United Natural Foods' (UNFI) CEO Steve Spinner on Q3 2014 Results - Earnings Call Transcript

|
 |  About: United Natural Foods, Inc. (UNFI)
by: SA Transcripts

Operator

Greetings, and welcome to the United Natural Foods Third Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Ms. Katie Turner of ICR. Thank you Ms. Turner, you may begin.

Katie Turner

Thank you, and good afternoon, everyone. By now, you should have all received a copy of the third quarter fiscal 2014 earnings press release issued this afternoon at approximately 4:05 P.M. Eastern Time. If anyone still needs to review the release, please reference the Investor Relations section of the Web site at www.unfi.com. As a reminder, the Webcast of this earnings call is also available on the company’s Web site. On the call today are Steve Spinner, President and Chief Executive Officer; and Mark Shamber, Chief Financial Officer.

Before we begin, we would like to remind everyone comments made by management during today’s call may contain forward-looking statements. These forward-looking statements discuss plans, expectations, estimates and projections that might involve significant risks and uncertainties. Actual results may differ materially from the results discussed in these forward-looking statements.

Additionally, in today’s press release and on the call today, the company will provide both GAAP and non-GAAP financial measures including operating expenses, operating income, net income, and earnings per diluted share. Presentation of these non-GAAP financial measures is not intended to be considered in isolation or as a substitute for any measure prepared in accordance with GAAP. For a complete reconciliation of GAAP to non-GAAP financial measures, please refer to the company’s earnings release issued earlier today and available on the company’s Web site.

And with that, I would like to turn the call over to Steve Spinner.

Steve Spinner

Thank you, Katie, and thanks again for joining us this afternoon to talk about UNFI’s fiscal third quarter 2014 results.

This was a very busy quarter for UNFI. We announced our agreement to acquire Tony's Fine Foods opened our new 450,000 square-foot building in Racine, Wisconsin and deliver topline sales growth of almost 14% compared to the third quarter of fiscal 2013. We have completed our initial regulatory filings related to the Tony’s acquisition and anticipate closing around July 15. And as we communicated during our calls to outline this acquisition, Tony’s is a very strategic part of UNFI’s future growth plans capitalizing on the growing consumer trends towards natural proteins and perishable specialty products, UNFI will leverage this very unique product and merchandizing offering across our North American distribution platform over the next several years.

Tony’s has a long history of growth throughout its current distribution area. The model is quite scalable and our teams are extremely excited about rolling their high touch high service model across the country. We will go to market in several ways. First, by opening additional Tony’s facilities; second through head-on acquisitions in this space; third by utilizing UNFI’s newly constructed perishable warehouses at Tony’s facilities; and lastly by integrating into UNFI’s current customer base. All four of these options have very compelling opportunities for us. We will follow a very clear model. Integrate back at the house, payroll benefits and related areas, but leave the high touch high service distribution model completely unchanged. This is what has enabled Tony’s success and UNFI will learn from their standards. I look forward to sharing more about our objectives as well as a long-term financial implication during our year in fiscal 2014 conference call in September.

Following completion of the acquisition of Tony's Fine Foods led by Scott and Karl Berger, Tony’s will work with the UNFI team to carefully align our opportunities and plan for an exciting roll out of UNFI perimeter products.

Let’s turn to our sales growth, almost 14% ahead versus prior year continues to prove the natural organic and specialty products are not a passing trend for the fast growing permanent part of consumer purchases. Additionally, with very low inflation less than 2%, real growth remains quite strong. Over the last five years UNFI has diversified its customer base, based on our philosophy of working hard to bring our products to the mainstream consumer.

This drive will continue to benefit our industry as more and more consumers come into these categories and become what we call crossovers. History and data has proved that once a consumer arrives in our space overt time they will demand more and more of our products and ultimately migrate towards our core consumer the natural and organic retailer. Given the growth in our space, competition has also increased. Conventional food distributors and continued movement to direct distribution by supermarkets for fast moving products will pressure our growth as the industry expands.

However, in our commitment to new distribution centers and our ability to sell the entire store, we’re well prepared for new competition. There were several headwinds during the quarter, the non-recurring start-up costs of our Racine, Wisconsin facility exceeded our plans driven by very conscious decision to begin the hiring and training at the facility earlier than originally planned to ensure a very smooth transition of customers beginning this month. Also during the quarter we continue to be challenged by the weakness in the Canadian to U.S. dollar. And I’ll touch on this momentarily in more detail.

And lastly we did incur expenses of $600,000 out of an estimated $1.3 million to $1.6 million in costs related to Tony’s acquisition during the third quarter; the balance will be incurred and recognized as expense in Q4. Our team was very pleased with our execution against our long-term strategies during the quarter. Operating income increased over 16% and our operating margin increased seven basis points versus fiscal 2013 third quarter. Helping to drive the results was the implementation of our UNFI technology and supply chain solutions at our new centers and the completion of our new demand planning inventory optimization platform in the west, with implementation in the east to begin this quarter.

