United Natural Foods Inc Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the UNFI First Quarter Fiscal 2021 Earnings Conference Call. I would now like to hand the conference over to your speaker today, Mr. Steven Bloomquist, Vice President, Investor Relations. Thank you. Please go ahead, sir.

Good morning, everyone. Thank you for joining us on UNFI's first quarter fiscal 2021 earnings conference call. By now, you should have received a copy of the earnings release issued this morning. The press release, webcast and the supplemental slide deck are available under the investors section of the company's website at www.unfi.com under the Events tab. Joining me for today's call are Steve Spinner, our Chairman and Chief Executive Officer; John Howard, our Chief Financial Officer; Chris Testa, President of UNFI; and Eric Dorne, our Chief Operating Officer. Steve, Chris and John will provide a business update, after which we'll take your questions. Before we begin, I'd like to remind everyone that comments made by management during today's call may contain forward-looking statements. These forward-looking statements include plans, expectations, estimates and projections that might involve significant risks and uncertainties. These risks are discussed in the company's earnings release and SEC filings. Actual results may differ materially from the results discussed in these forward-looking statements. And lastly, I'd like to point out that during today's call, management will refer to certain non-GAAP financial measures. Definitions and reconciliations to the most comparable GAAP financial measures are included in our press release. I will now turn the call over to Steve.

Thanks Steve. Good morning, everyone and thank you for joining us on our fiscal 2021 first quarter earnings call. As you saw in this morning's press release, we delivered another quarter of strong financial results. First quarter sales grew 6% and first quarter adjusted EBITDA grew 31%, resulting in a 45-basis-point expansion in adjusted EBITDA margin. With the strength we've shown during the last three quarters, the tremendous confidence we have in our company and our strong commitment to increasing shareholder value, it's clear to us that the best days for UNFI lie ahead. As we continue to build and optimize our DC network, expand our brands, win new business, and migrate our business towards customer solutions and expand our fastest growing segment, e-commerce, we believe the momentum from fiscal 2020 will continue as we grow sales and adjusted EBITDA in fiscal 2021 above and beyond our results from 2020, which were partially driven by COVID. As a result of COVID-19, many Americans have been working from home for the past eight months and doing so quite effectively. This paradigm shift means more and more meals will continue to be at home with products that have come through UNFI's distribution network. This trend will continue for the next several years as companies' office strategies evolve. At UNFI, our requirements for administrative and support offices will continue to shrink over the next several years as we've increased productivity and associate work flexibility with work from home. We've had and we'll continue to have great success in monetizing our dark real estate. These factors support our belief that food-at-home consumption will remain structurally higher and provide a strong tailwind to our business. The strategic steps we're taking are providing benefits today and, more importantly, they're positioning us for continued success in a post-COVID environment. We're consolidating distribution centers, reshaping our footprint, and investing in automation to drive operating savings. We're completing long-term labor contracts that provide stability and lay the groundwork for future efficiencies. And we're winning new business and focusing on higher-margin private brands, e-commerce, and retail solutions businesses, all key drivers that help our customers win. COVID has demonstrated how important local community markets are, and UNFI is uniquely positioned to provide the unparalleled selection, brands, and solutions that will generate sustainable win-win growth for customers and UNFI. The addressable market for UNFI is significant, and Chris will share some specific insights during his commentary. Our new long-term contract with Key Food signed in October reflects the critical importance of scale as well as the ease of doing business with UNFI. Key Food is a cooperative of more than 300 stores with a large market share in New York and the surrounding area, and we believe their decision to partner with UNFI is a clear and unambiguous endorsement of our business model and what only UNFI can do for them. As their primary grocery wholesaler, we will be supplying their stores with branded and private label conventional and natural products across a wide range of categories. We expect our sales to Key Food to total approximately $10 billion over 10 years or roughly $1 billion annually. To serve Key Food's Northeast stores we'll open a new highly productive distribution center in Allentown, Pennsylvania next fall. This facility will also serve as our enabler to significantly expand our conventional presence in the important New York City metro market. UNFI is well prepared to grow in this market with general merchandising in automated Carlisle, Pennsylvania DC; large scale natural DC in York, Pennsylvania; large scale conventional and fresh DC in Harrisburg, Pennsylvania; and now our new DC in Allentown. As to our largest customer, we've begun the process to address our supply contract, which, as a reminder, runs through October of 2025. Since the pandemic began, we've both been focused on operating our respective businesses and meeting the needs of our customers, efforts that will intensify during and through the holidays. We will heighten our focus on the contract renewal as we move into calendar 2021 and expect we'll be able to announce a formal extension of our partnership early next calendar year. Finally, we're launching the next round of productivity and efficiency work streams, shifting from integration activities to a series of transformational initiatives that will position UNFI for future sales growth and margin expansion. We began evaluation of this next phase of initiatives, which we're calling Value Path, a year ago. Value Path is a holistic approach to driving more value throughout our business, including across key elements of pricing, procurement, operations, and administrative functions. We believe these initiatives will drive an additional $70 million to $100 million by the end of fiscal 2023 and contribute to future bottom-line growth, margin expansion, and generate meaningfully incremental free cash flow. Let me now turn the call over to Chris to provide more context on our business performance.

