United Natural Foods Inc Q4 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to UNFI's Fourth Quarter Fiscal 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that this conference is being recorded. I would now like to hand the conference over to the speaker today, Mr. Steve Bloomquist, Vice President of Investor Relations. Please go ahead.

Good morning, everyone. Thank you for joining us on UNFI's fourth-quarter fiscal 2021 earnings conference call. By now, you should have received a copy of the earnings release issued this morning. The press release, webcast, and a supplemental slide deck are available under the Investor section of the company's website at www.unfi.com under the Events tab. Joining me for today's call are Sandy Douglas, our Chief Executive Officer; John Howard, our Chief Financial Officer; Chris Testa, President of UNFI; and Eric Dorne, our Chief Operating Officer. Sandy, 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 Sandy.

Thank you, Steve, and good morning everyone. Thank you for joining us on our Fiscal 2021 Fourth Quarter Earnings Call. Let me begin by saying how happy I am to join UNFI and how excited I am to be back in the food business. Over my career, I've had the opportunity to meet and work with many of our customers and I look forward to renewing and carrying forward those relationships. I also look forward to meeting customers that I've not met and learning how UNFI can help make all of them even more successful. I've been on the job for about seven weeks now and have spent the majority of my time meeting with customers, our senior team, and with associates across the organization, focusing on growth opportunities for customers and how we can all work together to capture these opportunities in a very complex operating environment. Several things have become apparent to me about this company. First, I've been impressed with the leadership team, both on an individual level as well as how they work together collectively to solve problems, serve our customers and our associates, and move the business forward. They've brought me up to speed and given me the support I've needed to successfully onboard during these interesting times. They also embody the values and culture that were a key part of what attracted me to UNFI. Second, my early take is that there are significant opportunities to improve the way we serve existing and new customers, and the opportunity to partner with suppliers to bring customers the highest-quality differentiated products and services that they want and need. Importantly, as the COVID pandemic lingers, our operating environment remains challenging. From our suppliers to UNFI to our customers, we are all facing challenges making, moving and delivering products through our interdependent supply chains. My focus will continue to be learning the full extent of this business, and assisting our team as we manage through the challenges and execute our plans for the benefit of our incredible community of customers. In doing so, I'm confident that we will continue to find ways to help our customers create value, which will benefit all of our stakeholders. The final point I'd make is, despite the challenges that we're managing, we have momentum in our business, and it is accelerating. I believe our plans for the new fiscal year will carry that momentum forward. Under the leadership of my predecessor Steve Spinner and our senior team, we delivered a solid Fiscal 2021, and we expect this new fiscal year to be even better. We start Fiscal '22 with less debt and an improved leverage ratio, and plans for further growth driven by a sincere focus on doing everything we can to serve our customers. John will go over the details of our Fiscal '22 outlook shortly, and I'm genuinely excited for the year to come. Let me now turn the call over to our President, Chris Testa, for his comments on our performance. Chris.