Additionally, UNFI customers are now using over 4,000 installations of our proprietary high UNFI order delivery solution and we have begun beta testing our new arrive electronic truck delivery notification system. In Canada, our business continues to grow, despite headwinds associated with currency exchange rates, we’re very committed to growth here. Over the past several years we have been acquisitive as we build our market share. This market has been challenged for us this fiscal year as we’ve implemented UNFI standards and operating metrics. But I am excited about Canada as our President, Lynne Brenegan leads us forward.

Our U.S. divisions continued to deliver very strong results across most of our operating platforms and high growth continues at our Woodstock manufacturing division, Blue Marble Brands and core UNFI distribution. We talk a lot about the needs for new distribution centers with our high rate of growth. This growth also requires us to invest in our people in a very significant way. And here UNFI is really succeeding. Through our national college hiring, development and secession planning programs, we’re attracting, promoting and retaining a terrific team.

Our capital expenditures were approximately 2% of sales during the quarter as we continue to build out capacity. We’ll provide additional color around longer term CapEx during our yearend fiscal 2014 conference call. New buildings are an important strategic need for UNFI. Our new buildings add a differentiated wide product offering, bringing us closer to the consumer by eliminating transportation miles and enhance our service bubble by reducing the time between order placements and order delivery. And as an added point of reference, UNFI currently expenses approximately $9 million a year in outside storage costs due to current distribution center capacity constraints.

Our capital expenditures associated with construction and infrastructure today are building a UNFI capable of integrating significant industry and market share growth over the next decade.

Now I’ll turn the call over to Mark Shamber, UNFI’s Chief Financial Officer. Mark.

Mark Shamber

Thanks Steve and good afternoon everyone. Net sales for the third quarter of fiscal 2014 were $1.78 billion, which represents growth of 13.8% or approximately $216 million over the prior year’s third quarter net sales of $1.57 billion. Excluding the $18 million in sales from the Trudeau acquisition that closed in the first quarter, sales increased by 12.6%. Inflation moderated both sequentially and on a year-over-year basis for the quarter, coming in at 1.64%, a 21 basis points decline from Q2 and 12 basis points decline from last year’s third quarter inflation of 1.76.

Year-to-date, net sales were 5.03 billion, yielding sales growth of $608 million or 13.7% over the comparable period of fiscal 2013. Excluding all acquisitions, our year-to-date net sales growth is 12.7%. For the third quarter of fiscal 2014, the company reported net income of $36.4 million or $0.73 per diluted share, an increase of approximately 15.1% or $4.8 million over the prior year.

Net income for the third quarter of fiscal 2013 was $31.6 million or $0.64 per diluted share. Earnings per diluted share increased by 14.2% as EPS growth was impacted by the higher average share count in fiscal 2014.

From a sale by channel perspective, the supernatural channel increased by 11.9% in the third quarter with supernatural representing 36% of total sales. Sales growth in the supermarket channel was 17.8% and supermarket represented 25% of sales. Independents sales grew by 10.2% over the prior year third quarter with independents representing 33%.

Finally, food service growth was 20.5% in the third quarter and food service represented 3.5% of net sales. Excluding the impact of the Trudeau acquisition, supermarket growth was 13.8% for the quarter and independent sales growth was 9.7%. As covered in the press release, growth margin for the quarter was 16.7%, a 6 basis point decline over the prior year’s third quarter gross margin of 16.8% and 44 basis point improvements sequentially.

The primary driver of our lower year-over-year gross margin was the foreign exchange impact from the declining value of the Canadian dollar on our Canadian business. Additionally, there were some carry over into February due to weather from an inbound transportation perspective. Year-to-date, gross margin at 16.7% a decline of 10 basis points to year-over-year driven by the same factors I just mentioned along with the continued mix shift in customer.

Our operating expenses for the quarter were 13.2% of net sales compared to 13.4% for the same period last year. This represents a 13 basis point improvement over the prior year as operating expenses as percentage of our net sales continued to benefit from our technological initiatives and strong execution by the General Managers and our broad line distribution center. In the quarter, we incurred $0.9 million associated with startup cost for our new Racine, Wisconsin, $0.6 million in transaction cost associated with our pending acquisition of Tony’s Fine Foods. And $0.4 million in duplicate rents and associated building cost associated with one of the Denver facilities we entered in the fourth quarter of fiscal 2013.

Excluding the portion of our Canadian business which involves the use of third parties for deliveries in certain areas, diesel fuel had a positive impact of 1 basis point on operating expenses in comparison to the third quarter of fiscal 2013 as fuel represented 70 basis points of distribution net sales in the quarter. Fuel in the quarter decreased by 1 basis point versus second quarter although our fuel expense increased by 6.3% sequentially due strictly to the highest sales volume; our diesel fuel prices in the third fiscal quarter declined by approximately 0.6% from the prior year’s third quarter was Department of Energy’s national average was down approximately 1.1% over the prior year.

Share-based compensation expense totaled $3.6 million in the quarter compared to the $3.1 million in the prior year’s third quarter. Share-based compensation expense represented 20 basis points as a percentage of net sales in the quarter consistent with the prior year’s third quarter. Operating income for the third quarter was 3.5%; a 7 basis point improvement over the prior year’s operating income of 3.4%. Adjusting for the $1.9 million and 11 basis points associated with the Racine startup, Tony’s Fine foods transaction cost and Denver’s duplicate rent expense, operating income was 3.6% and 8 basis point improvement over the fiscal 2013 third quarter after adjusting the prior year for $1.5 million expenses associated with the with the Auburn Washington labor action.