Thanks, Steve and good morning, everyone. On today's call, I'll provide a bit more context for our fiscal 2021 first quarter performance and discuss the key trends in our business. I will also highlight drivers that differentiate UNFI and give us confidence in our long-term growth. As you saw in this morning's press release, total sales for the quarter increased 6% or $375 million compared to last year's first quarter. To put this growth into perspective, consider the three-month period ended October 30. Syndicated food sales as reported by Nielsen increased 8.9%. This syndicated sales growth includes roughly 300 basis points difference between retail and wholesale inflation. The syndicated data also excludes the foodservice channel, which represents a nearly 100-basis-point headwind to UNFI's total company first quarter sales growth. Considering the impacts of retail inflation and those channels negatively impacted by COVID, we believe our 6% sales growth is outperforming the market and driving share growth for UNFI. Sales to our top 100 customers, representing nearly 70% of total net sales, were up approximately 10.5%. We believe our strong sales performance is being driven in large part by the long-term strategies we have discussed during previous calls as well as favorable consumer trends in specific channels. Namely, cross-selling efforts yielded an additional $60 million in incremental sales in the quarter. As we've discussed, previous cross-selling efforts consisted largely of many small wins with new item introductions. In fiscal '21, we're beginning to realize larger wins as customers begin to aggregate more purchases with UNFI. We continue to believe that increasing share of wallet with our current customer base of nearly 15,000 is a unique and very large growth opportunity for UNFI. This includes selling more natural product to conventional operators and vice versa, expanding professional services, and increasing the penetration of private brands and fresh categories. We estimate UNFI has a $140 billion addressable market, including $38 billion from incremental revenues from cross-selling to our existing customer base. The second driver of the Q1 results is new business. During the past 10 months, the grocery supply chain was stressed and UNFI displayed consistent performance through our safety protocols, aggressive hiring and leveraging our scale to procure high-demand products. This performance was recognized by the marketplace and has allowed our new business pipeline to expand, including the contract with Key Food that Steve spoke about earlier. In Q1, we began shipping to some of these recently acquired customers and we plan to continue to convert pipeline opportunities to new business wins to drive UNFI growth higher than the comparable industry growth. Another driver of our Q1 growth was favorable channel trends we continue to experience. Supernatural sales were up 9.3% over last year's first quarter, representing a 570-basis-point sequential improvement from the fourth quarter of fiscal 2020. This performance is largely being driven by center store grocery items that are overcompensating for some of the declines from adversely impacted categories like bulk and prepared foods. The fastest growing portion of our business is e-commerce, an area of accelerating importance to the success of our customers. Our e-commerce sales were up 93% in the quarter, including nearly 300% sales growth to the largest e-commerce player who has also grown into a top 25 customer for UNFI. It is estimated that e-commerce now represents 9% of total grocery purchases and UNFI is positioned to take advantage of this trend in several ways, including partnering with e-commerce operators, selling an online platform to our brick-and-mortar customers and through our owned e-commerce businesses under the UNFI Easy Options and On a Screen platforms, which sell grocery and wellness items on a direct B2B basis. In addition to these growth areas, UNFI is receiving secondary e-commerce growth from our brick-and-mortar customers that are using e-commerce solutions to sell groceries that they purchased from UNFI. To put this in perspective, Cub averaged over 30,000 