United Natural Foods, Inc.

Q2 2023 Earnings Conference Call

3/8/2023

spk13: Good morning. My name is Audra and I will be your conference operator today. At this time, I would like to welcome everyone to the UNFI second quarter fiscal 2023 earnings call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press the star key followed by the number one on your telephone keypad. If you would like to withdraw your question, press star one again. At this time, I would like to turn the call over to Steve Blomquist, Vice President of Investor Relations. Please go ahead.
spk01: Good morning, everyone, and thank you for joining us on UNFI's second quarter fiscal 2023 earnings conference call. By now, you should have received a copy of the earnings release issued this morning. The press release and earnings presentation, which management will speak to, are available under the Investors section of the company's website at at www.unfi.com. We've also included a supplemental disclosure file in Microsoft Excel with key financial information. Joining me for today's call are Sandy Douglas, our Chief Executive Officer, and John Howard, our Chief Financial Officer. Sandy and John will provide a business update after which we'll take your questions. Before we begin, I'd like to remind everyone 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 and the end of our earnings presentation. I'd ask you to now turn to slide six of our presentation as I turn the call over to Sandy.
spk12: Thanks, Steve, and good morning, everyone. We appreciate you joining us for our second quarter call. As you've seen in our release, this was a challenging quarter for UNFI. Before I turn it over to John to share more details on our financial results and our expectations for the rest of the year, let me address our performance directly by explaining what happened, how it happened, what we're doing about it, and how it informs our strategic and operational thinking about the company going forward. During the quarter, our top-line growth remained solid, with more customers again buying more categories from UNFI. clear evidence that our differentiated offering and customer-centric strategy is starting to work. We remain committed to our longer-term objective of above-industry sales growth and positively leveraged EBITDA after we lapped the procurement gains in fiscal 22 and early fiscal 23. All in, revenue rose over 5% compared to the prior year period, achieving $7.8 billion. the highest sales quarter in our history. However, our second quarter adjusted EBITDA and adjusted EPS were well below our expectations. As a result, we are raising our sales outlook and reducing our profit expectations and withdrawing our longer-term fiscal 2024 targets. Our reduced profitability this quarter was primarily driven by a lower gross profit rate, as we did not repeat the level of significant procurement and inventory gains experienced last year. Both of these gains in the previous year came during a time of significant industry volatility, given the steep acceleration of inflation, continued disruptions in the supply chain, and operational complexities. We also continue to experience elevated operating expenses as we're investing to service our customers, while supply chains and labor markets continue to gradually normalize. I'd like to address the lack of visibility into the factors that affected our quarter. While we expected inflation to decline and the supply chain to continue to normalize, we did not fully appreciate the benefit to last year's gross profit from buying inventory in advance of supplier price increases in a sequentially rising inflationary environment. We now realize the magnitude of these benefits last year which are not repeatable in the current environment. At the time, we did not have full visibility and sufficient detail into the commercial drivers of the benefits due to legacy issues with digital infrastructure limiting real-time data, which is required to fully understand and forecast these profitability drivers. We were able to understand these issues toward the end of the quarter due to the significant intra-period volatility, which has led us to a different set of financial expectations for fiscal 2023 compared to our December earnings call. During the quarter, we began to cycle significant price increases from prior year. We're taking decisive action to mitigate these issues in the short term and then to correct them for the long term in our transformation agenda. Importantly, these issues do not point to a fundamental longer term challenge to our business. In fact, our top line growth and longer term margin structure continue to be solid and we remain optimistic about ongoing conversion of our extremely strong and growing new business pipeline. What it also means is that we have a significant opportunity to improve our efficiency and profitability and digital and physical infrastructure. Finally, we