Our effective tax rate for the third quarter of fiscal 2014 was 40%. As we look to the fourth quarter, we would expect the tax rate for the quarter to be in the range of 39.5% to 40% depended upon our state taxes of portion. Inventory was $832 million at quarter end as days inventory on hand averaged 49 days for the third quarter, an increase of about three quarter of a day over the prior year’s third quarter when we were at 48 days. The higher average stays on hand resulted primarily from the later seasonal inventory build for the eastern and pass-over holiday.

Our DSO for the third quarter increased by approximately a quarter of a day while remaining at 21 days on the year-over-year basis due to the higher sales growth from the supermarket channel and supermarket customers tend to pay more slowly. Capital expenditures were $31.6 million for the quarter and/or at a $108 million of a 2.15% of net sales for the year-to-date, which is consistent with our full year guidance.

Our new facility new Racine, Wisconsin opened on our new Warehouse Management System and began receiving inventory in early May. The first shipments from Racine are scheduled to occur in late June. In addition, our Auburn Washington facility is scheduled to go live on our WMS in mid July and we expect to begin rolling out our inventory optimization modules on eastern half of the U.S. late in the fourth quarter. Outstanding commitments under our credit facility were $268 million at quarter end with available liquidity of approximately $200 million including cash and cash equivalents. Our leverage increased slightly to 1.2 times levered on trailing 12 months basis due to Easter falling later in the quarter and our increases CapEx in fiscal 2014.

As previously announced in May, we amended our revolving credit facility increasing the aggregate availability under the facility from $500 million to $200 million. As discussed in this afternoon’s press release we are narrowing our net sale guidance range for fiscal 2014 to $6.73 billion to $6.77 billion which represents an increase of 11% to 11.6% over fiscal 2013 net sales.

Adjusting for approximately $190 million of net sales for the 53rd week in fiscal 2013, net sales growth for fiscal 2014 is expected to be in the range of approximately 13.2% to 13.8%. We also updated our GAAP diluted earnings per share guidance for fiscal 2014 to arrange from 247 to 250 per share. Our previous GAAP earnings guidance was 245 to 251 per diluted share.

Our updated guidance does not reflect any anticipated sales or earnings from our recently announced agreement to acquire Tony's Fine Foods, which is expected to close late in the fourth quarter of fiscal 2014. However, our realized guidance does reflect approximately $1.3 to $1.6 million in anticipated acquisition cost, associated with the transaction, including at the $0.06 million incurred during the third quarter of fiscal 2014.

Additionally, included in our fiscal 2014 earnings guidance is approximately $3.2 to $3.4 million of non-recurring expenses associated with the plan opening of our new Sturtevant, Wisconsin facility and duplicate rent and building cost associated one of the Denver facilities that we existed in fiscal 2013, which has at least that we’ll not terminate until July 2015.

Our previous non-recurring expense guidance was $2.5 million to $3 million. To the extent of our proposed acquisition of Tony’s Fine Foods closes before the end of fiscal 2014 and will have a impact on our existing guidance, we will update our fiscal 2014 guidance upon confirmation of the acquisition.

At this point, we’ll turn the call over to the moderator for the question-and-answer session.

Question-and-Answer Session

Operator

Thank you (Operator Instructions) Our first question is from Andrew Wolf of BB&T Capital Markets. Please go ahead.

Andrew Wolf - BB&T Capital Markets

Hi, good afternoon. Steve you mentioned there’s a lot of continued competition or what have you from self distributed traditional change. And then I think you mentioned, I heard it right, was it traditional grocery distributors or you’re alluding, okay. And obviously by that you mean the case (ph) of the world or more like super value getting more specific?

Steve Spinner

Yes. Some of the traditional conventional food distributors at over the last couple of years have added quite a bit of natural organics.

Andrew Wolf - BB&T Capital Markets

So are you trying to, is there, I guess I am getting to is, there’s some kind of change from what you’ve seen in the last quarter of last year that you see accelerating or is that just sort of the way it’s been for a while and?

Steve Spinner

No, it’s really the way it’s been for a while; the industry growth is really nothing new. And so it’s obviously something that we’ve thought lot about it, over the last couple of years. And turning with the acquisition of Tony’s and really building out our product offerings so that it truly is distinctive, it’s a terrific hedge again kind of competition that we’ve seen coming in for the space.

Andrew Wolf - BB&T Capital Markets

Okay. Is any of that competition on price or is it just, hey, we’ve got this product too?

Steve Spinner

No it’s all on price.

Andrew Wolf - BB&T Capital Markets

Right.