e-commerce orders per week, which has led to an e-commerce sales increase of 200%. Although we do not recognize these transactions in our e-commerce reporting, this is an example of how UNFI is benefiting from this growing consumer behavior. First quarter sales to the change were up 5%, while sales to independents increased 7.4%. The strength of our customers in these channels reflects many of the same volume-driving initiatives we discussed previously, in addition to the desire for consumers to shop local and patronize stores with smaller footprints that are closer to their homes. This is especially true in the independent channel where we grew sales, with 45 of our top 50 customers in this channel, including 30 that grew sales at a double-digit rate. In addition to favorable revenue growth we are experiencing across our core business, we continue to expand our professional services and private brands businesses as well. Growth from these business units is expected to contribute to margin rate expansion for UNFI as we focus resources on driving these strategic initiatives. Both offer solutions that help customers increase sales, improve gross margins and lower operating costs and these businesses are unique to UNFI, which strengthens our long-term partnership with these customers. Our strong top-line results also extend to our retail business, where first quarter identical store sales increased nearly 16%. In addition to the e-commerce growth I already mentioned, the merchandising and operational changes we put in place over the past year continue to improve product mix and favorably drive results at both the Cub and Shoppers banners. On the operations side, we continue to move forward with our strategy to maximize our network and consolidate where opportunities exist to better service our customers and deliver operating efficiencies. We have previously discussed our consolidation efforts in the Pacific Northwest, where we expect the cost savings from that project to be realized as we move through fiscal 2021 and forward. We're next consolidating our Santa Fe Springs and Vernon distribution centers into existing DCs in Southern California. In both the Pacific Northwest and Southwest projects, we are modernizing our facilities by deploying automation, which is already proven to dramatically increase throughput levels, improve our capability to track labor, and lower operating costs. As we've worked through the investments we've made in these consolidation projects, we've absorbed about $20 million of higher operating costs in Q1 as a result of COVID-related challenges and new DC productivity growth. The good news is, we believe these incremental costs will diminish over the balance of fiscal 2021. To put these changes in perspective, when these large-scale optimization projects are complete, we will have consolidated from operating 10 distribution centers to six in these two areas. By eliminating a net four DCs from the network, we've removed meaningful fixed costs associated with these extra buildings. In the process, we generated approximately $125 million in cash proceeds while creating a footprint that requires less investment and working capital, and we can realize lower net operating expenses. We'd expect to achieve these types of benefits to varying degrees as we analyze and review the balance of our network. Lastly, as Steve touched on, since the end of fiscal 2020, we've finalized new labor contracts at seven distribution centers, covering more than 1,200 associates. We're pleased with the long-term stability and flexibility these agreements provide and we will continue to pursue the modernization of our labor agreements across the enterprise, as we negotiate the renewal of these contracts. When we consider the strength and diversity of our growing customer portfolio, the large addressable market opportunity in front of us, UNFI's unmatched product and service offerings and scale, and the relentless focus of our people to find solutions that benefit our customers, we're confident we'll continue to increase market share. To echo Steve's comments, we firmly believe our best days are ahead of us. With that, I'll turn the call over to John.