expect to see similar trends in profitability for our results for the remainder of the year as we continue to lap periods of significant benefits from procurement gains as price increase activity further decelerates. This is why we're reducing our profitability outlook. It has become increasingly clear to me in the 18 months since I joined UNFI that we need more scalable and streamlined capabilities and attendant cost structures so that we can more efficiently serve our growing customer base. To accomplish this, we've assembled a highly skilled and motivated management team to develop and execute a multifaceted transformation plan, which we reviewed with our board this quarter. This plan is focused on improving our customer and supplier experience, and addressing legacy integration and capability gaps in our digital and physical infrastructure, all intended to increase effectiveness and efficiency of our customer and supplier value propositions. Ultimately, we expect this will enable us to drive further growth, provide increasing value to our customers and suppliers, and importantly, accomplish this with structurally higher operating margins. It's still early in our transformation agenda, but we're optimistic about the improvement it will drive throughout our business. Our program is focused on four areas. First, network automation and optimization, which is designed to deliver capital and operating efficiency gains as well as customer experience improvements as we enhance our distribution network. Importantly, We also expect this will increase our network capacity and scalability, which will facilitate planned future growth. Second, commercial value creation, aimed at generating profitable revenue growth through simplification of our pricing and procurement approaches and improved visibility, transparency, and analytical insights for our customers and suppliers. Accomplishing this should make it much easier to do business with UNFI and allow us to turn 100% of our operational focus to helping our customers and suppliers win in the marketplace together. Third, digital offering enhancement. Working to fully integrate and enhance the functionality of the digital platforms we offer, including MyUnify, iUnify, and our third-party marketplace, and to expand the actionable intelligence we're able to provide through these platforms. And finally, infrastructure unification and modernization as we continue to make necessary investments in our digital infrastructure. This quarter's results serve as further support of the need for our transformation initiative. With urgency, we are working to finalize our plans. During this process, we're committed to providing the investment community with regular progress updates on the next phases of our strategic plan and a more detailed discussion in the quarters ahead. Our transformation plan reflects the combined knowledge of industry veterans and new leaders who have joined UNFI in the past 18 months. There is considerable experience across our team with these types of ambitious change-oriented agendas and technology upgrades. Given the complexity and importance of these undertakings, it has taken time to fully assess our capability gaps and to lay the foundation for us to be successful. We're excited to now have the pieces in place so we can push forward and become a unique value creator in our space. The opportunity to bring and execute this vision of much needed change at UNFI is part of what attracted me to the company. The next evolution of our strategy is all about combining the strong demand for our offerings within our $140 billion core addressable market with a more efficient and scalable cost structure, incorporating strategic investments as appropriate and where the returns are strong. We know that demonstrating sustained continuous progress is vital to creating long-term value for our shareholders. and we look forward to updating you as we embark on this multi-year improvement journey. We expect that we'll look back on this period as an inflection point in our company's history as we unlock significant value creation opportunities. Despite the volatile and challenging operating environment of the last three years that has impacted companies like ours in so many ways, we've been able to drive consistent sales and adjusted EBITDA growth as well as reduction in debt and leverage. And we believe our company is well positioned for the future. We have a unique and relevant customer value proposition as the industry leader that is resonating with our customers. And we have a team that's totally dedicated to delivering it, all of which is driving consistent top line growth. Once we're able to combine this with an improved supplier value proposition, and operating and technology capability improvements, we should be well positioned to optimize long-run profitability and returns. And with that, let me turn the call over to John.
