steve, Chris, and John will provide a business update, after which we'll take your questions. Before we begin, I'd like to remind everyone the 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.

Thanks, Steve. Good morning, everyone, and thank you for joining us on our fiscal 2021 third quarter earnings call. As you saw in this morning's press release, we delivered another quarter of outstanding financial results. Third quarter sales were over $6.62 billion. Third quarter adjusted EBITDA was $179 million. And third quarter adjusted EPS was 94 cents. All were in line with our internal expectations and keep us on track to deliver our full year fiscal 2021 guidance and record EBITDA year following 2020, which was positively influenced by the onset of COVID-19. We also reduced our outstanding net debt by $62 million in the quarter. From a year-over-year basis, you'll recall that last spring was truly an unprecedented time in the food industry. And we indicated on our last call, we would not positively cycle last year's third quarter in which our customers benefited tremendously from the stock up buying that took place as the COVID pandemic began to spread. But we're very pleased with our strong performance this quarter, which maintains the momentum building across our business. First and foremost, our team delivered. Our 28,000 associates across the U.S. and Canada adjusted, learned, grew, and executed for our customers. We care deeply about our role in ensuring that food continues to move, and our results demonstrated just that. This quarter's results again validate the work we are doing to both make our customers stronger and to drive shareholder value. we know it all begins with the simple yet powerful idea of what unify can do to make our customers more successful our data analytics and cross-selling capabilities position our customers to quickly pivot to sell more of what today's consumer wants our private brands help them offer desirable differentiated products to their shoppers at great prices Our services lower their expense structure and makes running their business easier. And our innovation is continually looking forward and asking the critical questions of what's next, followed by what will UNFI do to bring it to our customers in the easiest possible way? One of the larger industry dynamics is the return of cost inflation, which up until now has been relatively benign. As many of you know, UNFI has historically benefited from inflation based on the structure of our business model. In addition, we expect a tailwind from the return of CPG promotional dollars, which over the past 12 months have been considerably lower than historical levels. During that timeframe, large manufacturers have been able to sell their products without the need for regular promotions. which has begun to reverse as suppliers more aggressively promote their products to consumers with more choices as overall product availability improves. Another important topic has been the challenges around hiring and retaining associates. One of our most important core beliefs has always been to do the right thing, which includes continuously and proactively looking for ways to keep UNFI as an employer of choice. This includes looking at ways to create better work-life balance, our commitment to diversity and inclusion, and our relentless focus on safety. With June being National Safety Month, we are launching a new framework and rally cry for workplace safety that will drive safety culture even further to move us closer to our ultimate goal of zero injuries. We will be flexible. We will compensate our team fairly, and we will be creative and proactive as our workforce initiatives continue to evolve. We'll have more to say about these topics in two weeks as part of our investor day. In addition, we're always making sure our compensation levels are competitive. And to that end, we've adjusted wage scales in many of our markets over the past 12 months which has led to greater stability in our workforce. We're seeing improved productivity and decreased overtime offsetting these wage increases, which has allowed us to maintain consistent operating expense rates. In addition, we've continuously been investing in automation to improve throughput and order accuracy while easing the local challenges around available workforce. Over the past 12 months and through the balance of the year, we'll continue to make meaningful investments in two, soon to be three, automated facilities, and we'll continue to look for further opportunities to use technology where the business case makes sense. We'll provide additional color around our updated growth strategy and longer-term financial outlook in a couple of weeks at our June 24th Investor Day. As you read in the press release, the event will be virtual and include a live Q&A session following commentary from many of our leaders. We're hoping you can join us. Fiscal 2020 was a record year for UNFI in terms of sales and adjusted EBITDA. And fiscal 2021 is expected to be even stronger. We believe the factors I just spoke to, as well as the onboarding of Key Foods Northeast stores and the pipeline business Chris will address, will contribute to fiscal 2022 being another record year. Let me now turn the call over to Chris to provide more context on our business performance.

