United Natural Foods, Inc.

Thank you. Steve Blomquist, Vice President of Investor Relations. You may begin your conference.

Good morning, everyone, and thank you for joining us on UNFI's fourth quarter fiscal 2023 earnings conference call. By now, you should have received a copy of the earnings release issued earlier this morning. The press release and earnings presentation, which management will speak to, are available under the investor section of the company's website. We've also included a supplemental disclosure file in Microsoft Excel with key financial information. Joining me for today's call are Sandy Douglas, our Chief Executive Officer, and John Howard, our Chief Financial Officer. Sandy and John will provide a strategy and business update, after which we will 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 gap financial measures are included in our press release and the end of our earnings presentation. I'd like to now ask you to turn to slide six of our presentation as I turn the call over to Sandy.

Thanks, Steve. We appreciate everyone joining us for our fourth quarter call. In my remarks this morning, I'll provide a brief overview of our results, the operating environment, and then provide an update on the actions that we are taking to continue to reset and restore our profitability and improve the value we create for our customers, suppliers, and in parallel, our shareholders. As you saw in our release, our fourth quarter results for sales and capital expenditures were in line with the updated outlook we provided in June. while adjusted EPS and adjusted EBITDA finished towards the high end of their respective ranges. UNFI has not been immune to the post-COVID, post-inflation challenges that the entire food industry is facing. Despite these challenges, we remain confident in our multi-year value creation opportunity and our plan to create and capture it. We are seeking to build upon our strengthening foundation in market leadership position by investing in the necessary capabilities to create a differentiated technology-enabled food retail services company that generates sustainable growth, profitability, and shareholder value. To this end, this morning, we also announced a refreshment of our board, adding three new members with deep food industry, business transformation, and investment stewardship experience, who we believe will be highly valuable in guiding our customer and supplier-focused multi-year transformation plan in a disciplined manner that generates compelling shareholder returns. UNFI has a strong industry leadership position with an expansive supply chain as the largest wholesale grocery distribution and value-added food retail services provider in North America. with nearly 11,000 suppliers and manufacturers serving over 30,000 retail outlets. And the long-term growth opportunity and pipeline we see in our core business remains significant within a $140 billion total addressable market for our core wholesale business. However, considerable progress remains to be made modernizing and unifying our technology and network platforms as previous plans have taken longer than expected as the company faced the onset of the COVID pandemic, unprecedented inflation, and supply chain disruptions over the past few years. These events and their enduring consequences have brought cost increases across our total customer service system as we serve our large, diverse, and growing customer base. In previous quarters, we've outlined a four-part plan to transform and realize the full value of our platform, including details on how we plan to strengthen our supply chain for our retailers and suppliers through distribution network automation and optimization, introducing smarter technology systems, and investing in operational excellence and efficiency. We believe that we will further differentiate UNFI from our peers by complementing our profitable growth strategy with our operational transformation. And specifically, we expect to execute our transformation in a manner that restores and grows our profitability to sustainably improve shareholder value creation. We see significant sales and profit growth opportunities, so significant that we are unwilling to be incremental in our approach as we drive change and investment. Our transformation agenda is challenging, and it will take time. In the meantime, our management team is focused on working through the near-term environmental challenges, resetting the business and taking action to turn profitability around, while simultaneously investing in the business to sustain and significantly accelerate profitable growth over time. While we lay the groundwork for our transformation, The management team is also taking decisive action to revamp and lower our sustaining cost structure in the near term. The benefits from these more easily executable profitability drivers that I outlined on our last call will largely go towards offsetting higher operating costs that include additional labor and supply chain costs and the acceleration of work on our transformation initiatives. We also believe this transformation, including our planned investments to modernize and optimize our infrastructure, will help us to create a more nimble, streamlined, and responsive company. Let me briefly report on the near-term actions I previously outlined. Since our third quarter call, we've captured nearly $100 million of benefits on a run-rate basis, from work around our organizational structure, SG&A spending, and wholesale efficiency initiatives. Having completed a deeper dive, we now believe a greater opportunity exists than we previously thought to continue to improve and become more efficient. As such, we're increasing the near-term value creation benefit from $100 million called out in June to nearly $150 million. These amounts do not include the potential opportunity from improving our shrink rate which, as I mentioned on our last call, is meaningfully higher than the pre-pandemic run rate and which we expect to improve over the course of the year as we operationalize process improvements. These value creation initiatives are expected to benefit fiscal 2024, which will be an important year for UNFI as we take action to reset and begin to accelerate and expand our transformation program. including critical investments to our supply chain and technology infrastructure. Let me provide some more details on our transformation program progress and our plan going forward. Let me point you