spk10: Thank you, Sandy, and good morning, everyone. My remarks today will focus on the drivers of our financial performance this quarter, the progress we made strengthening our balance sheet and pursuing capital allocation, as well as our updated fiscal 2023 expectations. Turning to slide 8, net sales grew by 5.4% in the second quarter and totaled more than $7.8 billion, setting a new quarterly high and reflecting solid customer demand and elevated inflation. Wholesale sales grew by 5.4%, including inflation, net of elasticity of about 10%, as well as new customers and new categories with existing customers, partially offset by a decline in unit volumes. In wholesale, we delivered widespread sales growth across our three primary channels. This includes incremental volume from new customers added over the last year, additional categories and new store openings in Supernatural, and increased item and category penetration with existing customers. Retail sales grew 2.6% compared to last year's second quarter, a sequential improvement from the 1.8% growth rate in Q1, driven by higher average unit retail pricing. Our retail sales comparison was especially challenging this quarter as we cycled last year's onset of Omicron, as well as several weather events in the Minneapolis-St. Paul area, both of which added business in last year's second quarter. Flipping to slide nine, adjusted EBITDA totaled $181 million, which is lower than last year's $220 million. The biggest contributor to the year-over-year decline was our gross profit dollars prior to the LIFO charge in both years, which were close to flat compared to the 5% plus sales growth I mentioned earlier. Our growth profit rate, again prior to the LIFO charge, declined by approximately 80 basis points. The largest drivers of this decline in gross profit rate were lower procurement and inventory gains resulting from, among several things, supply chain volatility and a deceleration in the sequential rate of inflation. Like other food distribution companies, A portion of our gross margin is derived from buying into known price increases. The quantity and amount of these increases decreased year over year, which provided less opportunity to improve gross profit rates. Having said that, the state of our legacy data management and infrastructure, which we are addressing in our transformation agenda, severely limited our ability to fully assess and forecast the impact of these dynamics, both last year and this year. Additionally and importantly, We did not benefit from increased supplier promotions that could have offset some of what we experienced. I'll get to our full year outlook in a moment, but our expectation is that the third and fourth quarters will also be adversely impacted by these declining inflation dynamics. Notably, there was a significant sequential change at the end of the quarter in the trajectory of the underlying margin trends, with the first two periods of the quarter looking much stronger than the last period. Our operating costs as a percentage of sales improved sequentially from the first quarter and were roughly flat compared to the elevated level of last year's second quarter. We continued to invest in distribution center and transportation labor to provide the highest possible service levels for our customers, and we continued to experience inflationary pressures on certain fixed occupancy-related expenses, such as utility and energy costs. Our associate vacancy rates were in line with the first quarter, but significantly better than fiscal 2022. Our year-over-year fill rates have improved significantly, and as we stated on our last call, we expect to see productivity gains from a more experienced workforce in the back half of the fiscal year, which should enhance efficiency and continue to favorably impact our customers' experience. Within our retail segment, adjusted EBITDA was down about $4 million compared to last year's second quarter. The decline was largely the result of continued operating cost increases, including higher and new store startup costs. Our GAAP EPS was $0.31 in the quarter, which included a roughly $0.50 pre-tax LIFO charge as well as several smaller pre-tax items. Adjusting for these items and the tax impact, our adjusted EPS totaled $0.78 compared to $1.36 in last year's second quarter. This decline is primarily attributable to the adjusted EBITDA shortfall as compared to the prior year. Moving to slide 10, We finished the quarter with total outstanding net debt of just under $2.1 billion, a nearly $430 million decrease compared to last quarter. This reflects strong free cash flow generation of nearly $450 million. Free cash flow in the quarter included the benefit of the accounts receivable monetization program completed early in the quarter, as well as the expected lower levels of investment in working capital now that we're through the holiday selling season. Given the significant reduction in net debt partially offset by this quarter's lower adjusted EBITDA, our net debt to adjusted EBITDA leverage ratio decreased nearly half a turn sequentially this quarter to 2.6 times. During the quarter, we repurchased approximately 390,000 shares of UNFI stock at an average price of $41.36. Year-to-date through the end of the second quarter, we've repurchased approximately 730,000 shares at an average price of just under $39 for a total cost of approximately $29 million. Turning to slide 11, let's move to our updated expectations for the fiscal year. Given our performance year-to-date, continuing external volatility, and the near-term margin challenges Sandy and I have described about certain impacts on our business, we have reduced our profitability outlook for the year. As we look to the remaining two quarters and how our full year results could compare to our guidance, several factors will determine if we finish closer to the high end or the low end. First is where net sales finish relative to the outlook. Our sales guidance range of $30.1 to $30.5 billion