Thanks, Sandy. And good morning, everyone. On today's call, I'll provide color on our fourth-quarter performance and commentary on how these results and our Fuel the Future strategy will help drive growth for UNFI moving forward. We're pleased with our results this quarter and for fiscal 2021 in total. Sales for the full year came in about where we expected while adjusted EBITDA and adjusted EPS were both above our previous outlook. We believe our fourth-quarter results reflect the work underway as we begin to implement our Fuel the Future strategy. Focusing on the fourth quarter, sales totaled slightly more than $6.7 billion. This was down slightly from last year's fourth quarter, as we are now cycling the months in calendar 2020, with the elevated levels of early COVID-19 consumer demand. The anticipated sales decline in our retail, independent and chain channels, which were the largest a year ago, were partially offset by growth in the supermarket and other channels. On a sequential basis, our business is growing as sales in the fourth quarter increased about 1.6% from the third quarter. Part of this, about 80 of the 160 basis point increase was the result of accelerating inflation within our business, which increased to approximately 2.4% in the fourth quarter. The remaining 80 basis points was the result of the underlying strength of our customers' retail business and our consistent success with cross-selling, and the addition of new customers. A meaningful portion of the sequential increase came from our top 100 customers, where sales increased 2.2% from Q3 to Q4. The fourth quarter also included an incremental $80 million in cross-selling revenue, as customers continue to benefit from UNFI's unmatched product variety, and the value they gain from consolidating purchases. In fiscal '21, over $700 million of our total revenue came from cross-selling that was made possible by the merger of our conventional and natural businesses. Selling more to existing customers represents a $38 billion addressable opportunity, and we believe is UNFI's unique advantage. With over 18,000 unique customers representing over 30,000 locations, UNFI has significant growth potential with customers we already service. New customers will also play an important role for our future growth, and our sales pipeline includes hundreds of opportunities to help us grow share within the $140 billion addressable market opportunity we discussed. Let's turn to the growth platforms we spoke to at our Investor Day under our Fuel the Future pillar, namely owned brands, professional services, and fresh. Starting with our owned brands business, our three-pronged strategy for growth is built around increasing penetration with our existing customers, bringing owned brands to new customers and channels that presently don't carry them, and introducing innovative items that meet the evolving needs of today's consumers. We're making progress across all three fronts as we're now selling our owned brands' products to nearly an additional 500 stores that were onboarded during Fiscal '21. We realized significant top-line growth on key brands like Woodstock, Thomsons and Field Day. We've also introduced about 100 new items to our portfolio this year, and plan to introduce another 150 in Fiscal '22, including more plant-based and functional ingredient SKUs. This combination of larger customer base and relevant new product offerings is expected to be part of our growth in Fiscal 2022. Professional services remains another key differentiator for UNFI. In fiscal 2021, our services business grew 12% and we're looking for fiscal 2022 to be another year of double-digit growth. Our optimism is based on customer feedback that our portfolio of services adds value to their businesses and a robust pipeline of opportunities that our sales organization is actively pursuing. In fiscal 2021, we introduced 17 new services, and we expect to launch a similar number this coming year driven by current industry trends, as well as feedback from customers on what problems we can help them solve. Two noteworthy services coming this year include an advanced retail pricing platform that will allow customers to manage gross margins across the entire store in more sophisticated ways than were previously available from any wholesaler, and an offering that tracks scanned data against product code dates and provides the store real-time information on unsold products that may be going past their code dates and allows them to better manage inventory and reduce shrink. Finally, Fresh, where we continue to invest in people, infrastructure, and technology to strengthen our foundation and the platform for future growth as consumer demand continues to be strong for products sold around the perimeter of the store. A bullish outlook includes growing produce sales at a rate several hundred basis points above the total company growth rate. In addition to improving our infrastructure across the network, we've staffed many of our facilities with produce specialists that have a strong working knowledge of this category, which gives us further confidence in our ability to better support our customers and accelerate growth. We've also restructured our sourcing team to take full advantage of UNFI's purchasing scale. Deeper relationships with growers are expected to improve our supply consistency, reduce days out of the supply chain, ultimately improve product quality across the network and help drive sales. Finally, our bakery and deli category experienced double-digit growth in the fourth quarter. Consumer demand has increased since the height of the pandemic and UNFI is uniquely positioned with a broad portfolio of specialty items, including a majority of the SKUs we sell through our Tony's Fine Foods portfolio. Turning now to operations. Our fulfillment network is facing the same labor shortages, supply shortages, and ongoing pandemic challenges being felt throughout the U.S. supply chain. We continue to take innovative and meaningful steps to mitigate each of these headwinds, allowing us to provide the best possible service to our customers. Starting with labor, we have and will continue to modify distribution center associate wage groups as necessary to maintain competitive compensation programs. We're also taking steps beyond wage increases to focus on the work-life experience of our associates, including the implementation of new incentives, daily pay, enhanced health benefits, and flextime programs. These wage and lifestyle programs are part of our ongoing efforts to attract and retain talent. We have also refocused our entire organization on the recruiting, onboarding, and training of new associates in our DCs, so we're prepared for the upcoming holiday season and future growth. Suppliers face many of the same challenges we see in our network. The retailer community is growing fatigued with limited assortments and increasing out-of-stocks across several key categories. These supply challenges caused our inbound supplier service levels to begin to deteriorate in the fourth quarter. To offset these challenges, we continue to proactively meet with our vendor partners to get our deserved share of supply and get in front of the upcoming holiday demand so we can provide the best possible experience for our customers. Safety and the well-being of our associates is our top priority. As a result, we voluntarily and temporarily suspended full operations at our Centralia, Washington distribution center in the first week of August due to an increase of COVID-19 cases at that facility. During the shutdown, we continued to service our customers to the greatest extent possible, despite increased costs, by leveraging contingency plans to meet essential customer needs through moderating shipments and shifting the volume to other distribution centers. While we do expect this voluntary temporary shutdown to be a headwind to our Fiscal 2022 first-quarter financial results, the impact is incorporated into the full-year financial guidance that John will review with you shortly. We continue to maintain strong COVID safety protocols that are in line with or greater than CDC guidance, including mandatory mask-wearing, enhanced sanitation protocols, onsite vaccine clinics, and strict social distancing enforcement throughout our entire fulfillment network. Now turning to retail, our banners had another solid quarter. The 6% decline in sales was largely the result of cycling last year's 21% year-over-year increase. Putting the two-year comp at 15.2%, which is in line with or ahead of many food retailers. As you heard during our Investor Day, we are investing in our retail business to enhance the shopping experience for our consumers through efforts like an enhanced e-commerce platform, expanded delivery offerings, and improved data analytics and merchandising concepts. We're striving to make our stores more appealing and easier to shop. Finally, we're proud to have been recently awarded a Progressive Grocer Impact Award in the category of sustainability in resource conservation. This award recognizes our ambitious goals and progress under the Better For All platform, and is a great reflection of the strategic direction and outstanding efforts of our people. We will be releasing our next ESG report in early 2022, and we're excited to share all the great work being done at UNFI to make our world, our communities and our people better. Let me now turn the call over to John.