Chris? Thanks, Steve, and good morning, everyone. On today's call, I'll provide additional color on our fiscal 2021 third quarter performance and discuss some of the key trends we're currently seeing in our business. As you saw in this morning's press release, total sales for the quarter were $6.6 billion. As expected, this was below last year's record-setting third quarter, finishing 5.9% down but up 6.7% on a two-year stack basis. We calculate this by adding the year-over-year growth rate to the prior year-over-year growth rate and believe it to be an appropriate way to view sales this quarter given the unprecedented activity in last year's third quarter. For additional perspective, Nielsen syndicated retail sales declined 5.3% for our fiscal third quarter, which included an approximate 110 basis point inflation tailwind compared to UNFI's wholesale inflation. After factoring this in, we believe the change in our wholesale sales was about 60 basis points favorable compared to Nielsen's reported retail sales. And this is driven by our continued success with cross-selling and winning new business. Steve touched upon inflation in the quarter, which overall was relatively benign for us. However, we have received notice from many suppliers indicating they will be taking price increases in the coming months. So we expect inflation to have a larger impact on our business leading into fiscal 2022. As many of you know, inflation has historically been a positive tailwind to our wholesale business as our contracts generally allow UNFI to pass through manufacturer cost increases as well as higher outbound fuel expenses. Additionally, we anticipate higher supplier promotional spending to coincide with price increases, and we have already seen some indicators of this trend beginning. Let's turn to the performance of each of our sales channels. Our change business was down 5.6% compared to last year's third quarter and up 5.4% on a two-year stack basis. Within chains, we continue to be encouraged by the year-over-year increases we're seeing from cross-selling wins with several of our top 10 chain customers, including those with captive distribution networks. Our independent retailer channel was down 11.4% compared to last year's third quarter and up 3.8% on a two-year stack basis. Many of our independents have added e-commerce capability, are reopening their food service programs, and are using our professional service teams for store remodels as they look to differentiate and adapt to the shifting consumer shopping behavior. The Supernatural channel was up 0.6% compared to last year's third quarter and up nearly 17% on a two-year stack basis. As we reported earlier in the quarter, we signed a long-term agreement with this important customer and continue to support them as they open new locations, strive for operational efficiencies, and look for new ways to improve their customer experience. Our retail stores continue to perform as sales declined 9.3% compared to last year's third quarter and increased 14.9% on a two-year stack basis. following last year's record comp sales growth. Both Cub and Shoppers continue to do a great job adapting to various consumer changes and catering to the local consumer needs. For example, in the Twin Cities, Cub's My Cub, My Way philosophy allows customers to shop in-store 24 hours a day or place their online orders for delivery or click-and-collect pickup. all meant to meet the customer where and how they choose to purchase their grocery items. And finally, our other channel was down 3.2% compared to last year's third quarter and down slightly on a two-year stack basis, as strong e-commerce gains have nearly offset all the softness in both food service and military channels. Sales to our top 100 customers were down just 3.4% compared to last year's third quarter. about 240 basis points stronger than our total wholesale net sales. Despite lapping the unprecedented level of stock-up buying that occurred in last year's third quarter, nearly one-third of these customers had double-digit year-over-year sales increases with UNIFI. We believe this reflects the strength of their businesses and their confidence in rewarding us with a greater share of their purchases. Looking forward, our business pipeline remains robust, and we're optimistic we'll be able to add an incremental $500 million of annual new business that will phase in throughout fiscal 2022. This would be additional volume on top of the onboarding of key food, which will have an estimated $1 billion annual run rate, which will also phase in throughout fiscal 2022. Our newly reorganized sales team remains committed to executing against the large $140 billion adjustable market that we have described on previous calls, and we'll discuss more at our upcoming Investor Day. Let's talk about the progress we're making on some of our growth platforms, starting with owned brands. As we've said previously, we plan to focus on innovation and introduce new items to meet the involving needs of today's consumer. This year, we've continued to drive against innovation, launching over 100 new products across 15 categories on just our field day brands. Top selling SKUs include functional beverages, personal care items, and pantry supplies. At the same time, our essential everyday brand has record sales in the quarter with international customers as our Brands Plus team is aggressively expanding distribution in Central and South America. And finally, last week, we announced a new line of bold, no-sugar-added hot sauces that complement Woodstock's strength in the condiment category. And in keeping with our Woodstock brand DNA, these products are non-GMO project verified and are produced from a carbon-neutral facility. We'll continue to lean into high-growth consumer segments and high-margin categories for future owned brands expansion. We are also aggressively marketing our more than 150 services that bring the following benefits to our customers. First, customers save time, allowing them to focus on running their business. Second, customers save money, allowing them to reallocate savings to other drivers in their operations. And third, customers receive help in driving revenue by bringing new offerings or insights. A great example is our payments offering that generates significant savings in credit card fees for our customers. We've completed 148 installs over the past six months and in one instance saved a multi-store customer over $500,000 annually from just this single service. We'll have more to say about both our brands and services businesses at our investor day later this month. Within the important e-commerce space, our recently launched community marketplace continues to build as more SKUs get added to this innovative platform. Although it's still in its infancy, we remain optimistic about the long-term prospects of this extension of our UNFI EasyOptions B2B business. As for e-commerce capability that we provide to our brick-and-mortar customers, we've now added 215 stores to our platform in the past year, with another 120 in the process of being onboarded. These customers can now offer online ordering, click-and-collect, and delivery to their shoppers. Moving to retail, our retail banners continue to perform well under Mike Steiger's leadership. We're especially pleased with the traction e-commerce is getting at Cub, where third quarter year-over-year e-com sales increased 27%. We've recently expanded online ordering and delivery to include all Cub liquor as well as wine and spirits locations, reflecting the great work the team is doing to make sure we're meeting the needs of our customers. We're also proud of the efforts in the community, as exemplified by our recent partnership with the Minnesota Twins. where we've administered COVID vaccines at select home games in support of Minnesota's Roll Up Your Sleeves Minnesota Fans campaign. Finally, we're proud to have reopened our second Cubs store damaged during last year's civil unrest. Local leadership has built both a friendship and business relationship with the community group We Push for Peace, whose employees now greet customers entering the store. This progressive new model has not only strengthened our ties with the local community, but simply makes good business sense. On a trailing four-quarter basis, retail has contributed nearly $100 million in adjusted EBITDA, reflecting the strength of our operations and the brand loyalty within their markets. Lastly, let me make a couple comments on the operations side of our business. In addition to the comments Steve made earlier about our approach to compensation and workforce stability, We also continue to move forward with optimizing our supply chain and expanding our distribution center network to better service our customers and deliver operating efficiencies. For the first time this year, our outbound fill rate improved year over year as we continue to work with suppliers on the journey back to pre-COVID service levels. Our 1.3 million square foot Allentown campus remains on track to begin shipping early next fiscal year, and we're looking to add additional volumes through new customer wins in the New York metro area. In addition, the third quarter saw us begin to deploy several emerging technology initiatives, including new material handling technology to improve both the efficiency and work environment for our associates. We'll provide additional detail on our distribution network initiative that investor day, including some visuals that will help bring some of these amazing locations to life for you. Despite all the change with the industry and macro environment, UNFI has remained committed to our plan to leverage our scale and help our customers win. We have executed this plan throughout fiscal 21, and we're all very excited and optimistic for the future. Our associates have done an amazing job through this pandemic. getting product to our customers on time and in a safe professional manner. We're operating at a high level, and we have every reason to believe our momentum will continue into next fiscal year and beyond. With that, I turn the call over to John.