Thank you, Chris and good morning, everyone. On today's call, I'll cover our first quarter financial performance, balance sheet, capital structure and outlook for fiscal 2021. As Steve and Chris said, we're very pleased with our strong performance in the first quarter, in which sales totaled $6.7 billion. Adjusted EBITDA was $159 million and adjusted EPS came to $0.51 per share. As a reminder, our first quarter is historically our lowest quarter for these three metrics. First quarter gross margin rate expanded 7 basis points versus last year's first quarter, driven by a margin mix benefit from greater retail sales growth, relative to wholesale sales growth, as well as lower levels of promotional spending in our retail operations. This was partially offset by lower levels of supplier-related income in our wholesale business. First quarter operating expense rate decreased 25 basis points, driven by the benefits of our synergy and integration efforts as well as strong leverage on the fixed and semi-fixed portions of our cost structure. As Chris stated, our first quarter operating expense includes approximately $20 million, or 30 basis points as a percent of sales, of higher operating costs related to the start-up of three distribution centers in the midst of the COVID pandemic, as we focused on the safety of our associates and service levels to our customers. We believe these incremental costs will diminish over the balance of the year. Our 31% growth in first quarter adjusted EBITDA on a 6% increase in sales translates to a 45-basis-point year-over-year expansion in our adjusted EBITDA margin, the third consecutive quarter we've grown year-over-year adjusted EBITDA significantly faster than sales. These results provide evidence of UNFI's ability to leverage topline performance into even stronger bottom-line growth. We believe this growth algorithm over time will generate significant shareholder value. On a GAAP basis, we reported a loss of $0.02 per share, which included $0.44 per share in pre-tax non-cash charges related to the acceleration of unamortized debt issuance costs and original issue discounts due to the term loan prepayments made in the quarter and $0.30 per share in pre-tax advisory fees largely related to our Value Path project. Our adjusted EPS, which excludes the impact of these items and two smaller adjustments, totaled $0.51 in the quarter. Our GAAP and non-GAAP EPS both include the impact of the operational challenges I referenced earlier. Turning to the balance sheet. Our total outstanding net debt finished the quarter at $2.7 billion, a $128 million increase compared to year-end, but a $460 million reduction compared to just 18 months ago. This reflects our customary first quarter investment in working capital as we add inventory going into the holiday selling season in support of our customers. This higher level of working capital should convert to a source of cash in the second quarter. Our net debt to adjusted EBITDA leverage improved to 3.9 times as the increase in trailing 12-month adjusted EBITDA more than offset the small increase in our net debt balance compared to year-end. We expect a seasonal reduction in working capital and the proceeds from the sale of our Tacoma DC, which were collected early in Q2, to contribute to debt and leverage reduction in the second quarter. In mid-October, we issued $500 million in eight-year unsecured notes, the first for UNFI. This note issuance used to pay down an equal amount on our secured term loan was executed to extend and stagger the maturity dates of our capital structure while maintaining ample liquidity and flexibility to meet the needs of the business. This refinancing was a key step toward optimizing our long-term capital structure and we believe it will enhance our ability to refinance the remaining balance of the term loan in the coming years. As Steve and Chris mentioned, we believe the current operating environment will continue to benefit food-at-home consumption, which combined with further anticipated cost savings from the work Chris spoke to gives us a high degree of confidence in our ability to achieve our FY '21 operating guidance. Therefore, we are reaffirming our full year guidance for net sales, which we continue to expect to be in the range of $27 billion to $27.8 billion. Adjusted EBITDA, which we continue to expect to be in the range of $690 million to $730 million and adjusted EPS, which we continue to expect to be in the range of $3.05 to $3.55 per share. As Steve mentioned, we are strategically investing in a new distribution center in Allentown, Pennsylvania to serve Key Food. Because of this investment, we are updating our FY '21 guidance for capital expenditures, debt reduction and leverage. We now expect capital expenditures to increase by roughly $50 million to a range of $250 million to $300 million. We also expect a corresponding $50 million decrease in our debt reduction outlook and now expect to reduce total outstanding net debt by approximately $250 million in fiscal '21 and we expect to achieve net debt to adjusted EBITDA leverage of approximately 3.5 times by year-end, a small increase from the 3.4 times provided as part of our original outlook. This assumes, as I said on the last call, a nominal amount of asset sales beyond the proceeds for Tacoma. Additional proceeds from asset sales, which last year totaled nearly $150 million, could improve our net debt position and further improve our leverage. The capital we are investing in our Allentown facility will improve our competitive position in the Northeast, allow us to further build market share in Metro New York and position us for further growth beyond the incremental Key Food revenue of $1 billion per year. While it will reduce our net debt reduction outlook for this fiscal year, we believe it will lead to higher levels of free cash flow in the future. We remain very focused on improving our operating efficiency and have completed a substantial portion of the integration synergies related to our acquisition of SUPERVALU ahead of schedule and above our $185 million target. As Steve mentioned, Value Path is our next set of productivity initiatives that will enable us to transform our business and lay the foundation for continued topline growth and EBITDA margin expansion. The current year benefit of these initiatives is included in our fiscal '21 guidance. We expect the full impact of these productivity initiatives to ramp up over time reaching an annualized incremental gross benefit of $70 million to $100 million by the end of fiscal 2023. We expect to reinvest a portion of these savings in driving market share gains, accelerating innovation and investing in automation. The balance of these cost savings are expected to expand operating margins. Before I turn the call back to Steve, let me state that we are committed to increasing value for our shareholders. We remain confident we can grow our business over time and realize that consistent performance is the cornerstone to driving shareholder returns. We expect to generate meaningful cash flow over the coming years and we are committed to further reducing debt and improving our leverage. Thank you for your time this morning and for your interest in UNFI. With that, let me turn the call back to Steve.