Thank you, Chris, and good morning, everyone. On today's call, I will cover our fourth-quarter financial performance, balance sheet, capital structure, and outlook for next year, our Fiscal 2022. As Sandy and Chris both said, we're very pleased with our operating performance this quarter and the finish we had to Fiscal 2021. Sales for the fourth quarter totaled $6.7 billion, slightly below last year given the prior comparisons Chris mentioned, while adjusted EBITDA of $201 million and adjusted EPS of $1.18 per share were both higher than last year, and contributed to our finishing above our Fiscal 2021 full-year outlook. Fourth-quarter gross margin rate increased 7 basis points compared to last year's fourth quarter, driven by the benefits from our Value Path initiatives, partially offset by a higher year-over-year LIFO charge. Gross margin rate in our retail business was approximately flat to last year. Fourth-quarter operating expense rate increased slightly compared to last year's fourth quarter, driven by higher employee-related costs, as well as $9 million in start-up costs related to Allentown that I mentioned on our last call. These two items were partially offset by lower levels of pandemic-related costs and incentive compensation expense, as well as the benefits from Value Path on our ongoing operating expense. We're pleased with the fourth quarter's adjusted EBITDA rate of 3% of net sales, the second-highest quarterly rate during the last three years. We also experienced leverage in our P&L for Fiscal 2021 as we increased adjusted EBITDA by nearly 11% on a 1.5% sales increase. Our GAAP earnings per share totaled $0.69, which included $0.49 in net after-tax charges. Our adjusted EPS for the fourth quarter totaled $1.18 per share, further demonstrating our P&L leverage. As you know, UNFI contributes to various multi-employer pension plans across our wholesale and retail operations. Across these plans, we look for opportunities to maintain benefits for our associates, while also reducing risks around retirement benefit obligations. During the fourth quarter, we elected to withdraw from three multi-employer retail pension plans, covering certain associates in our club banner. These defined benefit plans have been replaced with defined contribution plans going forward. This action resulted in a $63 million pension withdrawal charge in the fourth quarter, which is recorded in the operating expense line of our P&L. To satisfy our withdrawal liability, we'll make cumulative annual after-tax cash payments of $3 million, which will have a nominal impact on our annual free cash flow. Across our multi-employer pension plans, we will continue to look for opportunities to maintain benefits for our associates, while also reducing risks around future retirement benefit obligations. We may have another transaction before the end of the calendar year, and we will consider additional transactions that further decouple our retail operations from its remaining multi-employer plans. Turning to the balance sheet. We have $9 billion in net debt, and total liquidity of over $1.3 billion. A combination of cash provided by operations and asset sale proceeds led to a $317 million reduction in our net debt level compared to the end of Fiscal 2020, and a nearly $1.1 billion reduction since the SUPERVALU acquisition. Our lower net debt balance and Q4 operating performance drove our leverage down to 3.1 times, an improvement from 3.9 times leverage at the end of Fiscal 2020. These figures include a $310 million capital investment back into our business, including nearly $80 million towards the Allentown distribution center, as well as additional investments across the business to enable growth, deliver automation, maintain our physical assets and help us deliver synergies and cost savings, all with the goal of better serving our customers. Let's turn to our outlook for fiscal 2022. Today's operating backdrop continues to evolve and change quickly, so our guidance for fiscal 2022 reflects our current expectations. Starting with net sales, we expect fiscal 2022's full-year net sales to be in the range of $27.8 to $28.3 billion, which represents more than a $1 billion increase over fiscal 2021, or about 4% at the midpoint. Net new business, including the phased onboarding of new business in the Northeast and with our largest customer, as well as continued cross-selling and new customer wins are expected to contribute 4% to 5% of growth. We're also assuming modest contraction in overall industry growth. We're expecting adjusted EBITDA for Fiscal 2022 to be in the range of $760 million to $790 million, also about a 4% increase at the midpoint. From a puts-and-takes perspective, Fiscal 2022 will benefit from the higher level of sales and the continued benefits from our Value Path initiative, net of dollars reinvested in the business. Temporary year-over-year headwinds include higher levels of wages and benefits as associates are assumed to make more frequent visits to healthcare providers. The ending of our transition services agreement will save a lot and add rent expense from the strategic value-maximizing sale-leaseback at our Riverside, California distribution center, where we've exercised an option to monetize that asset. These costs as we transition from Fiscal '21 to Fiscal '22 are all included in our outlook and at this point, we don't foresee items of a similar magnitude for '23 or '24. Adjusted EPS is expected to be in the range of $3.90 to $4.20 per share, an increase of about 4% at the midpoint. This assumes an adjusted tax rate of approximately 26%. It also includes lower net non-cash pension income based on the improved funded status of retirement plans, which are now slightly overfunded on a net basis compared to last year's $294 million net underfunded position. This favorable change in the funded status has allowed us to further de-risk these liabilities by migrating to a more conservative asset allocation, which in turn leads to a lower assumed return on assets and a year-over-year decrease in non-cash earnings per share. Given the cadence of onboarding new business, and the timing of the temporary voluntary Centralia closure, we expect growth to be weighted to the back half of Fiscal 2022. The timing and impact of these items will determine our cadence for the current fiscal year and our ability to deliver the sales, adjusted EBITDA, and adjusted EPS targets I've outlined for you today. We expect to reduce net debt by $150 million in Fiscal 2022 which concludes the investment we expect to make in the working capital to support our new business. The use of cash in Fiscal 2022, unlike Fiscal 2021 when we received an overall net tax refund driven by provisions within the CARES Act which required us to utilize prior-year net operating losses at a 35% rate. Capital expenditures are expected to be approximately $300 million, which excludes the amount for the Riverside sale-leaseback transaction. We expect leverage to be less than three times by the end of Fiscal '22, driven by higher adjusted EBITDA and further debt reduction, including applying the proceeds of our Riverside monetization to reducing debt. The fundamental growth drivers we outlined in June remain unchanged and we believe that they will be the catalyst that delivers the fiscal 2024 targets provided at Investor Day. Except for the Centralia temporary closure, all of the fiscal '22 headwinds I spoke to were considered when we established our fiscal 2024 targets provided at Investor Day. Therefore, we continue to feel confident in our ability to meet or exceed those targets. Increasing value for our shareholders remains a priority and focus of UNFI. We remain confident in our ability to grow our free cash flow. Operator, we're now ready to take questions.