Thank you, Chris. Good morning, everyone. On today's call, I will provide additional context on our quarterly financial performance, balance sheet, capital structure, and full-year outlook for fiscal 2021. As Steve and Chris said, we're very pleased with our operating performance this quarter. We delivered strong results as we cycled last year's unprecedented stock upsurge as COVID-driven demand began. Sales for the third quarter totaled $6.62 billion, adjusted EBITDA was $179 million, and adjusted EPS was $0.94 per share. Third quarter gross margin rate was 34 basis points lower than last year's third quarter, driven predominantly by lower levels of supplier-related income in our wholesale business. Last year's third quarter was a largely normal promotional environment, which didn't begin to change until well into our fiscal fourth quarter and has yet to return to the pre-pandemic levels. The gross margin rate in our retail business was approximately flat to last year. Third quarter operating expense rate increased 13 basis points to 13.09% of sales. This included the deleveraging impact of lower sales and nearly $3 million in startup costs related to our newest DC and Allentown, partially offset by lower COVID-19 related costs, as well as the benefits from our Value Path program. This quarter's strong performance was the result of the team doing a great job managing expenses in light of a changing environment, demonstrating our ability to run the business more efficiently over time. We're pleased with the third quarter adjusted EBITDA margin rate of 2.71%. On a GAAP basis, we reported $0.80 per share, which included $0.14 per share in after-tax charges, primarily related to advisory fees for our transformational Value Path initiative. Our adjusted EPS totaled $0.94 per share. Turning to the balance sheet, our total outstanding net debt finished the quarter at $2.43 billion, setting another quarter-ending record low following the super value acquisition. We generated $129 million in net cash from operating activities in the quarter, which led to a reduction in total outstanding net debt of $62 million. Our year-to-date net cash from operating activities and asset sale proceeds, net of capital expenditures, have allowed us to reduce our net debt by approximately $200 million on a face value basis, which keeps us on track to achieve our full-year debt reduction target. Our net debt to adjusted EBITDA leverage ended the quarter at 3.3 times, up a tenth of a turn from the second quarter due to the expected year-over-year decline in adjusted EBITDA as we cycled last year's third quarter, partially offset by lower debt levels. This is a full turn lower than where we were at the end of last year's third quarter. As you read in our press release, we're reaffirming the comments we provided on our last call towards the guidance ranges we originally provided on last year's fourth quarter call. As for net sales, we're anticipating several new business wins to take longer than originally anticipated to onboard, which will cause us to finish at the low end of our sales guidance. This includes some of the business Chris referenced regarding our pipeline. As for adjusted EBITDA and adjusted EPS, our strong cost controls and the benefits from the Value Path Initiative we introduced earlier this year will allow us to finish at the upper end of the guidance ranges we provided for each metric, both of which include approximately $13 million in Allentown startup costs. We're maintaining our previous guidance of $250 to $300 million for capital expenditures and approximately $250 million of net debt reduction on a face value basis, both of which include this year's investment in our new Allentown Distribution Center to support key food. We continue to expect our net debt to adjust at EBITDA leverage ratio to finish the fiscal year at approximately 3.3 times. Increasing value for our shareholders remains a priority and focus of UNFI. With our differentiated business model and large addressable market, we remain confident in our ability to grow our business and generate meaningful free cash flow. We look forward to providing more details on our future growth plans, including the metrics we would use to measure our success at Investor Day in two weeks. Thank you for your time this morning and for your interest in UNFI. With that, let me turn the call back to Steve.