to slide six, which includes a summary of our transformation plan to truly leverage the power of our competitive advantages through what we're calling One UNFI. We're working to modernize and unify our technologies, infrastructure, and processes to drive better service for our customers and suppliers, as well as improve our internal analytical capabilities to guide the company and help us be as dynamic and responsive as possible. Slide seven shows a broad roadmap of the key work streams we're pursuing over the next few years under the four transformation pillars that we previously identified. First is the work we're doing around our supply chain, what we've called network automation and optimization. We formally announced that Centralia, Washington will be the first location where Symbiotics automation technology will be installed. On our last call, we also stated that we've begun the design phases for the next two installs and expect to be running up to four of these projects simultaneously as we further expand the automation levels in our distribution systems. We'll take learnings from Centralia to fine-tune the implementation of ensuing projects prior to completion and expect to accelerate the pace of installs as we gain confidence in our processes and the intricacies of the system. Collectively, when we complete, these projects are designed to increase our capacity, improve our service levels, enhance the customer experience, make for a safer workplace, and importantly, create meaningful operating efficiencies. We're also continuing our evaluation of fast and slow moving facilities and regional DCs and how best to migrate our network in a way that will further enhance our capacity, lower our cost structure, and optimize DC footprints and working capital levels. Next is our work around commercial value creation. which aims to enable us to generate more profitable and scalable growth through UNFI and a more streamlined experience for our customers and suppliers. We see significant potential to increase the visibility of profitable growth opportunities and data-driven real-time insights across our ecosystem. Said simply, our suppliers want to see our customers and their shoppers better so they can make productive investments in sales, merchandising, and marketing opportunities across the 30,000 plus retail locations that make up our customer base. Our customers want them to do so, and UNFI's opportunity is to build the capabilities necessary for this to happen seamlessly. We're also focused on building related capabilities and streamlining legacy processes to help customers and suppliers grow faster and more profitably together and to ensure that UNFI is rewarded appropriately for the value created. Over time, our goal is to evolve our go-to-market programs to reduce complexity and drive accelerated supplier brand growth with and for UNFI customers. The third area of our transformation focus is enhancing our digital offering, which is another way that we can more effectively connect our customers and suppliers to grow their businesses collectively and profitably. Digital transformation is the key enabler to fully activate the commercial opportunities in our ecosystem, opportunities that many of the large retail chains are activating now. While we will be providing more specifics as we progress in digital, let me give you a quick example of early progress in this area to help illustrate how important elements of this plan are coming to life. Our newest value-added supplier program, UNFI Insights powered by CRISP, provides suppliers with a granular understanding of sell-through data across natural and conventional channels directly through the myUNFI.com supplier portal. The UNFI Insights team is dedicated to uncovering the latest data and actionable intelligence so suppliers and customers can see each other and their shoppers and drive mutual benefits. We have seen solid early adoption and positive initial feedback from suppliers of this early stage program. And finally, our fourth transformation program is the work of technology infrastructure unification and modernization, where we plan to reduce the number of systems used to run the business across areas such as finance, warehouse management, procurement, promotions, and data management. We're planning for our first go-live implementation of a common warehouse management system accompanied by what we're calling hyper support to ensure success. which will serve as the pilot for the continued rollout of a single solution. As we talked about before, this is consistent with our goal to simplify the business model, to lower our cost structure, and improve the customer experience. Common platforms are expected to lead to enhanced efficiencies, more uniform data sets, and improved business management. Similar work streams are moving forward in other parts of the business, guided by executive leaders and cross-functional teams. While we expect our transformation program to be a multi-year endeavor, we're already making progress, adding incremental growth and profit-accretive drivers to our business, while also making long-term structural improvements to our efficiency, processes, and cost space. So, in summary, I'd want to make sure that I leave you with three things. Fiscal 2024 is an important year as we emerge from three years of unprecedented volatility and look to reset our profitability in the near term while investing in critical foundational skills, infrastructure, and capabilities that we believe will accelerate growth in sales and profitability for UNFI, our customers, and our suppliers. Second, there have been and continue to be challenges that impact the entire food industry. but we're taking decisive action to strengthen the business and drive improved performance. We run a complex business and know the path forward will take time, tenacity, and discipline, and that we'll need to be adaptable along the way. But we also know the way to fully realize our vision and maximize shareholder value creation is through a proactive combination of near-term action and the multi-year transformation path that I've outlined. And finally, with the steps we are taking to continue to strengthen both our leadership team and our board, we are positioning our company to capture the significant profitable growth opportunities that lie ahead. We look forward to updating you on our progress along the way. And let me now turn the call over to John for his insights on our financials.