assumes moderating inflation through the end of the fiscal year, which we expect will lead to slightly improving volumes compared to first half trends. We have assumed that consumer confidence does not decline dramatically and interest rates do not rise beyond current forward expectations, either of which could impact spending on food at home. Our updated outlook range assumes only a modest improvement to our consolidated gross margin rate in Q3 and Q4 compared to Q2. This is predicated upon a very slight improvement in certain processes that drive procurement opportunities, as well as our belief that vendor promotions will improve gradually as we go through the back half of the year. We're not expecting any other meaningful fluctuations on our wholesale or retail margin rates sequentially. The continued strength of both private brands and services is also expected to be modestly additive. Our assumption is that our operating expense rate remains in line with Q2, Within this, we expect to see further productivity and expense rate improvements in our distribution centers now that we've stabilized vacancy rates and anticipate this will be partially offset by some of the early spending associated with our transformation initiatives. A revised adjusted EBITDA range of $715 to $785 million, along with modestly higher expectations for depreciation and amortization, is expected to result in adjusted EPS, of between $3.05 and $3.90 per share for the year. We also now expect our year-end adjusted EBITDA leverage ratio to be roughly flat compared to the end of fiscal 2022, driven by net debt reduction, including the benefits from the AR monetization program, offset by lower full-year adjusted EBITDA. Given our updated expectations for this year, we have withdrawn the long-term fiscal 2024 financial targets originally provided at our June 2021 investor day. Turning to the summary on slide 12, the near-term volatility we've experienced has given us even greater insight into the opportunity we have to improve our operations. While it would take time for these actions to benefit results, we believe that our customer value proposition is strong and getting stronger and that sustained methodical and steady improvement and structurally higher profitability is attainable as we execute on this plan. Operator, please open the lines for questions.
spk13: Thank you. At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. We'll go first to John Heinbacher at Guggenheim Securities.
spk11: Good morning, Sandy, John. This is Anders Meyer on for John Heinbockel. Thank you for taking our question. To start, can you provide us with further detail into the state of the new business pipeline? Can you quantify it, and do you expect further acceleration beyond the next six months, and where would that primarily come from?
spk12: Hi, Anders. Sandy here. We don't disclose or quantify the new business pipeline. We generally refer to it qualitatively, but To give you a little bit more texture, we are seeing a significant amount of interest in our wall-to-wall services categories across conventional and natural. Our pro services, which help customers become more efficient and grow faster, and our Brands Plus program, which is particularly relevant as consumers look for lower priced options. We quantify the pipeline using technology and we're able to say that it is larger this quarter than it was in recent history. And what it reflects is interest in the market in our offerings, which we are continuing to craft and execute. We have reported in past quarters that we were implementing new business in the second half of the year.
spk11: that is largely implemented uh one major initiative will happen in the fourth quarter i hope that's helpful yep very helpful thank you and to follow up you withdrew the 2024 targets we understand that it is still early but how do you think at least conceptually about the secular growth algo is this just a reset to a lower more permanent base yeah the way i'd answer that is that
spk12: It's likely that we'll give guidance for 2024 at the end of the fiscal year as we normally would, but there's a lot of volatility in the environment right now, and we want to see how this plays out. We remain confident that the company is very well positioned. As I mentioned, the pipeline, which drives the top line, is very strong, and we'll look forward to giving investors an update on 2024 at the appropriate time.
spk03: Great. Thank you.
spk13: We'll take our next question from Mark Cardin at UBS.
spk14: Good morning. Thanks so much for taking our questions. So to start, you talked about getting some more visibility into the procurement labs towards the end of the quarter. How are you thinking about the compares over the course of the next few quarters? Should we expect to see pretty even impacts in 3Q and 4Q? How could it trend into 1Q next year? Just some additional color there would be great.
spk10: Yeah, this is John. We generally don't provide quarterly guidance, but broadly the way you're thinking about it is reasonable.
spk14: Okay, great. And then looking at your adjusted EBITDA overall outside of the procurement challenges, did you guys see any major shifts in the trajectory of your specialized services businesses, your private label operations, just some of your higher margin areas?
spk12: We continue to see strong growth in both of those businesses with double-digit growth.
spk03: All right. Thanks so much. We'll move next to Andrew Wolfe at CL King.
spk05: Thank you. Good morning. On the gross profitability, it sounded like from sort of follow-up to the last question, so was Q2 or perhaps even Q1, were those kind of the peak periods for holding gains and the other kind of gains you could get through buying into accelerating inflation, just to understand externally how we could think about modeling. I mean, you gave us guidance on how you think it's going to flow, but just in terms of inventory gains, what's the early part of last year, the peak period?