Thanks John. As John discussed, we are laser focused on driving our business forward and highly motivated to increase shareholder value. In the near term, we'll use our free cash flow to continue to reduce debt; over time we'll look at a broader range of capital allocation alternatives. In the next month or so, we'll release our 2020 environmental, social and governance report, covering performance in the 2020 fiscal year. After over a year of work, we'll also be announcing our 2030 ESG vision and ambitious 10-year plan to pioneer solutions to pressing social and environmental issues within our food system. This plan includes expanding and enhancing our policies and practices related to climate change, waste reduction, food access, safety, well-being and diversity and inclusion. Notably, we recently announced our formal intent to set a Science Based emissions reduction target. Our target, which is under development today, will be submitted for approval to the Science Based Targets initiative within the year and will serve as a foundational goal under our Better for Our World pillar, which commits UNFI to reduce our contributions to climate change and increase resilience through operational excellence, investments in clean energy and the pursuit of environmental justice. With this important milestone UNFI is the first grocery wholesaler to join a global movement of companies acting to mitigate the worst impacts of climate change and transition to a low-carbon economy. With millions of Americans struggling every day to access nutritious food, it is simply unacceptable that so much food gets wasted. We recognize the importance of collaboration as we work to address this challenge and are thrilled to have recently joined the U.S. Food Loss and Waste 2030 Champions to share best practices with others in our industry. As a critical link in the food supply, UNFI is committed to digging in to help find solutions. Finally, working with our board succession planning committee, I'm optimistic that we will be able to announce my successor early next calendar year. Our process has been quite robust and has identified exemplary talent both inside and outside of UNFI. I'm also excited about our search for board members who bring a wider range of transformational and large-scale experience to our company. To wrap up, I'm really pleased with our business performance and encouraged by the holiday selling period and the sequential improvement in sales we've seen compared to the 6% growth in the first quarter. We're confident in our ability to deliver on our full year guidance and more excited than ever for our future prospects. With that, we're ready to take questions.