Thank you, Sandy, and good morning, everyone. As Sandy noted, we finished the year toward the upper half of the outlook provided on our third quarter call and our focus continues to be on driving improved capabilities, operational efficiencies, and near-term profitability. Today, I will provide commentary on fourth quarter results, our balance sheet and capital structure, and our outlook for fiscal 2024. With that, let's review our Q4 results. Turning to slide nine, fourth quarter net sales grew by 2% and totaled more than $7.4 billion, primarily reflecting inflation and new business wins, which more than offset a decline in unit volume. Sales from our three primary wholesale channels grew by nearly 3%, including the impact of inflation of nearly 6%, with Supernatural growing the fastest at over 9%. 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. Unit volumes remained negative, but improved sequentially by about 100 basis points from Q3 and were slightly better than Nielsen's total U.S. food volume changes, which is representative of performance for the grocery industry as a whole. Retail sales declined 2 percent compared to last year's fourth quarter, primarily driven by lower unit volumes, partly offset by higher average unit retail prices. We've continued to experience pressure across our retail footprint, primarily located in the Minneapolis-St. Paul market, due in large part to tightening consumer demand, reductions in government support programs, and more intense competition on price. Flipping to slide 10, adjusted EBITDA for the fourth quarter totaled $93 million, which was at the top half of the implied range we provided in June. This compares to $213 million in the year-ago fourth quarter. As we indicated would be the case with our updated outlook, the biggest driver for the decline in Q4 year-over-year profitability was lower levels of procurement gain opportunities resulting from decelerating inflation. This resulted in a reduction in our gross profit rate prior to the LIFO charge in both years of approximately 175 basis points, or more than $100 million. We also experienced higher levels of shrink compared to last year's fourth quarter, which we are actively addressing. Our fourth quarter operating costs as a percent of sales were flat to last year. However, last year included approximately $14 million in higher performance-based incentive compensation expense compared to this year. Excluding this performance-based incentive compensation expense, our operating expense rate increased by about 25 basis points. A good portion of this came from higher health benefit costs driven by a higher level of claims representing a more normalized run rate as associates return to more pre-pandemic medical visits. Within our retail segment, adjusted EBITDA decreased to $4 million primarily due to margin investments intended to drive traffic and basket size improvements, as well as higher than normal costs associated with recently opened stores. During the quarter, we opened one new store, bringing total stores opened during fiscal 2023 to six stores. Our gap EPS for Q4 was a loss of $1.15, which included $0.90 in after-tax costs and expenses composed primarily of LIFO, restructuring, and business transformation. Our adjusted EPS totaled a loss of $0.25 compared to $1.27 of income in last year's fourth quarter. This decline is primarily attributable to the lower adjusted EBITDA compared to last year, as well as lower non-cash pension income and higher DNA, which was driven by elevated levels of investment, which is expected to continue. Moving to slide 11, we finished the quarter with total outstanding net debt of just under $1.95 billion, a $70 million decrease compared to last quarter. This is our lowest net debt balance since the October 2018 closing of our super value acquisition, reflecting our strong efforts to prioritize debt reduction over the past several years. Our net debt to adjusted EBITDA leverage ratio finished fiscal 2023 at 3.0 times. Turning to slide 12, let's move to our outlook for fiscal 2024, which will be a 53-week year. From a reporting perspective, our fourth quarter will have one additional week, making it a 14-week quarter. We expect fiscal 2024's full year net sales to grow approximately 3% or $900 million at the midpoint of the $30.9 to $31.5 billion range we've provided. This includes an approximate $600 million or 2% benefit from the 53rd week. Our growth will include the addition of new business from customers added in fiscal 2023 we have yet to cycle. the continued growth of selling more products to existing customers, new customer wins, and anticipated strong growth within services. We expect full-year inflation to continue to moderate and be in the low to mid single digits, which is a decline compared to the over 9% reflected in our fiscal 2023 results. We're also expecting ongoing near-term volume headwinds as consumers continue to adapt to higher costs across their household budgets. We expect fiscal 2024's full-year adjusted EBITDA to be in $450 to $550 million range. This decline primarily reflects approximately $125 million in lower anticipated procurement gains, primarily in last year's first and second quarters, resulting from the continued decline in the number of supplier price increases compared to the first half of fiscal 2023. It also includes normalized performance-based incentive compensation accrual of approximately $62 million. This compares to fiscal 2023 when no material performance-based incentive compensation was paid to eligible associates. Partly offsetting these items is the estimated contribution of $9 million from the 53rd week, as well as the near-term profitability drivers Sandy discussed earlier. with nearly half of the actions addressing profitability from cost savings, including our recent regional reorganization and other SG&A and operating expense rationalization, and the remainder being driven by skew rationalization and contract review benefits. Additionally, as Sandy mentioned, we expect there could be some upside from shrink improvement as we operationalize and scale process improvements during fiscal 2024. From a cadence perspective, we would expect our first quarter to be the lowest of the year in absolute adjusted EBITDA dollar terms and likely to be similar to the adjusted EBITDA level we generated during Q4 2023. Our first quarter is expected to have the largest percentage decline compared to last year as we cycle last year's elevated level of procurement gains and further build the benefits of our near-term profitability initiatives. Finally, we expect fiscal 2024's full-year adjusted EPS to be in the range of 88 cents lost to 38 cents of adjusted net income. This primarily reflects lower adjusted EBITDA, as well as lower non-cash pension income and higher DNA. It also includes about $21 million of higher net interest expense, primarily resulting from higher expected interest rates and ABL balances during the year, and an additional week of interest expense. More than 65% of our debt is currently fixed rate, taking into account our approximately $800 million of hedges in place, as well as our senior notes. We expect to invest approximately $400 million in the business in fiscal 2024, with the primary driver of the increase compared to fiscal 2023 being investments in our transformation agenda, with the largest component going towards network optimization and automation. This also includes investments to improve critical infrastructure as well as drive higher profitability and growth in the future. Turning to the summary on slide 13, we expect fiscal 2024 will be a pivotal year for our transformation into a more modernized, technology-enabled partner for our customers and suppliers. While we expect this will be a multi-year endeavor, we are committed to making progress as quickly as possible and look forward to updating our shareholders on this path. We are confident we're taking the appropriate actions to best position UNFI for improved efficiency and profitability, enhanced growth, and long-term success. We strongly believe that combining a more dynamic and nimble UNFI with our industry-leading position will enable us to drive meaningful and sustainable shareholder value creation. With that, operator, please open the lines for questions.