Steve Spinner

Yes. It’s firstly all on price, because they don’t have a differentiated product line it’s a pretty narrow group of products that they coming to market with. And typically their distribution programs and to be less than ours become, because they are coming to the store with full truck or virtually a full truck with conventional product and so the distribution model itself is much more efficient for them to carry along the mark. And so it’s really nothing new, but I think it’s an important point to make. So it hasn’t affect us, affected us in a significant way when looking at this year versus last year, but I think it was just an important commentary to make that, we’re not the only one it’s out there, there are other people that are coming into the space to compete on the fast moving items.

Andrew Wolf - BB&T Capital Markets

Okay. And then just on the guidance I wonder if you clarify I think the last things, Mark you were walking about was $3.2 million of non-recurring cost to get Racine open and for the duplicate rent?

Mark Shamber

Well, it’s the Racine part -- portion of and it is the Racine opening and another portion of it is the Denver rent for the building that we existed at least other run out until the end of fiscal 15, so there is the two items. And really the Denver rent has not increased but as Steve alluded to in his comments we’ve made some intentional changes in bringing people on board in opening up Racine. And so the original guidance was $2.5 to $3 million and now it’s 3.2 to 3.4 because we will likely incur above $500,000 to $600,000 more in non-recurring than when we had started -- when we had initially projected.

Andrew Wolf - BB&T Capital Markets

Okay and how do you -- could you give us separately, the Racine portion and the duplicate rent.

Steve Spinner

I give ranges because that’s the whole reason. It’s probably at this point, it’s probably at 1.2 million to 1.6 million on the Denver side for the dead rent and the balance now is probably a 1.8 million to 2 million on the Racine side.

Andrew Wolf - BB&T Capital Markets

Okay. And the other housekeeping on the gross margin, I might have missed that but could you give us the impact for the weather in February and Canadian currency.

Steve Spinner

We didn’t break it out before, Andy and I’m not sure this quarter we will I mean it was only 6 basis points. So the two of them combined were only like three or four bips.

Operator

Thank you, the next question is from Scott Mushkin of Wolfe Research. Please go ahead.

Unidentified Analyst

Hey good after this is Mike Ottaway (ph), thanks for taking the question. Steve, bigger picture question for you? So over the next six months or couple quarters you guys are going to have a lot more capacity coming online with Wisconsin and then Hudson Valley. How should we think about this in terms of the opportunity for your guys to kind of go after new business, and how it positions you heading into fiscal ’15.

Steve Spinner

I mean the first thing that it does, is you’re not well, let me take a step up, for the first six months it’s more cost than anything else, because we’re moving a lot of freight around because we’re taking out of Chesterfield, Dayville and York, in populating Hudson Valley and the same thing is true for the Midwest where we’re moving from 2 DCs in the Midwest into Racine. And so it just takes us a while to get settled into the facility, so in the short term, you know, six months or so, there really is not a lot of efficiency this cost. For the long term it does give us a very unique ability to go to both new and existing customers with lots of interesting opportunities, whether skew expansion, new categories, new customers, anchored tenants if you will and those things we’re working hard to bring home but you know it’s going to be a while before we make all these, those things happen because obviously there’s a lot of moving parts. You may have noticed in my comments earlier that I talked about offsite stores and the manner of money that we spend keeping product in third party warehouses is pretty spectacular, and that’s only because we don’t have the capacity to put in our own DCs. So the first thing we do in those markets is we eliminate the offsite storage and that by itself takes some time logistically to get it all moved out. And so I think you know generally that’s where we are. Does that answer your question?

Unidentified Analyst

Yes, yeah that’s really helpful, thank you and then on the kind of fresh side of the business when you combine Tony’s with Albert’s and some of the other fresh business that you have, how much of the business now do you consider fresh and where do you think that could go over the next three to five years and then I guess how should we think about the contribution to some extent these businesses should be able to put more value add, maybe a higher shrink but more value add than dry grocery distribution, is there an opportunity on the EBIT line to move higher over time.

Steve Spinner

Yes, so. Well first Albert’s is predominantly organic produce and they do some perishable protein and cheese but they’re predominantly organic producers, Tony’s is predominantly fresh protein and specialty cheese and related kind of commercial food products. You know when we did the analysis that we talked about, the overall operating margin was going to be somewhat dilutive and we haven’t gotten into the specifics only because we haven’t provided any guidance yet, which we’ll do once we get into talking about 2015, and it’s only because protein has a much higher case cost, so for example if our case cost is $15 and their case cost is $45 their actual gross profit dollars per case is higher than ours but their gross margin associated with it is much less. And so we’re going to have to kind of see how that all plays out as we look at the 2015 budgets and like I said we’ll get into some clarity there in September.

Operator

Thank you, the next question is from Jason DeRise of UBS, please go ahead.

Jason DeRise - UBS

So I guess I just wanted to come back to the idea of competition, you know it’s always been the case that has perhaps has become larger than and it was likely that you would lose them and then replace them with many more smaller breads. Do you think that equation is changing where you have to write harder to find the least smaller brands to replace the bigger brands?