Our first question comes from Rupesh Parikh with Oppenheimer. Your line is open.

Thanks for taking my question. So Steve, just going back to your comments, you said you are seeing a sequential improvement quarter-to-date. If you can provide any more color in terms of what you guys are seeing, is there pantry loading, are you seeing any geographic differences? We'd love to hear what you are seeing lately. And then just for the quarter itself, how did Q1 play out versus your internal expectations? And then my final question, you had meaningful success so far with the Key Food win, and it sounds like you're doing well on the cross-selling front as well. Just overall, what are you seeing out there on the competing front from KeHE and some of the other players?

We are seeing sequential improvement. I don't think it's pantry loading. I think that we're winning more business and we're cross-selling more products to a wider range of customers. If you look at the growth across our channels, that's consistently getting better, and so we feel pretty good about what the numbers are telling us. Remember that we're going to be lapping March, April, and June coming up early next year. But as we see it right now, the numbers look really good. Regarding the quarter itself, we were pretty much right on target, exactly where we thought we would be. As for competition, one thing I would add, which Chris mentioned, is the $140 billion addressable market. Because we have the largest position in fresh, and a large presence in conventional and natural, we've done the work to calculate where the opportunities are, and there's a lot of room to continue to grow with new customers, existing customers, new channels and expansion of channels.

Hi Rupesh. It remains a competitive environment, but through the pandemic we performed very well, and that's opened up our pipeline. In Q1, we began closing new business because we have a stable supply chain, scale to procure new products, and the ability to sell natural, conventional and private label. So yes, it remains competitive, but what we're hearing from customers and seeing in results is that we're getting new business.

Your next question is from Bill Kirk with MKM Partners. Your line is open.

Steve, I believe you said that you expect you can announce a formal extension with Whole Foods early next year? Can you help us understand that expectation? Has it come from conversations with them or is it based on your understanding of some of your aligned incentives?

We've got a long-standing relationship with them; our businesses are deeply intertwined. When both of our companies became deeply embedded in making sure we could get food out into our communities, Whole Foods in their stores and us in our DCs, we consciously decided to postpone renegotiation until the beginning of next year to focus on operations. I have every expectation, and they have every expectation, that this will get done in the first part of next year.

My second question: I think I heard $20 million in extra costs in the quarter related to COVID and start-up at the DCs. How much of the $20 million is just DC related and how much was COVID?

I'll address that. We invested in sustainable safety protocols in all of our DCs, and that's part of that expense. These are unprecedented times. As Chris mentioned, we've consolidated facilities in the Pacific Northwest, opened a new facility in Southern California, and had some challenges with labor. We had some over-reliance on third parties, which we are resolving, and we needed to maintain our commitment to customers and service quality. I remain confident in our operating expense plan for the balance of fiscal '21. We're seeing stabilization trends in the Pacific Northwest and in the new DC in Southern California. We've added investment in automation in both the new Southern California DC and one of the new DCs in the Pacific Northwest. We're optimistic about where we're heading.

Your next question is from Matt Fishbein with Jefferies. Your line is open.

Regarding Value Path, can you help us conceptualize the initiatives that are within that plan, and perhaps what we should expect in terms of cadence for the $70 million to $100 million savings? And how should we think about how much of that is earmarked for reinvestment? And then I have a follow-up. Also, along with the $20 million in operating costs absorbed in the quarter, how much of these two items — Value Path and the operating costs — were already included in your fiscal '21 expectations versus what's been incremental since you were last on the phone three months ago?

I'll address that. First, re-emphasizing our performance around synergies for the SUPERVALU acquisition: we exceeded our four-year target of $185 million in two years, and still have a few initiatives remaining. Value Path is designed to unlock different work streams and different sources of value throughout the organization. It's about optimizing our operating model. It covers private brand sourcing, delivery frequency, distribution center productivity, and organizational effectiveness. We have those work streams stood up and are starting to see some value. We're reinvesting some of that in fiscal '21. The $70 million to $100 million target is well under way for the end of fiscal '23. You can look at this as fine-tuning our operating model, how we're going to market, investing in our people, and driving EBITDA growth through the process. Regarding the $20 million, that was incremental. Our quarter still showed a 25-basis-point improvement in OpEx rate reflecting leverage in fixed expenses, transportation and administration. We're looking forward to the balance of the year with clear expectations.