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. And your first question today comes from the line of Mark Carden from UBS. Your line is open.

Good morning. Thanks so much for taking our question. So looking to 2024, you're lapping a few quarters of lower inventory gains beginning in 2Q. Your cost savings sound like they're falling nicely into place. Still, your guidance is assuming a meaningful step down in profitability. So what's changed the most relative to where your expectations may have been three months ago? How much of it's macro driven? And to what extent are you building in some conservatism just given all the initiatives that you have in place?

Yeah, Mark, this is Sandy. Thanks for your question. I guess we're looking at several factors. If you look at the fourth quarter and consider the momentum of the business, the addition back of performance incentives for executives, you get to a fairly low run rate. You add back then the actions that we've taken, most of which we've already captured, and you get sort of in the range of our midpoint. The external environment continues to be pretty soft, so I think we're going to manage our way this year. we're taking a number of initiatives to try to optimize the results. But the net of all those factors gave us the range that we provided today.

Got it. That's helpful. And then what are you seeing from your independent grocer base? Would you expect the pace of customer migration to mass to pick up in 2024 and further pressure the channel? And if so, how does that typically impact demand for value-added services and private label?

Yeah, I mean, you can't really generalize about independence. There's some incredibly strong and vibrant ones and then some that are struggling. This community is the focus of our whole product service makeup. I mean, it's our job to help them succeed. I think broadly compared to independence and syndicated data where our customers are outperforming the market by a small margin. But we've got a lot of programs, and you mentioned two of them, brands and services, that are designed to provide independence with a great own brand program at multiple price points and then services that help them save money and compete better. In the end, their success is the most important priority we have.

Great. Thanks so much. Good luck, guys. Thanks.

Your next question comes from a line of John Heimbacher from Guggenheim Securities. Your line is open.

Hey, Sandy, maybe talk to, you know, what procurement gains were pre-COVID in a normal environment, right? It looks like, I don't know, maybe they got up to $250 or $300 million at the peak, right? Was that all just gains on stuff that was in your inventory, or was there a lot of forward buy, right, that went along with that? And, you know, when you think about that, does that then, you know – what you had earned right over the past couple of years, right, sort of an EBITDA margin in the upper twos, you know, is that no longer attainable, you know, any time, right, or over a very long period of time because those inventory gains are just going to be very de minimis the next couple of years?

John, Sandy, let me come at this a couple of ways and then I'll ask John Howard to to add to my comments. Definitely, we saw an out-of-pattern increase in procurement gains beginning in January of 22, and that last year before the year-over-year disinflation started, and that generated numbers in line with your estimates. And that was the out of pattern part. You've got really two things going on there. You've got actual price increase events, both the frequency and depth, and then you have promotions. And we saw a decline in promotions while prices were going way up. What we expect to happen is that as price increase events decline, we expect promotions to come back, although they've done so very slowly. As we look forward and we see units continuing to be soft, the consumer to be stressed, and inflation now returning to lower levels, we definitely expect consumer products companies to start promoting more. They'll need to in order to drive sales. And so we'll see a positive there. The out-of-pattern high number of price events have kind of return back to more normal levels. We're still cycling the higher ones, as John mentioned in his comments. But net, net, net, from a run rate perspective, we'd expect it to be slightly positive as promotions come back. John, do you want to add anything?

No, I think that's spot on. The only thing is to put some numbers around that 23 to 24 impact. It's going to be about $125 million that we've, of course, factored into our guidance. And most of that is going to be in the first two quarters of FY24 as we cycle those gains that were still happening in the first half of FY23.

Great. And then maybe the second thing, right? So leverage is going to go from three to four times, right, turns this year. You'd say that's temporary. I think there was some commentary with the board changes. of strengthening the balance sheet. So do you feel a need to do that urgently? And then what do you do? I know you securitized receivables before. I don't know if you want to do that. I don't know if you want to sell retail at a low level. I don't know what the options are to strengthen the balance sheet short term.