Thanks, John. As John discussed, we remain laser focused on driving our business forward and are committed to increasing shareholder value. We're pleased with our year-to-day performance and remain confident that we'll deliver on our full year outlook. Fiscal 2020 was a record year for UNFI in terms of sales and adjusted EBITDA, and fiscal 2021 is expected to be even stronger. We believe the factors I just spoke to, as well as the onboarding of Key Foods Northeast stores and the pipeline business Chris addressed, will contribute to fiscal 2022 being another record year. We're also in the midst of active succession planning for UNFI's new CEO. While we don't have any incremental update today and don't plan to announce anything prior to or at our June 24th investor event, the process continues with the support of our top tier search firm and our board of directors. To reiterate my comment on the last call, our business is strong, our future is bright, and I'm confident UNFI will have a new and exciting leader later this year. In conclusion, I am thrilled with our performance this quarter. We have a great deal of momentum, and I continue to believe that UNFI's best days lie ahead. With that, we're ready to take your questions.

If you'd like to ask a question at this time, please press star, then the number one on your telephone keypad. If you'd like to withdraw your question, press the pound key. First question comes from Edward Kelly with Wells Fargo.

Hi, guys. Good morning. So the first thing I want to ask you just about, you know, on the sales guidance and being at the lower end of the sales guidance, you talked about some of the business wins taking a little bit longer to materialize. Could you just provide a bit more color on that and on what's happening there? And then in addition to that, the $500 million in new business wins that you're talking about for 22, just additional color on what's driving that as well.

Hey, Ed, this is Chris. Uh, thanks for the question. So, um, yeah, so as John mentioned, we're affirming the sales guidance, uh, at the low end of the range for the year. Uh, we feel very good about where we're coming in on sales for Q3 and where we'll finish in Q4. Um, you know, we have some commitments from new customers. They're, they're rather large, uh, and large commitments always take a little bit more time than the smaller ones. Uh, we're winning new business every day, every week from multiple sources, from multiple competitors. Um, And it's just going to take time to onboard it. That said, we have the commitments is why we feel comfortable given the $500 million number. And just to reiterate, that's on top of the onboarding of key food, which will happen in phases starting in fiscal 22 as well.

Okay, and then just a follow up, I wanted to ask you about the cost side, and specifically related to drivers and driver pay and retention. It's obviously a lot of, you know, pressure in the marketplace today, we are hearing about, you know, some food service guys paying bonuses to hire drivers as they're trying to ramp business back again. Just curious as to the extent that that's impacting you. And then what's your outlook for driver pay inflation from here? Do you think that that's a line item that will pick up or do you think sort of business as usual?