spk12: Yeah, hi, Andy. It's Andy. The inventory gain was a Q2 22 peculiarity. You'll recall that that quarter was particularly volatile in the supply chain. We had significant vacancy changes as Omicron hit. We did everything we could with third party labor to meet our customers needs through the holidays. And it just was probably the most volatile quarter that I've seen, at least in my time with the company. And what inventory gains represent is inbound or outbound. We just ended up with about two tenths of 1% more inventory than we expected. And that was a positive variance on the P and L and the quarter that didn't repeat and hasn't repeated since then. From a procurement gain standpoint, the rapid onset of really extreme inflation occurred in the sixth period or the final period of the quarter. And our insight into it came as we lapped it. But so you can model it from that point on for about 12 months. Got it.
spk05: Thank you. And on labor productivity, it seems like the trends are kind of continue to slowly improve. Are you expecting the rate of improvement to increase based on your commentary that, you know, the newer workers become more seasoned?
spk12: Yeah, Andy, I think the comments that John made in the script are accurate. We expect gradual improvement based on the experience base of the talent in the DCs. As we talk more about the transformation agenda, that's where we're focused on applying process and technology to make further gains, not only from an operating perspective, but also in terms of quality to our customers and capital utilization. But we think there's room for continuous improvement that we're pursuing urgently. And then we think there's room for strategic improvement as we implement the transformation agenda.
spk05: Okay, last question for me is on the top line, you know, I know you have strategies that are, you know, helping with penetration and new business. But, you know, the industry itself is, you know, your average store is down, you know, maybe a bit single digits in volume, which would mean, you know, if nothing much changed year over year, the case ordering would be down quite a lot too. So did that weigh in on results much for the company or were some of the sales strategies able to offset that?
spk12: Well, the company's not immune from and our customer base is not immune from the general industry trends. Obviously, the economy is slowing down. There's a lot of focus on value and the value position retailers, a number of whom we do not serve, are gaining share. I think what makes up our top line as a wholesaler is customer gains, expansion and categories, and then the underlying performance of our customer base. So you'd see some of our strategy as a wholesaler playing into the results. You'd see some of the underlying performance. The only other color I'd offer is that we serve a large number of retailers, and many of them are winning strongly and innovating, and they're very agile. Independents are that way. besides earning new business, is to make sure that we're doing everything possible to help our customers succeed and compete. And I think that's one of the reasons why we're earning new business.
spk03: Thank you. We'll take our next question from Leah Jordan at Goldman Sachs.
spk00: Thank you. Good morning. I was just seeing if you could provide some more detail on unit volumes. know how they trended in the quarter versus the industry on a sequential basis and year-over-year and also how are you thinking about volume trends for the balance of the year when you look down among your different segments sure so I think we probably all have the same syndicated facts food stores running about minus three total measured channels of
spk12: down minus two where some of the big discounters are improving that number and then our numbers we reported down mid single digit which is really in line with the kind of customer base we serve that's being driven obviously by hyperinflation and price elasticity a little bit of share loss to the big formats which is why we're so focused on helping our customers be more competitive As we look ahead, obviously we don't claim to be expert accountants, but what we can see and is driving our performance is that there are significantly less price increases taking place and that should lead to lower inflation. Lower inflation should result in units bouncing back and exactly how and when that happens is anybody's guess, but we would expect inflation to moderate as the year goes on and units hopefully to improve slightly.
spk00: Great. Thank you. And I just had a follow-up on your private label strategy. Just seeing if you could provide an update on that. How did growth in that category kind of track versus industry as well as your internal expectations? And where are you tracking to your longer-term goal of potentially doubling that business?
spk12: Our Private brands performance in the quarter was very strong. As I mentioned earlier, it grew double digit. We've recently skilled up and put a very talented leader on top of that business. We're overhauling our strategy by kind of sharpening our brand positions and improving our KBI execution. There's a lot of collaboration going on with leading retailers in our system. And I would say you know, six months into the new plan that we're pleased about the results. There's a lot of opportunity for us to continue to give our retailers a competitive edge with very well-positioned brands, and the early performance of the new team is very good.