Steve Spinner

Okay so, Jason, first one point clarification. This only affects less than one third of our business because it only affects the supermarket channel. It doesn’t have the impact on the other channels of business that we have because there really isn’t a direct option. That’s number one. And number two, the second of things happening. I would say that 40,000 feet is really nothing new in terms of the amount of product that falls out, that goes direct versus a few amount of new product that’s coming in. The great thing about this industry is that it’s incredibly vibrant; the new product environment. There are so many new products, you’ve been to explore this, you can see thousands and thousands of new products come in. Second of all, new capacity makes it a lot easier to bring on a lot more product and live with a little bit more risk associated with the products that we bring and they may not move. Obviously when your very tight, it’s much harder to do. And so the last thing I would comment on his we do actually have some interesting data that points to products that leave us, for example if you think of a large brand that we may carry 50 SKUs and we will lose, the top eight fastest moving items in that particular brand, just because it’s cheaper to take it direct. But when you factor in, the field rate associated with that retailer’s ability to buy direct versus our ability to fill the deliveries by putting entire UNFI, a lot of cases the retailer comes to the conclusion that we would rather pay a little bit more on the distribution and have them in stock and save a couple of hundred basis points on the acquisition cost, but not have the fill rate. So we frequently take back products that we have lost to direct over time. I know that’s a long winded answer, but unfortunately it’s a complicated issue that it’s really nothing new to it today. It’s just a little bit more complicated.

Jason DeRise - UBS

Okay, and what are the -- I guess one of the debates in jail financial community is about where the natural organic market is from a saturation point of view and a growth point of view; do you feel that there is a temporary saturation either from a supplier, distributor, or retailer point of view versus where the demand is for the category?

Steve Spinner

Saturation for UNFI, you mean?

Jason DeRise - UBS

Now, the industry, really.

Steve Spinner

No, I don’t think that. No, definitely no.

Jason DeRise - UBS

Any color, why?

Steve Spinner

I think the whole industry is growing so rapidly. Consumers clearly have -- said through their actions that you’re going to buy more and more of our products, and that’s true across everything we do whether it’s Albert’s produce, organic produce or Albert’s perishables or prepared foods or looking at the growth within Tony’s organization, or looking at the growth within the UNFI core categories that we traded in for a long time. Very clearly consumers have voiced the fact that their interest in our products are here to say.

Mark Shamber

And Jason, I would add; when we look at the sales trends for the quarter to date, we’re probably, we usually give a range instead of giving exact number, but we are certainly within 30 to 40 basis points either way of where we have been tracking. So we haven’t seen -- if you look at the second quarter we are 39 on an overall 12-6 exact position, we’re similar range of this quarter. The trends are holding through the first five weeks of the fourth quarter. So we really haven’t seen any noticeable degradation in the overall sales. There may be shift within channels but we haven’t seen overall sales being impacted.

Steve Spinner

Let me just make one other comment. For the last, well I do know, three or four years we are talking about protein, and you know we tried to build that within and - calls and internally and externally we’ve talked a lot about protein being kind of last bastion of finishing out the store for UNFI, we worked hard on this one, and we were incredibly fortunate to be able to acquire something like Tony’s that has a rich history and culture like ours. And the most important thing that they have to offer is there more excited about rolling their products and their platform across the country than we are. And that’s a great marriage. We’re really excited about where a Tony’s picks up.

Jason DeRise - UBS

Apologies to the rest of the queue if I could squeeze just one more in about Tony’s. As we’re trying to do some of the math on it in understanding the working capital; has they grow or they, you know generating free cash flow because of the better working capital of their business model?

Steve Spinner

They are, they have got some pretty strong returns from a free cash perspective given their overall profitability. I mean they have got much lower DSO days on hand as we sort of touched on in the previous call. So they generate some good free cash.

Jason DeRise - UBS

So in terms of like covering your cost of capital or payback or generating economic profit, how you want to define it from that point of view or are you able to share some metric about that just by the deal?

Steve Spinner

I think that, I think certainly once the deal closes and we get to the fourth quarter and cover that in September, we’d be happy to do so. I mean there is components that will have factor in that I don’t want to necessarily get into the accretion at the moment simply because we’ve got to factor in sort of where intangibles, we’re going to have to amortize and we’d like to make sure that the deal is closed before we start talking to that level.

Operator

Thank you. The next question is from Karen Short of Deutsche Bank. Please go ahead.

Ryan Gilligan - Deutsche Bank

Hi this is actually Ryan Gilligan on for Karen. How should we think about the chatter out there by some of your suppliers that there was destocking at UNFI. And kind of along the same line, it looks like the independent channel slowed slightly on a two year average basis. If that you guys just becoming more efficient or was there a slight slowdown in demand?

Steve Spinner

Well without getting into talking about specific suppliers, I mean in the west we did deploy our inventory optimization to buy supplier. And so if you notice, I mean overall our inventory actually increased slightly during the quarter. But because we introduced the tool by supplier, I mean it is possible that one or more suppliers could have seen some reduction in the inventory. The whole basis for our demand planning tool is to make sure that we have an appropriate amount of inventory in the right DC at the right time.