John, I'll answer that strategically, and then I'll let John pick apart the pieces. The refreshment of our board, from our point of view, is going to strengthen our offense. We have a transformation plan and a strategy that we're investing in and that we are excited about and confident that it's going to make a significant difference. Now, we're in the investment phase, so it's obviously out there in the future that the benefits will come. But I think as a board, new members and old members alike, we're aligned on the importance of that. What the financial review with the new board and the new skill sets is just going to help us make sure that we're sweating every decision we make in the most detailed way to ensure that not only are we driving the transformation strategy, but we're also maximizing returns to shareholders on a strong basis. strong liquidity, we have the resources we need to invest in the plan, but we want to make sure that every stakeholder of ours, customers, suppliers, and shareholders are getting the best possible return.

John? No, I think that's right. I think the way we think about that leverage, just a little more granular, John, is We are going to end up taking a little higher than where we were in 23, but I don't want to lose sight of the focus that we have had over the past few years on reducing debt since the acquisition. We've paid down $1.4 billion worth of debt since the acquisition, getting that total debt down to that below $2 billion. So we are continuing to focus on that as part of our overall capital strategy.

Thank you.

Your next question comes from the line of Leah Jordan from Goldman Sachs. Your line is open.

Thank you. Good morning. I first had a couple questions on cost savings. Just wanted to touch on the contract review part of the original $100 million. Is it fair to say that you're fully done reviewing all of your contracts at this point and that they're they're fully consistent. Just any update on that. And then the second piece is around the incremental 50 million that you've found since last quarter. You know, just what specifically are you seeing there? And then how should we think about timing? Is that fully incorporated within your guidance for next year?

Sure. Hi, Leah. Sandy here. The specific answer to contracts is that a significant amount of that work has been done. to assess them, I would bucket the opportunities into immediate action, contractual improvement opportunities that obviously take time, and then projects in particular categories, for example, where we may be experiencing unsatisfactory economics where we need to work with the supplier to change how we go to market. A significant amount of the quick wins have been captured. The longer-term contractual ones are obviously being done in partnership with our customers or suppliers, depending on where the contract sits. And the projects are obviously more ongoing. In terms of increasing our outlook, I would say that area has been an area that's been helpful. And remember that a lot of that is necessary to offset increases in operating expenses. And that makes sense to both suppliers and retailers. But we're going to make sure that every single one of our agreements is fair, it's modern, it's consistent, and that it's thoughtful relative to the unique characteristics of a given situation. And so that's where a lot of the plus side has come. The rest of the program is, as we've described, SKU optimization, zero-based budgeting, flattening the organization to be more agile and more effective, and all of those programs are on schedule.

Okay, great. Thank you. And then my follow-up is just a little bit longer term. Understand next year, you know, you're still executing on your transformation efforts. But how should we think about margins in a normalized environment? You know, is it possible to get there in 25 or how are you thinking about timing? And what is the key unlock you're looking to beyond whatever is happening in the inflation backdrop?

Sure. I think obviously we haven't given an outlook for years past fiscal 24 yet. And we intend to continue to refine our assumptions, and as we get the implementation plans laid down specifically, we'll have a more specific outlook for those years. But from my point of view, the opportunity, as I said in my script, that we see in the transformation agenda to make this company more profitable and to allow it to grow faster and create more value for customers and suppliers is significant. And, you know, beyond that, we haven't really provided public information. But we view the opportunity as significant is the simplest way to put it.

Thank you.

And your next question comes from a line of Scott Mushkin from R5 Capital. Your line is open.

Hey, guys. Thanks for taking my questions. I got a couple kind of... short ones and then maybe more strategic. So when you, you mentioned market share and you're kind of just a little bit above IRI Nielsen, are you referring to the total market or just the supermarkets?

In that particular line, I believe we were talking about the total market. Perfect.

And then I don't, I don't know if you had said it, um, maybe I missed it. Did you talk about service levels in the quarter?

Uh, service levels. I don't know that we mentioned it, but we, uh, We are seeing service levels improve sequentially. I think we mentioned last quarter that they were up about 10 percentage points versus 12 months before, and they're remaining at that level.

And then final little housekeeping going on here. Inflation, you guys said low to mid single digits. I mean, we're tracking it kind of flattish right now over the last six months, so that seems somewhat aggressive, and I was just wondering maybe you could get into... why you think it's going to be at that level?

Yeah, I'm happy to take that one. We exited Q4 with just under 6% inflation for our business, and so the way we're thinking about that is it's going to continue to decelerate as we move through 24, ending somewhere in that very low single digits, but the average for the year will be something in the low single digits, 2% to 3%.

Okay, that's great. And then my final one is a little bit more strategic. You know, when you look at automating these facilities, you know, everyone's kind of on that path a little bit given the activities from Walmart. You know, how should we look at that from a timeline perspective? You know, when would you have the bulk of the facilities automated? Is this a five-year process? Just a little, you know, kind of thoughts on timing here.