Yeah, I'll start it, Ed, and then Eric may want to weigh in. You know, as we think about the rest of this year and next year, I would say that there are a couple different inputs to look at, right? So fuel, cost of goods, labor, inflation, those are the primary inputs that are changing. Fuel is somewhat neutral to us because the vast majority of fuel increases we pass through. Increasing cost of goods is a benefit to us because as a wholesaler, The vast majority of our business is on the cost plus. That will turn out to be a benefit to us because it has increased cost of goods. We pass it through, and we typically buy into rising markets. Inflation, to which there has been very little, obviously we expect to have some more inflation come our way throughout the balance of this year and certainly into 22. That's also a benefit because we pass that through. On the labor side, we've done a ton of work throughout the year in making sure that our folks, drivers included, are being paid a competitive wage. And as you heard in the script, we've increased wages throughout the year, and that's obviously reflected in our numbers. But more importantly than wages is having a really good environment, having really good work-life balance, managing overtime, managing productivity, managing turnover. And as a result of doing that, we've seen an increase in productivity. We've seen more stability in our turnover. So I think we're optimistic. But again, the labor market for drivers and warehouse is shifting, and we've done a really good job shifting with it. We have a new facility opening in Allentown, Pennsylvania, which is going to be our first lifestyle center, which has some really sophisticated technology around flexible work hours, shift sharing. So we feel pretty good about where we are. Eric, anything you want to add?

Yeah, thanks, Steve, and thanks, Ed. I would just add my optimism as well, given all the – in associate focus program that we've introduced over the last 12 months and just to reinforce steve mentioned earlier we've adjusted a good deal of markets across the country to maintain pace on wages on premiums and we're going to continue to to modify as we go here but the big headline here is around associate focus programs around flexible work around shift sharing. And, you know, we're expanding rosters where necessary to help mitigate the work-life balance situation and manage overtime as well as reducing throughput or turnover, excuse me. So that's all I'll add. Great. Thanks, guys.

Next question comes from John Heindockel with Guggenheim.

Let me start with cross-sell. When you think about 2021, where will the cross-sell revenue contribution come in, do you think, and how that compares to what you expected? And then when you think about 22, just order of magnitude, could the cross-sell contribution be as much as double 21, or is that optimistic?

Hey, John, this is Chris. So two stats. on cross selling. One is the incremental cross sell, right? So those are the wins that we gained over the year. And then two is the rolling cross sell. So ones that we gained in the prior year, prior quarters that we continue to maintain. So for fiscal 21, we think the incremental will be somewhere around $250 million. So that's new revenue gains that we didn't have in the prior year. The vast majority of that coming from conventional customers uh that where that we sell natural to and that we are augmenting their captive distribution with our now broader portfolio of conventional products so that's where fiscal 21 is going to come in i think fiscal 22 you know we're not giving fiscal 22 guidance but i think you could expect to see fiscal 22 incremental cross-selling to again be in that range around 250 um to 300 but also realizing the gains of the 250 we got this year

Yeah, I would only add that, John, if you think about what we said during the sprint, 20 was a record heavily driven by COVID. 21 is going to be a record heavily driven by cross-selling and expense control. We also said that 22 is going to be a record driven primarily by new sales onboarding and expense control. Most of those sales wins and most of the pipeline are by selling more to existing customers.

Maybe secondarily, when you think about two topics, right? So you've been hurt by supplier promo income being down or negligent. Would that be a drag of as much as $40 or $50 million this past year? you know, for 21, you know, just sort of order of magnitude, that should come back. And then secondly, when you think about key food in Allentown, right, so a drag 13 million this year, you know, you'll sort of ramp up next year. Is it neutral, do you think, to the P&L in 22 or still a drag?

Yeah, so, you know, I don't know exactly what the drag on – supplier promo is it's material. But I don't know what the exact number is. And, you know, it's not going to come back all at once. It'll start to come back over time. And, you know, as you know, in the heat of COVID, suppliers discontinued a lot of SKUs to focus on the ones that they could manufacture and the ones that consumers wanted. obviously in order to get those SKUs placed back into retail, CPGs are going to have to pay for that. And so we're going to start to see that turn around, I think, towards the back half of this year, the back quarter of this year and throughout 2022. As far as the expenses in Allentown, I think the majority, and I'll let John or Eric correct me here, I would say the majority of the startup costs will be taken in this fiscal year. I think there'll be a bit of a drag next year as the business starts to ramp up. Did you say that's right, John?

Yeah, that is correct, Steve. We've got the $13 million that John mentioned that we talked about in my script, and then we're expecting somewhere in the neighborhood of maybe another $5 to $10 million in FY22. That'll be part of that number as well.