Mark Shamber

And I would just add to that is when we talk about the inventory optimization and we did it last year in the west and we’re getting ready and starting it now in east this year. The one item to highlight that we referenced is that it varies certainly by suppliers, there may be some where we’re adding to inventory levels and someday we’re decreasing what we carry on hand. But the ones that are actually taking reduction at least on a one-time basis is really a function of the fact that they are better able to execute and that we’re able to ensure or they are able to ensure that when we’re reordering products that it hits our docks, it hits our warehouses in the timeframes that we want and we’re not having to carry multiple extra weeks of inventory as is the case with some other suppliers.

We referenced in the first quarter and then going into second quarter for the holiday season that we built inventory levels above what we would be comfortable carrying simply because we didn’t have complete comfort that’s across the entire base of our suppliers that they could have the product and that they wouldn’t get caught by out of stocks. So this is -- for those that are sort of taking the one-time adjustment and getting down to levels we’re looking to carry going forward, it’s actually a positive in the sense that they’re able to execute, whereas some of the other suppliers struggle on that quite frankly.

Steve Spinner

Our service level actually has been very strong during the last 13 weeks.

Ryan Gilligan - Deutsche Bank

That’s helpful, thank you. And is there any reason why the impact on margins at the eastern division wouldn’t be the same as the western division? I guess have you guys discussed what you expect to happen.

Steve Spinner

Also ask the question about the independence.

Ryan Gilligan - Deutsche Bank

Right, thanks.

Steve Spinner

I wouldn’t say there was a fall in the independent demand; it could have been, because it’s so small I think it could have been related to the number of new store openings, one period versus the next. But I wouldn’t say there was a slowdown in the independent channel.

Ryan Gilligan - Deutsche Bank

That’s helpful, thanks. And I guess just one quick follow up on the inventory optimization. Are you guys expecting any difference between the divisions in terms of margins lift and have you guys quantified what you expect the margin lift will be?

Steve Spinner

We have not quantified and it’s difficult to project as to where that lift will come from. I mean the mix of products is different and the capacity in some of the warehouses varies, and so that is a factor as we go through. Again part of the reason that we’re looking to sort of adjust some of the carrying levels for inventory with certain suppliers.

So I don’t think that there is any sort of specifics there, we didn’t provided on the west other the highlight that we did get some left and I think that we’ll take that same approach with the east.

Operator

Thank you. The next question is from Stephen Grambling of Goldman Sachs. Please go ahead.

Stephen Grambling - Goldman Sachs

I guess turning first, speaking with gross margin. You had a solid performance given all the headwinds. Can you just give us a little bit more color on how you’re thinking about this line item in the fourth quarter, even further out given the Tony’s transaction is going to model the comparisons a bit.

Steve Spinner

Well as it relates to the fourth quarter anything I’ll reference it with the expectation that the transaction doesn’t close, because when it closes will impact, have that sort of relative impact the later in the quarter the less impact it has. Certainly on a year-over-year basis we would expect the gross margin to be down significantly probably more in the range of where we reported the third quarter this year, then where last year’s fourth quarter was. The any benefit we got in the IO side would not occur in the fourth because we’re really rolling it out going end to the first quarter 15 and it even be fully deployed so late in the first quarter of 15. So I am going to think from that standpoint Steven, we’re probably 10 to 15 basis points either way from the 167 that we just reported.

Stephen Grambling - Goldman Sachs

And then I guess looking further out, I mean one of the things that you mentioned from the competitive set was differentiating the product offering there is also the settlement of there are been focused on price, do you feel like as part of the strategy you also incorporate some price investments as well?

Steve Spinner

Yes. I mean, we have overtime, certainly as the channel mix has changed. So I wouldn’t say there’s any different to future that we have and already been leaving in the last couple of years.

Stephen Grambling - Goldman Sachs

Right. And that’s helpful. Thank you so much.

Operator

Thank you. The next question is from Mark Wiltamuth of Jefferies. Please go ahead.

Mark Wiltamuth - Jefferies

Hi, good afternoon. On the inbound freight just wanted to see if that was a help in the quarter on gross margins or was it still little bit of drag there because of the weather issues that did trickle onto the quarter?

Steve Spinner

Well, yes, so I would say from a standpoint the weather issues were dry I mean I think that our performance over inbound standpoint continues to improve by the year-over-year basis. So on a year-over-year perspective it was probably better overall, but we did have some drag that was associated, really in those months of February with some of the loads that we are still moving on our protect from freeze perspective.

Mark Wiltamuth - Jefferies

And is there any way to kind of tell us how much are there you can take this, in terms of how many more quarters are benefit, you think you have or is there some way measuring how deep into the, I guess your system the inbound freight effort has gone?

Steve Spinner

Well, you know we’ve had it in place for two years now at the end of this quarter it’s roughly two full years. We think there is still opportunity there, we started with some of the biggest items and we’re now moving to that next layer and we’re trying to work more closely with our supplier to see whether there’s opportunities where we can both benefit from that standpoint. So I would certainly say that it’s not complete, how many quarter or how much longer it would grow other than in access or beyond, our over our growth of the business still remains to be seen. But, we’re still identifying opportunities in trying to pursue those. So I think there’s at least few more quarters.

Mark Wiltamuth - Jefferies

Okay. And is there any general role some we supply to your other DC’s as they come on in terms of the startup inefficiencies?