Scott, I'm going to answer that with the information that we've provided, unfortunately, which won't give you all the answer to that because there's some competitive sensitivity there. But before I do, let me make sure, in your first question, you asked a question about market share, and I want to make sure we're connecting exactly on what the universe is. The universe that we're outperforming is just the supermarket channel. It's basically like for like. It's not inclusive of discounters and So, if you're comparing it to customers that are like our customers, we're performing slightly better than the broader market. On the question around automation, as I mentioned in my script, we are going live in our first one. We have several other projects started. Our pace will be directly related to the capability and confidence we get in our ability to run those projects effectively and how many of them we can do at a given time. They have a wide range of benefits. Probably a very important one of those is the economic value they create. And as we get full confidence and visibility into that, that will then dictate exactly what the end footprint looks like. Right now, we're going to the most obviously productive sites, and that was what we announced in our first agreement with Symbotic. We also have some each pick automation that we're doing in parallel. It's more tactical, but in the end, we will automate our distribution system in a very disciplined and economic way, and the speed will directly relate to our capability to do it well.

Perfect. Thanks, guys. Thanks for taking my questions. Thank you, Scott.

Your next question comes from a line of Kelly Bunya from BMO Capital Markets. Your line is open.

Good morning. Thanks for taking our questions. Just wanted to ask again about the procurement gains. I think one of the challenges with that has been just the visibility into how that has impacted the P&L. So I guess at this point, have you been able to go back and do some more analysis that gives you confidence in the magnitude of procurement gain headwinds that you have forecasted in fiscal 24? And then I have a couple more follow-ups.

I think principally, Kelly, we do because we have now experienced Q3 and Q4 of last year. And we have the ability now with all of that data to triangulate in on the data sources that we have and project it forward for Q1 and Q2. And the numbers John described in the script are how that's weighing on the P&L for fiscal 24. I would go further to say that we have learned from that a lot about how our margin operates through our distribution systems, and that's helping us create value, not just forecast.

Okay, and can you give us any color on the specific dollar amount and pacing of the return of promotions and what is baked into your guidance? and how that compares to historical levels of margin that you generate from promotional activity.

Sure, Kelly. This answer is going to frustrate you, but you may have some more information than I do on this. What we're seeing is we're seeing suppliers talk about accelerating promotions. Their actions are slightly behind their words, but because of the fact that inflation is coming down and unit velocity is not matching it on a one-to-one basis, it's logical to us that we will see supplier promotions improve. And that's what we believe they're saying. It's what they're telling us. But it looks to be gradual, and it may be a function of fiscal years and how next year, which most of the suppliers are calendar fiscal, will begin. You know, from a supplier perspective, we're seeing it slowly increase, but it's still below pre-pandemic levels. From a retailer perspective, we're seeing promotions accelerate as retailers look to drive their price positioning, particularly those that are price positioned. But as suppliers get more promotional, we are eager to help them get a return and to invest more.

Okay, that's helpful.

And maybe just within your guidance, can you talk a little bit more about the retail profitability? That took a pretty big leg down here. And maybe can you talk about the factors? Is that your own retail stepping up, your own promotions? And I guess in similar vein, what does your guidance assume in terms of customer mischief pressures?

Well, listen, when you look at our retail business, which is, I think, about 10% of our business, we have an extraordinary brand franchise in Cub, which is the market leader in the Twin Cities area. Twin Cities is a typical US market, and it's prone to all the challenges that we see across the country. reducing federal assistance, student loans coming back. There's plenty of pressure on the consumer. There's also a significant amount of price competition in the market, and we're seeing that. It's a big market for home market for one discounter. It's a big market for another, and we're seeing all kinds of competitive activity. So our team has doubled down on that, and they're investing in promotions to try to retain and grow their customer count. And then they're also experiencing higher than pattern labor expenses, so that's impacted their profitability. From a more broad standpoint, and our outlook for our retail business is incorporated in our guidance, but that brand, the CUB brand, is a strong brand and we expect it to succeed going forward. As it relates to kind of market shifts, there's clearly pressure. in the market coming from discounters. They're investing and they're taking share, and that's evident in the syndicated data. What our job is to try to make sure that our independents and our customers in general are equipped with the best costs, the best promotional investments and programs to help them compete effectively and to outperform their peers at first and to gain share in the market. And many of them are. Many of them are doing very well. I would say sales in general are soft at this stage, and we're going to continue to work to try to outperform the market, but our guidance incorporates that kind of an outlook.

And Kelly, just one reminder, the FY23 retail reflects the expenses to open those six stores that I mentioned in my script that we would not expect to repeat in FY24.

Did you share a number on that, John?

I don't think we've disclosed that number externally, but it'll be, for all six stores, it'll be a few million dollars.

Okay. And maybe I can just squeeze in one more here on CapEx, and if you are willing to comment at all on how that might play out over the next several years as you work towards this automation and optimization process? We've had CapEx go here from 250 to 320 and now planned at 400 million. So should that continue to creep up in the out years?