John, this is an amazing facility. I mean, it is.

Yeah.

I think it's 1.3 million square feet between two buildings. It's a campus. It's really the first building we're opening, as I said earlier, a lifestyle building that's going to be really associate-friendly. It's going to be a fun place to work, and we're really excited to see that roll out. And one other comment I want to make back to Ed's question earlier on drivers is one of the significant benefits we have is unlike food service, our drivers are not touching every case. And our trailers have hydraulic lift gates and electric pallet jacks, and they're bumping a dock for the most part, and they're moving the full pallets off the truck and into the retail store, whereas the food service drivers have to touch every single case and put it on a hand truck. And so that's one of the reasons why we've had so much success in hiring drivers specifically out of food service while they were down. Thank you.

Next question comes from Eric Larson with Seaport Global Partners.

Yeah, thanks, everyone. Thanks for the question. So, Steve, I'd like to drill down a little bit more on kind of the underlying inflation rate. And obviously what we're seeing from the CPG companies is kind of high single-digit input cost inflation. I think it's probably been 10, 12 years since we've actually seen it that high. So is that what you – is that sort of underlying cost rate what you think that the CPG companies will price, and you're starting to see that now where it will be mostly a 2022 event? That seems high to me, Eric.

Yeah. But look, I think there's going to be material inflation that makes its way through the system. But we're going to have to wait and see. And you're right, we haven't seen inflation in a very long time. Christian, John, you want to add something to that?

Yeah, I'll just add, you know, we have a process for CPG increases, our suppliers increases, where we get notifications 60, 90 days in advance. And to your point, Eric, they are higher than normal. I think a lot of CPGs held off during COVID. And in the meantime, labor's increased, transportation's increased, and there's been raw material inputs that have increased. So they are coming in. They haven't quite hit yet, but what we've seen in the notifications, they are higher than normal. I would put them more in the mid-single digits than the high single digits, but we service so many suppliers that It's hard to say an aggregate where they'd come in. I agree with Steve that the high signal seems high. I think it's going to be more in the mid-single digits, which, again, is significantly higher than the 1% to 2% that we typically see.

We did see some, Eric, some inflation in our proteins, and that was almost exclusively driven by the meat producer's inability to actually make the product, what I would call short-term labor.

Okay. Yeah, that's sort of the refrigerated kind of the perimeter of the store stuff, and that tends to be sort of pass-through. Those tend to be sort of pass-through products, but your center of the store items tend to be more when CPGs take those prices up, they hold them, and and then they tend to promote it back, and you rarely see those prices go back down again. So when you look at what you might be, what we call transitory inflation or not, what are your viewpoints on that? Could we see... I mean, could we see, you know, more volatility? Like let's say in your fiscal 22 or 23 or maybe late 22, prices come back down, which, you know, so more volatility in that. Or would you expect to see with higher prices a higher rate of sustainable promotion?

Yes, you're exactly right there. So what's going to happen is those costs are not going to come down. They're going to stay inflated. And in order to move the product, the product will be heavily promoted. And in either way, that's a big tailwind for us because if the cost of goods go up, we buy into rising inventory and pass through the price. If the CPGs heavily promote the product, we manage the promotion, and that turns into gross margin for us. Okay, perfect. Thank you, everybody.

Next question comes from Jim Solera with North Coast Research. guys.

So looking at the top 100 customers, obviously you guys perform better on the sales side there than just kind of with the business in general. What's driving the discrepancy between those top 100 customers? Just that you have a broader selection of the portfolio that you sell into them. Is it better cross-selling some of the service platform? What's driving the better performance of those compared to business as a whole?

Hey, this is Chris. I'll take that one. It's really a couple things. One, we're talking about really sophisticated, long-standing customers that have quickly adopted e-comm, have quickly adopted pricing strategies, have quickly adopted to offering food service and prepared foods in their store. So they're just really good at strategy and execution. But the second part is cross-selling. We have a huge benefit to offer large customers that want to use us to offset some of their either capacity constraints or their transportation constraints and use our system to offset that distribution that they would typically carry. And so the other thing is now that we have this broader portfolio by bringing these two companies together, we have a really unique offering to sell natural and conventional nationally, which really no one else can do. And the benefits of that are really being seen with our top 100 customers because we're selling them a broader portfolio of products that we didn't have two and a half years ago.

Great. And I just, when you're looking at that overall incremental cross-sell opportunity, especially on the service side, what percentage of that would you say comes from those top 100 customers versus the rest of the business portfolio?