spk13: We'll go next to Peter Sella at BTIG.
spk07: Great. Thanks for taking the question. I wanted to ask about the vendor promotions. I think you guys mentioned you're expecting those to increase in the back end of the year. Did I hear that correctly? And are you starting to see evidence of that? And is that embedded in the back end of the year guidance?
spk12: Yeah. This is Sandy. We are seeing a slight uptick in vendor promotions. We expect that to continue. You know, we're still well below pre-COVID levels, but in conversations with vendors at a couple of major conferences over the last 30 days, they indicate that they're going to become more promotional.
spk04: But, you know, it's gradual is the way I would describe it.
spk03: Great. And then just on the inflation,
spk07: Can you just remind us again what the inflation was in 2Q23 and what your expectations are for the back end of the year?
spk10: Yeah, I'll take that one. This is John. So for the second quarter this year, our overall inflation impact to the overall company was just below 11%, which is compared to Q2 last year was a little over 11%. So just to give you that sense. And while we're expecting inflation will moderate as we go through the back half of the year, which is in our forecast, we haven't provided specific guidance around that number, just that we expect it's going to moderate.
spk03: Great. Thank you very much. We'll go next to Christina Katai at Deutsche Bank.
spk09: Good morning. This is Jessica on for Christina. I just wanted to follow up on your comments on improving fill rates. So just can you give us a few more details on what you're seeing there and if there's any intricacies that we should think about? Thank you.
spk12: Yeah. Christina, this is Sandy. Fill rates are about 12 percentage points better in the second quarter than they were last year, which is a significant improvement. There continue to be categories that are stressed and parts of categories that are stressed. and we're still a ways away from where we were pre-COVID, but we've certainly seen them improve year over year and sequentially from the first quarter.
spk03: Thank you. We'll move next to Kelly Bania at BMO Capital Markets.
spk14: Hi. Good morning, guys. This is Ben Wood on for Kelly Bania. Thanks for taking our questions. I want to step back and just look a little bigger picture at the inventory gains. Do you believe that the significant inventory gain headwinds is something that's being felt across the broader distributor landscape and among your competitors? And is there any risk that this kind of lower profitability reset spurs a less rational competitive dynamic?
spk12: Yeah, Ben, specifically to the inventory gain, that was the second quarter issue last year for us. that impacted about two-tenths of 1% of our inventory, and we have not seen it repeat since. So I wouldn't think that's a broader issue. It just was a function of the supply chain volatility in the quarter. And really, the broader picture here is a kind of an analytical miss on our part. As hyperinflation began last year, without the experience of that scenario before, we missed the cause of it. going up and therefore we just didn't have the right forecast for this year the competitive environment obviously very competitive but it doesn't it hasn't increased or decreased uh and and it really if you look at slide six of our deck what you see is that our operating margins as we sort of head out of the covet era are right on what they were beforehand we just enjoyed a lot of growth which we both earned and also seen as a part of inflation so i wouldn't describe the competitive environment in a in a really different way than it has been and and we would expect it to be great thank you and then um just another quick one from us i think you mentioned that you're seeing some share losses and the bigger players
spk14: by your customers. Can you just walk us through the competitive positioning of your customers and your retail, maybe how they are aligned to mass and value players? And then what might you be messaging to them going forward to focus on to take this share back?
spk12: Sure. We serve 32,000 food stores, so a very wide set of positionings from large natural to to very, very strong ethnic-positioned retailers in a number of key markets that don't report to IRI and Nielsen, so they don't get counted in that share calculation. And so their strategies to win vary by their positionings. What our job is as their back end is to have the tools and resources at the ready that allow them to win, to buy right for them, to get them items that are sharply priced, supplier promotions and services that allow them to streamline their operations, be more competitive and profitable. And we collaborate with them on strategy, but they drive it. Our job is to serve it. And, you know, independents are very wily and capable and innovative, and many of them are gaining share. but there is a significant trend in price competition from the big players, and right now in this economic environment, it's working for them on the margin.