Yeah, Kelly, this is Sandy. What I would say is, A, we haven't given out year guidance or really any specific strategic planning information, largely because we're in the first year of really starting to roll out our transformation. But if you look at the $400 million in our capital budget, the majority of it is focused on transformation, a minority being kind of the maintenance capital that keeps our system going. So we've pivoted to investing in changing the profile of the company and accelerating profitable growth. Our plans going forward will be with our newly constituted board and the financial review will be to rigorously go through all expenditures and make sure that every investment we make this coming year and forward delivers not only maximum transformation benefits, but also outsized shareholder returns. And so we wouldn't be in a able to give out your guidance on this, but the process by which we will set that will be rigorous and will be designed to drive the transformation and deliver shareholder returns.

Thank you.

Your next question comes from the line of Peter Saleh from BTIG. Your line is open.

Great. Thanks for taking the question. I just want to come back to the conversation around shrink. Can you guys give us a sense of what you have modeled into your 2024 guidance at this point for shrink? And are you seeing any changes there, or is it kind of pretty consistent levels of shrink across product types and customers? Just trying to understand the dynamics going on at that level right now.

Sure. Thanks, Peter. Shrink is an important opportunity for us. As we mentioned last year, the shrink levels in our business have increased significantly over the past few years. They're driven by four main categories, procurement, inventory gains or losses, damages, and spoilage. And all four of those have different root causes. And we've stood up a team to look at each of them and to manage them rigorously. We've identified root causes. We're rolling out new processes and training across our system. And the entire management system is producing some early results. We haven't disclosed the specific component of shrink improvement that's in our guidance, but we see the opportunity as being significant and multi-year starting with this fiscal year.

Understood. And then just lastly, Sandy, last we spoke on that shrink, the net inventory piece I think was kind of the piece we discussed in more detail. Shouldn't that piece really start to improve as your employees become more experienced and more tenured? Are you already seeing that or is that yet to come?

Yeah, that's a knowledgeable question. The answer to that is yes, that helps. Overall operations improves as turnover goes down, and that's a core part of our people strategy in our system. And that's not just shrink. It's all aspects of customer service and efficiency. But in addition to folks being more experienced, there are also process and system improvements that are rolling out to try to take the variability out. and we've identified where the root causes are, and we're in the process of rolling out the improvements. And I expect this number to get better as we go forward.

Thank you very much.

Your next question comes from a line of Andrew Wolfe from CL King. Your line is open.

Thank you. Good morning. Sandy, I wanted to also ask the CapEx for a moment. you know, executive and maybe board view. Like, could you just give investors and us just some sense of how, you know, you guys are formulating and planning, you know, return on investment or ultimate earnings power. I know some of it is, you said is contingent on how the implementation goes and the returns that come from that. But, you know, CapEx has gone up quite a lot. So could you just give us a sense of how you're thinking about that and, I guess one of the ways I'd like you to frame it, and you can frame it other ways, is how much of this is margin, recapturing the margin that has been diminished recently, and how much of this is, I think you've alluded to, a robust pipeline. How much of this is really more top-line driven?

Sure. So let me start by saying that every dollar of capital that we allocate is scrutinized through several different angles. Maintenance capital is, by definition, maintenance capital. But what we have done is we've taken the transformation agenda and the capital that's embedded in it, and I think I mentioned in a previous question that it's about two-thirds of the total capital. That's not all incremental. We've actually sweated through the maintenance capital and kind of zero based it to try to source some of it. So the increase is not equal to the total of the transformation. And I would say the biggest load of the capital right now is operational. It's automation and network related, which is focused on, I mean, there are top line benefits because customer service and customer experience gets better, but the big payoff is actually in efficiencies in the supply chain, and then the ability to get more efficient growth out of the buildings that exist. An automated building can actually produce a whole lot more sales than one that's not. And that gives you return on capital, it gives you working capital benefits, etc. So our transformation agenda Certainly, it's focused on creating a great customer experience and enabling UNFI to serve the maximum number of customers and categories profitably. But in doing that, we want to have a system that works very efficiently. And then through sort of the non-capital side of our transformation, which is more about how we work with suppliers and how we make the commercial system work is how do we fully activate that using data to create growth and to earn profitability as we generate growth for some of the bigger profit pools in the system which come out of our suppliers. So it's a very general answer, but if you want to follow up, Andy, I'm happy to answer.

That's okay. I just had one clarification follow-up is you mentioned, I think, that I think first you said it's mainly operational network, which to me means margins. But then you said an automated system also has better throughput. So I just want to, again, back to how you're justifying how the board is voting on this and justifying the investment. Is it justified all through margin? And then if the better capacity that you get through automation allows more customers to Is that sort of even a better return than has already been agreed upon, or is it both?