I'll add that safety is our top priority. Opening large, highly sophisticated DCs in the middle of COVID is difficult, so the operational team delivered a strong operating expense number despite the $20 million of incremental cost — a heroic effort from our operations teams.

Your next question is from Kate Howard on for Karen Short with Barclays. Your line is open.

Are you planning on providing EBITDA by division similar to last quarter when you broke out the channels? If not, can you give some color on how that shook out, specifically retail and chains?

Yes, we'll provide that. If you look through the supplemental schedules, you'll see that information included there. The retail numbers show the year-over-year sales growth and a big uptick in retail EBITDA at about 130% growth. There will be supplemental information in the 10-Q coming out later today.

Your next question is from John Heinbockel with Guggenheim. Your line is open.

Steve, I want to drill down on the $38 billion opportunity with existing customers. Can you provide color on average share of wallet by channel — chain versus independent — and what friction points exist to picking up more of that $38 billion? Also, when the drop size goes up with incremental business, what might the incremental profit margin be?

The addressable market is $140 billion and the $38 billion is the incremental opportunity with existing customers. A dramatic industry shift has happened, similar to food service years ago, where larger players took more share and independents that used many suppliers migrated to a few. Retailers see economies of scale in buying center store, frozen, chilled, dry brands, floral, produce, and meat from one supplier. COVID accelerated this change as retailers focused on reliable supply. UNFI is uniquely positioned to do that nationally. From a margin perspective, it's essentially unchanged, except that protein has a lower markup due to the expensive case cost. On a margin dollars perspective, it's still accretive.

Based on current business, is your share of wallet with existing customers roughly a third on average, well under 50%? And the $60 million cross-sell this quarter—should we expect that to ramp during the year such that the annual cross-sell could be $300 million to $400 million?

To add color: the $140 billion estimate starts from the total industry and removes categories we won't play, and the remaining is the wholesale opportunity. The $38 billion existing-customer opportunity includes customers where saturation hasn't been reached. For example, our seventh largest customer, a large natural customer, we are up 58% with because we started selling them conventional food to help with their captive distribution. That's one clear cross-sell example. These opportunities are margin accretive. If a truck is already going to a customer, additional drops are better economically. As for cross-sell cadence, we don't have a specific target for the year, but we expect sequential growth each quarter. In fiscal '20, our cross-sell wins were largely new item introductions, but in fiscal '21 we're seeing larger opportunities with bigger customers to sell expanded fresh, brands and both conventional and natural products.

Your next question is from Edward Kelly with Wells Fargo. Your line is open.

Steve, can you talk about how you're calculating that roughly 300 basis points inflation difference between retail and wholesale? I assume this is primarily in the chain and independent customer base. Is that number even bigger for them, and does that translate to margin for that customer base? Also, are you seeing any incremental freight pressure, such as higher driver pay or more spot market usage for higher demand?

The roughly 300-basis-point difference is because of reduced promotional spending at retail. If you look at the quarter and year-over-year, promotional dollars have contracted, depending on the period, anywhere from 5% to 10% less promotional spending at retail. Also, some SKU reduction has occurred, with retailers claiming 5% to 10% fewer SKUs on shelves because of supply chain constraints. Regarding how this unwinds, I think the largest CPG companies scaled back SKUs heavily to focus on core production. When they bring back the full assortment, retailers will likely demand promotional support from manufacturers, but we may not see a return to historical promotional cadence until fall of next year, after vaccines are fully deployed and things normalize. That creates an opportunity for us because processing promotional activity is a significant profit center for UNFI.