spk03: That's just the general state of play. Great. Thank you.
spk13: Next, we'll move to William Reuter at Bank of America.
spk02: Good morning. I just have two. The first is on the change in the outlook regarding inventory gains and forward purchase opportunities. Are there any investments in systems that are going to be required to have greater visibility, or is it just that the environment moved very quickly in terms of what those purchase opportunities were?
spk12: Yeah, this is Sandy. One of the things that I've seen since I joined the company is an opportunity to address system maturities and modernization. And we've been building a plan for the last six months to take advantage of the opportunity to finish the integrations of past acquisitions, modernize our tech stack, establish a common data architecture so that we could begin to realize the full benefits for our customers of the extraordinary capabilities we have around the country. And in the middle of that is an opportunity to get much more effective at granular and real-time analysis, which would have really helped in this situation. So we were in the process of building that plan. And as I mentioned in my comments, the board approved it, and we're moving forward. So think about it as people, processes, and systems deployed to build the analytical competence of the company. Some of that costs nothing. uh some of it will involve investment that will be done in a very disciplined way uh but the net effect of it is that we expect to have a more granular and and real-time view of our metrics and we will expect to deploy all of that capability for the benefit of our customers uh and more efficient operations got it and then my second question you mentioned the broad
spk02: different baskets or groups of customers that you do serve, I would have thought that in the current environment, maybe natural and organics would do a little bit better than traditional grocery because traditional grocery may be experiencing that trade down to dollar stores, et cetera, that you mentioned. Are the natural and organics customers doing better than our more traditional grocers?
spk12: Some of them are, and I'm not trying to give you a cute answer. It varies. We're seeing... some of our natural customers do extremely well and in some cases they're giving us more to do for them which makes it look even better and you can see that in our results but there is a bifurcation generally and some of the natural customers are taking full advantage of it some of the more conventional retailers are doing very well because of the diversity of their offer their food service offer So it varies really across the board based on the capability of the customer.
spk02: Great. That's all for me. Thank you.
spk13: And your last question comes from Scott Mushkin at R5 Capital.
spk06: Hey, guys. Thanks for choosing me in here. So I got to say that I'm a little bit confused, and maybe it's me, but I think you guys said the inflation rate year over year uh was a little over 11 last year and a little under 11 this year so why wouldn't the forward buy opportunity still be there um given the fact that you're you're still going up 11 hey scott sandy um 11 is the year-over-year inflation um
spk12: The forward buy opportunities happen in much narrower circles. Suppliers are obligated in one format to give us 60 days and the other 90. And the forward buy impact happens in that cycle. And what we're seeing right now is while the accumulation of all the price increases that have happened in the last 12 months add up to significant year-over-year price inflation, the number of price increases that are happening now is reduced by about two-thirds from last year. And that significantly impacted P6. And when we lapped it, we were able to understand it analytically. And as we look ahead, it was more impactful than we had expected. And that's what we've now applied to our second half guidance. That's what you said.
spk06: I thought it was me, and it was. So the second question is, I mean, did you guys just not have the systems in place to understand how much forward buying you were doing?
spk12: Great question. Our systems, the way they're structured now, do a very good job of aggregating DC data each period. And they do it accurately, and it's very controlled. However, the granularity of that data And the real-time ability to analyze it is not strong. And if you recall in the second quarter last year, and again, I'm just giving this to you the way we experienced it. Second quarter operating environment was crazy. And we reacted to it like many others did by renting people and doing whatever we could to try to service customers. I mean, I mentioned last year that our vacancy rate went from about 9% to 20% in seven days right before the holidays. And so that was where our focus was. And while margins started to pick up in P6 due to forward buying, the operating expense side of our business grew and we had lots of sales and no EBITDA growth in the second quarter last year. And so as the year went on, margins continued to improve uh as a result of ford buying but the company's focus was largely on making sure that we were operating properly and as efficiently as possible and we missed it the other thing i would say and this is as it happened uh the macro nature of the the systems and the way they worked worked very well with an experienced management team that had experienced the trends over time And the one scenario that none of us had was the rapid increase of extreme inflation. And so the questions that we would have asked were not as natural. And that just led to us missing it until we lapped it. And once we lapped it, we saw clearly that this is a big driver. You know, nothing makes a bad forecast good. It's simply bad. But what it doesn't mean is that the company is really in a different place after it gets through it. And then that's what you saw on slide six. But that's how we missed it, why we missed it. And I don't know if you have a follow-up question.