It's hard to say. You know, the top 100 customers are bigger wins. I mean, we're getting smaller cross-selling wins at every level. If you think about just a you know, an independent conventional store that wants the top 200, 500 natural items. You know, those are really helpful to them and their customers, but it's not really moving the total needle. I don't have that top 100 customers, but I would say the vast majority, over 75% of those wins are happening with the top 100. Okay, great.

Thanks, guys. Sure. Next question comes from Greg Barishanian with Wolf Research.

Good morning. This is Spencer Henderson for Greg. Just a quick follow-up on the inflation discussion. What is your outlook for retail and wholesale inflation in 2021? And are you hearing anything from your retail partners about concerns about passing through elevated cost increases? And then how should we inspect the cadence of benefits from higher inflation flowing through to your business?

So I don't have any additional color on the actual numbers related to inflation other than we know inflation is going up. As to when it goes up and how much it goes up, I'm not sure. But I certainly believe that it's going to be in the mid-single digits, which we said earlier. As far as pass-through, as Chris said earlier, from a policy perspective, Depending upon the product category, we typically get between 60 and 90 days advance notice, which gives us the ability to buy into rising markets, which is a source of gross margin for us, which will be a tailwind. But we pass through 100%, or pretty damn close to 100%, of the cost of goods that get pushed to us.

Okay, that's helpful. And then can you give us a quick update on fill rates and then any sense of when vendor promos get back to pre-COVID levels? And then are there any categories that are standing out as being a laggard in getting back to those historical fill rates?

Hey, Spencer, this is Chris. Yeah, so fill rates, we're seeing the highest fill rate we've had all year. We have over 600-bit improvement from the start of the year, albeit we are still well below where we were pre-COVID levels. It's a tailwind for us. Because as Steve mentioned, fill rate going up means a lot more new products are starting to come into the marketplace. New products is a good thing for us. It's a good thing for our customers with slotting fees and promotional dollars. As far as the categories, it's really mixed. You know, some of those categories that were really far behind are still lagging, as you'd expect. I'm talking about air disinfectants and cleaners. They're still far behind pre-COVID levels, but they're gaining. Right now, what suppliers are really dealing with is transportation, which is a new challenge that didn't exist. That's in labor. And so that's what's kind of causing the fill rate to get even higher. But we're optimistic. We had 600 bps improvement from the start of the year. We had 200 bps improvement from Q2. And, you know, we're talking to our suppliers every day about how we can get

uh our fair share of those uh high demand products great thank you next question comes from peter selley with ptig great uh thanks thanks for taking the question i just want to come back to the conversation around labor inflation and or shortages and warehouse personnel and drivers How much of this issue, the ongoing issue right now, do you feel is related to outsized or high unemployment benefits, which is, I guess, more transitory as that ends in September? Or how much of this do you think is kind of a more permanent change in the industry structure?

Yeah, you know, this is personal opinion. I don't think much of it is really associated with – Unemployment benefits on the driver side. Our drivers are sophisticated, they're knowledgeable, and they're working. I think we're in a temporary period where the demand for freight is outpacing the ability of the industry to move the freight. But I do feel like it's temporary. Once we get back to stability economically, people are back at work, and the pandemic is predominantly behind us, I think this is all going to stabilize. And like we said earlier, you know, there are pockets where we have some struggles around finding drivers, but generally speaking, we're in really good shape for all the reasons. about earlier. So it's a long way of saying I think we're just in a temporary period where demand for drivers and fleet is just outpacing the ability for the industry to cover it. But it's near term. It will pass.

Understood. Very helpful. And just lastly on the on the inflation that you guys are anticipating on the cost of goods um is the path through is there any delay in the path through of the of the cost to to the to your customers or is it fairly immediate it's immediate no delay great thank you very much next question comes from bill kirk with nkm partners

Hey, everybody. Thank you for taking the question. Just one for me. What does capacity utilization look like at the new New York facility once you have the billion annual from Key Foods on and once you have the incremental 500 million up and running? So I guess the question is, how much more room physically will that location have for future wins on top?

Yeah, Bill, this is Eric. I'll take that. Just as a reminder, you know, the facility is 1.3 million square foot. It's multiple buildings. Yes, we are onboarding 300 and so key food stores, but we do have additional capacity there post the opening to handle the Metro New York marketplace for future customer growth. So we're pretty excited about what that building offers us in that marketplace and looking forward to seeing it come to life here in less than eight weeks.