Yeah. I mean, it's sort of which side of it do you look at it. There's definitely operating margin improvement check. But there's returns on capital improvement to the extent that you can move more sales through a building and not have to build a new building. Now, is that sales or is that just getting better asset productivity and driving returns up? Well, it's both. But I think we talked about in previous calls, this is a low margin business, so sales drives a low gross margin. To the extent that it can be done in a capital efficient way, that's going to create returns immediately for shareholders. To the extent that we have more customers, besides the gross margin, it also increases attractiveness to our suppliers who will then invest to try to grow with the customer base that we have. That's one of our biggest assets and one of our biggest opportunities. Very few of these investments have just one stream of value that's a part of the investment. But certainly the operating margin benefits are significant in the supply chain investments. But they have sales and supplier margin benefits that come off them as well.

Okay, that's clarifying. Thank you. And just one last question is more probably for John. On the... $94 million variance in the wholesale gross profit. Could you maybe give us a sense of, I know most of it's inventory gain, but you did say shrink as well. Just kind of proportionalize that perhaps. And then if we were, if you were to just to adjust all that out, what is going on with the underlying gross margin, you know, at the customer level and, you know, kind of with, you know, supernatural growing much faster, at least in the past, it's been kind of, take it down the gross profit rate a bit. So could you just discuss how the underlying gross profit is doing?

Yeah, I'm going to take this one too. The answer is that customer mix can affect our underlying gross profit. And sometimes the larger customers will generate a gross margin decline. There also tend to be very efficient customers. So when you get it to the bottom line, sometimes that's muted. We don't share specific information about customers. And as I mentioned earlier in the question on independence, we see outsized growth from all over our customer base. It's more correlated with the success of their brand and their concept than their size. So, you know, when you see real strong growth coming from a very large customer, you probably got it right that it's going to be a little bit negative in the gross profit, but there are benefits. every customer relationship and we have really strong partnerships with our large customers and we mutually look for ways to create more value for each other in the partnership and that's part of the process of account management.

Okay, thank you.

And your final question comes from a line of Bill Kirk from Roth Capital Partners. Your line is open.

Hey, thank you, everyone. Sandy, you just kind of hinted at something. You provide such vital access to market for so many brands. It's harder for them, especially the smaller ones, to get the shelves really any other way. So I guess the question is, is there an ability or an appetite to increase the slotting fees to be in your warehouses, especially as you're making improvements to those warehouses?

Well, Bill, You just asked a super strategic question that I'm not going to answer directly, but let me see if I can frame the answer in a way that would give you what I think would be the question behind the question. We see a significant opportunity to be a value-added resource to help suppliers and our 32,000 customers see each other, exchange data, and for the high margin suppliers who are very growth driven to be able to invest to deliver brand execution and growth consistent with their commercial strategies and ultimately their brand strategies. The very, very largest retailers have built tools that help them do that. We see an opportunity for UNFI to get in that business and ultimately create growth opportunities in the most relevant brand building channels that a brand can have to execute it. So, the question you asked is the specific type of fee. The way I might frame it is to flip it over and say, well, maybe there's a subscription fee for a different kind of partnership that's all about moving the agenda faster and helping our customers be more competitive and more successful with brands and more investable. And that's something we're working on. It's not something we have completely figured out, but it's something that's work in progress.

Okay, thank you. And if I could go back to John's question or one of John's questions in the beginning, the JCP team highlighted unified substantial assets. And it's hard not to think back to, I guess it was 2018, When super value, their assets, we're looking at either divesting retail and or sale leasebacks of some of the owned real estate behind the distribution centers. Is that what is implied by highlighting the substantial assets? It's just hard not to think back to that. So I guess, is there an implication there or an inference to be made from highlighting the substantial assets in that way?

Yeah, this is Sandy. What I would say there is in my conversations with James, I think he's excited about the potential of what UNFI can do. And so I think he uses the word asset broadly beyond just financial assets, but more market position, opportunity, mission. But part of what we're going to be doing with the board over the next few quarters is doing a really thorough financial review. Think of that as strategy with a fair amount of rigor to ensure that every dollar we use is maximizing its impact for our strategy and for shareholders. And so to the extent that we look at financial assets in that process, which we of course will, that will happen. But it'll all be tied to the context of what we're trying to accomplish to build a company that's extremely profitable and grows profitably for years to come.

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

And we have reached the end of our question and answer session. I will now turn the call back over to UNFI's CEO, Sandy Douglas, for some closing remarks.

Thanks, Operator, and thanks to everybody for joining us this morning. Fiscal 2023 was a challenging and difficult year, and we expect fiscal 2024 will continue to present macro challenges and other hurdles as we accelerate and expand our transformation journey. However, our team is energized to lead UNFI into the future. I've spoken before about the competitive advantages we have, which we believe position us well to succeed as we work to improve key capabilities and bring new value to customers, suppliers, and shareholders. This will be a multiyear improvement journey where patience and persistence will be necessary, but we are confident we're on the right path to reset the business, to turn around our profitability, and to accelerate sales and profit growth going forward. We expect to have additional proof points of our transformation strategy during the year, and we'll provide updates as we execute. 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 these are challenging times and we thank you for the trust you continue to place in us. Earning your continued trust is our highest priority. We look forward to updating all of you on our progress again in December after our first quarter.

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

Again in December after our first