spk10: Scott, this is John. Your question made me realize that I misspoke in my inflation response. So I want to correct that data. So our Q2 inflation that I said was just under 11% is correct. When I said just over 11% for Q2 last year, that was Q1 of this year, showing that sequential deceleration that Sandy was talking about. Q2 last year was just under 6%. But the key is exactly what Sandy highlighted, that sequential deceleration. OK. So I apologize for that. When you asked your question, you made me realize I gave the wrong data point.
spk06: I appreciate the clarification. So then the last thing as we look at this business model, you guys obviously pulled your guidance. It seems like expense growth remains an issue across all you guys, you know, employee costs, all this, and maybe gross margin as you kind of look at it right now, it's going to take time to kind of build that as the efficiencies and other things come in. Is that the right way to look at this?
spk12: Yeah, Scott, the way I would look at it is, and I'll just kind of walk down the P&L for you. The top line is really strong. And the margins that we're getting from customers is solid. As I travel around the country and meet with customers, and I've been in 30 or 40 of those meetings in the last 30 days, what we're working on for customers and being driven by customers is resonating and we're getting good feedback about our improvement for them and the relevance of what we're bringing to help them succeed. So I feel really good about the top line and margins generally flow as a function of that value and you know, customer mix shift here or there, or retail's margin shift into wholesale, those things will move around a little bit. But basically, we're steady there, and therefore, the top line will convert. The area that where we're elevated, and if you go back to Fuel the Future, one of our KBIs was to be 10 basis points a year down in our supply chain expense, and obviously, that's gone the other direction. And that's the opportunity we have, and we made the decision T. To make sure we were taking care of our customers as best as we possibly could and then work on efficiency from that position and I started talking about the improvement agenda. T. You know, a few quarters ago and that's now taken the form of a detailed transformation plan to attack that and we believe there is a set of very common sense proven approaches that we can take that will. in further increase our quality to our customers, but then also drive efficiency in the way our system operates, efficiency in our operating expenses and efficiency in our capital. And while some of that will be achievable with discipline and therefore be very high return, some of that will require investments in technology and automation where we'll have very disciplined returns. But that implementation is the center of our transformation plan. and we look forward to giving the street more details as we go forward.
spk06: Perfect. Thanks for taking all my questions.
spk04: Thanks, Scott.
spk13: And that does conclude the question and answer session. I'll turn the conference back over to Sandy Douglas for any closing remarks.
spk12: Thanks, Operator, and thanks to everybody for joining us this morning. While I'm not pleased with the results that we reported today, I remain highly optimistic about UNFI's ability to create value for our customers, suppliers, associates, and as a result, for our shareholders. I hope you've heard and take away from today's call that we are on a path to transform UNFI from the bottom up with an enduring focus on serving our customers in the best manner possible. We believe our focus on continuous improvement will lead to growth and perpetuate the flywheel effect that I've described in the past and generate solid returns for our shareholders. For our customers and suppliers, we thank you for your continued partnership and the business we do together. For the UNFI associates listening today, our thanks to each of you for everything that you do for our business, our customers, our communities, and each other. And for our shareholders, we know this is a challenging quarter, but we thank you for the trust you placed in us and we will work diligently to deserve that trust. While we have a lot of work to do, I remain extremely optimistic about the value creating potential in front of us, given our unique and unmatched customer value proposition. Customer feedback and contract renewals support this thesis. Our technology and operating capabilities represent meaningful improvement opportunities, and we will invest in a disciplined, timely, and appropriate manner to capture the immense benefits that they represent. We know we have work to do, and we're doing it.
spk04: We look forward to updating all of you again after our third quarter.
spk13: And this concludes today's conference call. Thank you for your participation. You may now disconnect.
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