Steve Spinner

No, I mean there’s nothing easy or straight forward. I mean it depends on what time of year they open, how soon we start bringing people on, the customer mix associated with it. And in some cases when there’s relocation, the relocation have less expense associated then the startups of a Greenfield but beyond that is no easy rule of thumb.

Mark Wiltamuth - Jefferies

And what their full speed to end up with a better margin than you had previous or is it really just the revenue growth came here within maybe cease?

Steve Spinner

Well, keep in mind that, one of the ways we justify the new distribution centers is by putting them close to the ultimate consumer, for the retailer. And so we eliminate a lot of miles, right. So it’s a fooled out strategy to -- when we put a new DC, we put it closer to where we have a lot of customer locations. And so elimination of the miles if typically what gives us the ROI ability.

Mark Wiltamuth - Jefferies

Okay. Congrats on a solid quarter and look forward to next year.

Steve Spinner

Thank you.

Operator

Thank you. The next question is from Kelly Bania of BMO Capital Markets. Please go ahead.

Kelly Bania - BMO Capital Markets

Hi, good evening. Thanks for taking my questions. Just Mark, first one it’s a recap on guidance so narrowed the earnings per share range a little bit, but that’s in spite of I think a total of an incremental $2 million of cost for that over Q3 and Q4.

Steve Spinner

Correct. So about a 600, well, actually about 800,000 Q3 between the transaction cost and the incremental we’re seeing in that another million to -- well, 800 to million two in the fourth quarter.

Kelly Bania - BMO Capital Markets

Right.

Steve Spinner

Yes.

Kelly Bania - BMO Capital Markets

And then just curious on we’re seeing with the new WMS system. How do you feel about that system coming on board, do you anticipate everything going smoothly, just to may be an update on how you saw that rolling that out?

Steve Spinner

Yes. It is live, it’s running and it is pretty slick, hence we’re really excited about that. All of our new DC’s will come in the new platform we’ve got a DC converting over the next 60 days, where we feel great about it.

Kelly Bania - BMO Capital Markets

Great. And then just back on Tony’s, looking at your competition may be you’re reading all competition, how many of those competitors offer kind of the full suite of products that you now will offer with the addition of protein?

Steve Spinner

There is no body that I know of, that has a full offering of natural organic ethnic gourmet and perishable protein and specialty cheese. There are distributors in the market that may carry portion some of that product offering, but there is no one that I know of that can deliver the store in its entirety.

Kelly Bania - BMO Capital Markets

Great, that’s helpful. And then just one last on the offsite storage cost that you mentioned, are those spread out throughout the country or is there anyone region where once you get a new DC there that will help alleviate some of the cost?

Steve Spinner

Yes, again, that’s one of the drivers for putting in this the new building. It’s obviously locations where we have a lot of offsite storage and so while the number is spread out across the country. It is pretty heavily concentrated in the areas where really tight on room.

Operator

Thank you. The next question is from Mark Segal of Canaccord Genuity. Please go ahead.

Mark Segal - Canaccord Genuity

Hi, guys. A number of year suppliers have called out key commodity inflation that’s been fairly sharp, have they communicated to you their desire for price increases perhaps in the back half of the calendar year and given that a lot of your business is cost plus, can you talk about how quickly you’re able to pass that cost through and how you handle that?

Steve Spinner

Mark, we typically get about 60 days notice with respect to price changes. So to the extent that anyone was looking to put a price change through for July 1st or August 1st, we would know about that now, but if folks are doing in September, October, they may signal or they may start talking about. But until they officially announced it, it would simply be they looking to put it through. And from that perspective, the 60 days notice gives us the opportunity to get that reflected in our system into our catalogues into our pricing for our customers. So down the day, it takes effect, we’re able to pass the long concurrently.

Mark Segal - Canaccord Genuity

Okay and a follow-up the price question, on the third party storage cost and the trucking miles saved on the build-out of your new facilities, would four new buildings are DC planed, can you talk about cadence wise how we expect does that cost come down in chunks perhaps is more region more impactful than the other just how do we think about that over the next call it three year or so?

Steve Spinner

I wouldn’t say they come down in chunks, but what I would say is that it’s a gradual process because we’re constantly evaluating the roots that we have and whether they better served from one facility or another facility as well as the miles that we’re travelling from our distribution centers and trying to get the best mix to hit delivery times for our customers as it also takes the more expeditious root two of the customers. I think it’s a gradual decline. What I can probably give you best from a standpoint of how that works out is that, every quarter we provide what our field expenses, and if you look at where it’s gone as a percentage of our total sales, you’ve seen that it’s comedown overtime even while the prices have stayed relatively constant. And some of that’s by adding more efficient with the fleet, but a lot of it is by reducing the miles that we’re travelling to get to our customers and/or basically routing more effectively with the existing customers trying to find the right DCs the surface customer.

Mark Segal - Canaccord Genuity

Okay and then on potential new business that’s out there in the massive supermarket channel or perhaps business that you’re negotiating to keep, have you started discussing any other new Tony’s offering yet or have you been able to call out any customers with the new products?