To add, it's a combination of reduced promotional spend and retailers taking price; those two combined are approximately 300 basis points or a little more.

On freight, we are seeing some pressure primarily driven by market factors around COVID, seasonal retail and heavy imports. We're changing our model from intermodal to over-the-road where appropriate, pushing carriers for more guaranteed road capacity, and moving from an annual bidding process to quarterly to stay closer to the market. We can effectively manage these pressures going forward.

Your next question is from Jim Salera with Northcoast Research. Your line is open.

To drill down on the e-commerce opportunity: what do you think the current penetration is and what is the opportunity over the next year or so? What is the opportunity to expand e-commerce with existing customers that maybe don't use the full suite of products?

COVID accelerated e-commerce adoption. Pre-COVID, grocery e-commerce purchases were around 3%. Today, estimates are around 9% to 10%; we thought we'd reach that level three years from now but it's accelerated. We are well positioned to grow with this trend because we service very large e-commerce providers — our e-commerce number was up 92% and our top e-commerce customer was up almost 300%. The next largest e-commerce customers are significant growth opportunities too. Second, our own e-commerce business, though small, including On a Screen and Easy Options, is up almost 50% and serves a B2B secondary market. Third, we sell e-commerce solutions to brick-and-mortar customers who want to adopt click-and-collect and delivery-to-home. Given these elements, it's not unrealistic our e-commerce business could double in 2021. Much of this growth is not cannibalization of in-store sales; a large portion is click-and-collect and delivered-to-home activity where we sell groceries to retailers and they handle the e-commerce fulfilment. We also see trade-off from away-from-home dollars moving into home consumption in e-commerce channels.

Our final question comes from Kelly Bania with BMO Capital Markets. Your line is open.

Can you share any color on your EBITDA margin outlook for the rest of the year? If you remove the start-up costs you mentioned, Q1 margin is higher. Your guidance implies a similar range for the rest of the year; should we expect the back half to be weaker or any lumpiness to consider? Also, when you said you might reinvest some savings to gain market share, what exactly does that mean — capacity, capabilities, pricing? Finally, on the DC closures and optimization, what's the expected savings from closing those four DCs and potential over the next few years as you optimize further?

We had approximately $20 million in incremental costs in Q1. We expect to recover that as we move through the year with our operating plan and accelerated consolidation of DCs. We don't expect dramatic lumpiness; we know what will happen in Q3 and Q4 as we lap last year's pantry loading, but as a standalone FY '21, we expect the margin to remain in the band we've discussed as we move through the year. As for reinvestment, it includes winning business, driving innovation and investing in automation — essentially the items you mentioned: capacity, capabilities and targeted investments. Regarding DC closures, the anticipated value is embedded in our FY '21 guidance and in the $70 million to $100 million annualized run rate we aim to achieve by the end of FY '23. There's significant working capital improvement from reduced inventory and monetizing dark real estate. Since acquiring SUPERVALU we've monetized considerable real estate and will continue to do so. Net working capital improvements are reflected in our Q1 numbers and contributed to an $80 million improvement in free cash flow versus Q1 last year, which includes the impact of DC consolidation.

We appreciate you hosting the call. We're going to conclude at this point. If there are any follow-ups feel free to give me a call later today.

Just one other comment to close. I am so proud of this team and what they've accomplished in very difficult circumstances. Our primary focus has been and continues to be keeping our people safe in the midst of the pandemic, both from the virus perspective and for physical safety as well. For the quarter, growing 6% but on an adjusted basis more like 9%, we're exceeding the industry's growth in a significant way. We're leveraging the bottom line by growing adjusted EBITDA over 30%. We continue to grow free cash and we've paid down over $460 million of debt over the last 18 months. We're meeting our internal objectives in almost every way. The company is doing very well and I'm proud of what we've accomplished and look forward to delivering a strong year. Thank you for your participation; we appreciate it.

This concludes today’s conference. You may now disconnect.