And keep in mind. We have big facilities in York, Pennsylvania, Harrisburg, Pennsylvania, Carlisle, Pennsylvania, Hudson Valley, New York. We have that market really well covered.

Thank you. That's it for me. Thank you, guys.

Next question comes from William Reuter with Bank of America.

Good morning. Earlier when you were discussing the challenges with drivers, you noted that it wasn't necessarily about wage inflation, but it was more about offering greater flexibility to them. Will the effect of offering greater flexibility to your drivers to attract them have the same impact in terms of the labor hours that you'll be using as inflation would? And is there some way to put some sort of numbers around that?

I'm not sure I understand the question. I think what you're saying is, Inflation, you're talking about wage inflation?

Yeah, so earlier an analyst asked about whether you were seeing wage inflation of your drivers, and the answer was kind of no, it's not necessarily about wage inflation. It's about trying to attract additional drivers by offering greater work-life balance, flexibility, etc., I was I would expect that offering that flexibility is going to require more hours. So effectively, your total cost of labor increases. Is that incorrect?

So we have we have already increased wages for our drivers in some markets around the country, and that's reflected in our in our financial performance and in our expectations for the year. But what I what I believe is happening is the workforce is changing. A lot of associates today want less overtime. They want work-life balance. They want to be able to leave in the morning and come home at night. They don't want to go on multi-day runs. And so that's very different than the way it was even three, four years ago where the opposite was true. And so our routes and our route planning and our DC management are all predicated on what the worker of today really wants out of a job. And as long as we can give them what they want, then we're going to keep our turnover down and our productivity high. The other thing that's really important to us is safety and having a really robust safety program that demonstrates to our workforce, drivers in particular, that we care. And we do. And all those things combine into a different type of workforce today that was here three or four years ago. And companies just have to change and be cognizant of, you know, what the worker of today really demands. And all of that is reflected in our numbers that you've seen so far this year, how we're committing to the numbers from the rest of the year. and what we see happening in 2022, which, by the way, we've already said is going to be another record year.

Male Speaker 1 Okay. That's helpful. And then, just as a follow-up, obviously, the retail business has performed very well over the last year. Trying to figure out what a sustainable level there may be challenging. But has your perspective changed on your interest in keeping that asset, you know, given that you had explored different options, you know, in the past? Where is your guys' plan with that currently? Thanks.

Yeah, I mean, I can tell you that as a leadership team, we are so incredibly proud of what our retail division has done. You know, they've been there, they've been open, they've been supporting the communities in so many different ways. And, yes, our financial results have been just incredible throughout the pandemic, and they continue to be incredible. I think, as you know, we took them off the market during COVID. didn't feel like it was an appropriate time to try to sell a retail business, and they are not back on the market today. And we'll talk a lot more about that at the investor day. But today we own it, we love it, and we're going to continue to run it in just an exemplary manner that we have over the last couple of years.

Thank you for the insights. The last question comes from Jim Solera with North Coast Research. Hey, guys.

Just a follow-up question on the driver supply. Steve, you had mentioned that the demand for freight is really outpacing the supply right now. Do you anticipate that the... The way that that will balance itself out is you'll see more people, more drivers entering the market, so there's going to be a greater labor supply, or fill rates will improve, and so that will take miles off the road, or maybe if you build more DCs, you'll have less miles to travel. Just trying to put some context.

Yeah, I mean, I think that what's really happened is there's been just so much pent-up demand for product that gets shipped by truck. over the last year or so. And we're seeing that demand in all of the primary statistics that you would look at. But I would say that it will come off. And so as that demand falls off, the labor market for freight will stabilize. And that's really what I was trying to get at. We're hiring drivers. I think there will be more drivers coming into the marketplace. We know how to do it. We've got a big fleet of owned vehicles and drivers who represent us every single day. So, you know, I think we're just in a temporary lull. And if you certainly look back in the history of freight, we've seen this before. And the demand will come off. More drivers will enter the marketplace. and it will be much more stable. It may take another year or so, but, you know, there's lots of things that we're doing to make sure that we have a terrific driver workforce to deliver our products every day.

Great.

Thanks. All right. Well, thank you very much. Thank you very much for joining us today. I can't tell you, you know, I've been here for 12 years. There's never been a more exciting time to be at UNFI. I truly believe that the best years are in front of us. As I said earlier, 20 was a record, 21 is going to be a record, and 22 is going to be even better. So thanks for joining us. Be safe, and we look forward to seeing you at our Investor Day on June 24th. Have a great day.

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