Steve Spinner

I mean given that transaction hasn’t closed and it requires FDC review. There are very specific rules along those lines. Having said that there was high interest from our customers from that perspective as soon as the deal was announced, our Group President, Sean Griffin, got a request in the first two hours after the deal was announced, asking when we were going to bring that product.

Operator

Thank you. The next question is from Eric Larson of CL King. Please go ahead.

Eric Larson - CL King

Three quick questions, and mark I apologies, if you’ve already covered this. Did you quantify the impact of the Canadian dollar in the quarter? You may have already covered this point.

Mark Shamber

We didn’t quantify it. We said that between the Canadian dollar and some of the carryover on the frozen products that it was probably three or four basis points, but we did not break it out specifically or individually.

Eric Larson - CL King

Okay. Thank you. I apologies instead. And then just on a broader question I know this is kind of tricky any thoughts you may have on this or not, I know I think this fall is the end of the three-year agreement with Safeway on that contract, any thoughts on that or you know how you’re thinking about that or what’s going on there.

Steve Spinner

Well, I think we’ve had a good relationship with Safeway and we don’t talk about any contracts that we’re currently pursuing and or attempting to renew but we feel that we’ve had a good relationship with them for the three years and that both parties have helped to grow that business and so we would expect that, we would expect that we would be in a good position to retain a, but beyond that I don’t think I’m in a position to comment on anything specifically.

Eric Larson - CL King

Okay, fair enough, and then just a final quick question. I know it’s early days on this but Tony’s acquisition as you look at Tony’s today, obviously you want to, Steve’s comments regarding expansion of that product, significant product line across the country etc. did it change any of our thoughts on your CapEx spending as a percent of sales or would you look at more as a reallocation of some capital expense away from other things into that acquisition. How would you look at that today?

Steve Spinner

You’re right on the money. We would reallocate. And keep in mind that, it wasn’t a coincidence that all of our new DCs have extremely large, fully refrigerated loading docks and significant multi-temp (ph) storage facilities for these kinds of products.

Operator

Thank you, the next question from Ajay Jain of Cantor Fitzgerald, please go ahead.

Ajay Jain - Cantor Fitzgerald

Question. I just wanted to confirm your CapEx outlook for the year, I think most recently it was 150 to a 160 million dollar range, is that still the right range, I think that implies around 50-60 million in the fourth quarter, does that sound right?

Steve Spinner

That’s still the same range, what I would say is it probably implies 40-50 million in the fourth quarter. Certainly things can slide Ajay as it relates to some of the new construction that we’re starting but you know, that’s the expectation looking forward.

Ajay Jain - Cantor Fitzgerald

So unrelated to the financing for the Tony’s acquisition do you think you’ll need to draw down on your revolver to support that CapEx spending in Q4.

Steve Spinner

Well, no, I mean in the fourth quarter we generate free cash, I mean if you go back and look at the last three or four years I mean the fourth quarter is the quarter where we generate the vast majority of our free cash. So while for the full year perspective we still expect to be free cash flow negative as we said when we gave the guidance last year, when we get to the fourth quarter certainly we would expect that our free cash would be positive, it would be more than sufficient to cover any CapEx in the fourth quarter.

Ajay Jain - Cantor Fitzgerald

Okay and on the two, actually on the new distribution facilities, can you just provide an update on the timeframe for California when that becomes operational.

Steve Spinner

I’m sorry, can you say that again. You talking about California, Ajay?

Ajay Jain - Cantor Fitzgerald

Yes, the northern California facility.

Steve Spinner

We haven’t announced a exact timeframe yet, I mean directionally it’ll be our fiscal ’17.

Mark Shamber

’16.

Steve Spinner

’16, well end of ’15.

Mark Shamber

Yes, I mean I think as we, when we referenced California before I mean there’re, there can be challenges from a permitting standpoint so until we get through those hurdles and actually begin construction at the timeline. The timeline is a little bit in flux until we’re past all the permitting requirements.

Steve Spinner

We have the land.

Mark Shamber

We own the land and we’re going through the process now.

Ajay Jain - Cantor Fitzgerald

Okay, it’s still a little ways away, and just last one, I know you’re not giving guidance for next year right now, but just heading into fiscal ’15, how much incremental D&A is associated with the two facilities in Hudson Valley, and Wisconsin as they’re starting to come online now.

Steve Spinner

You know, we haven’t gotten to that level yet from a finalizing you know the construction aspects and so until we’re willing to give the fiscal ’15 guidance I don’t that I’m comfortable sharing the incremental amounts.

Ajay Jain - Cantor Fitzgerald

Okay, thank you very much.

Steve Spinner

Taken in an absolute they might just get layered on with our overall D&A and there are some items that come off that would offset some of that incremental.

Operator

Thank you, there are no further questions in the queue, I’d like to turn the floor back over to management for any additional remarks.

Steve Spinner

Thanks for joining us this evening and we look forward to sharing our fiscal 2014 highlights and fiscal 2015 guidance in the fall, I hope you have a terrific summer, thanks again for joining us.

Operator

Thank you, ladies and gentlemen this does conclude today’s teleconference, you may disconnect your lines at this time and thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!