Thank you. Our first question is from the line of Bill Kirk from MKM Partners, please go ahead.

And good morning, everyone. Thank you for the questions. My first question is for Sandy. Back in June, the company gave the goals for fiscal 2024, and I guess my question is, what areas do you envision as maybe the most challenging and the heaviest lifting? And which areas toward those goals are more of the lower-hanging fruit in your mind?

Thanks, Bill. Seven weeks in, I'm still very much on a steep learning curve, learning about all facets of the business. I'm learning from the senior team about the details of the strategic plan. I have to tell you, I like what I'm seeing. The plan is customer-focused and growth-oriented with an estimated $140 billion addressable opportunity that we talked about with existing and also potential new customers. In parallel, our customers are counting on us to do the very best job possible to meet their product and service needs in a complicated environment. So for at least the foreseeable short-term, my focus continues to be on learning about our business, listening to our customers and UNFI teammates, and accelerating the quality of our execution on behalf of our customers.

Thank you. And then maybe one has been manufacturer-led activity versus retailer-led. And then, what do you expect that to look like going forward?

Yeah, I'm not going to speak to the retailer-led promotions because that's really for the retailers to speak about. But the manufacturer-led promotions are starting — we are seeing more activity in our promotions. The thing that is still a headwind for us, Bill, is the fill rate. Those two things go hand-in-hand. Promotions come as the fill rate improves, and we didn't see steady improvement on our inbound supplier fill rate up until the summer. Then the summer months, it started to decline for all the macro issues that I'm sure everybody is aware of: raw material shortages, especially in bottled beverages, labor, freight, and so forth. From a percentage base, we're happy with what we're seeing on the promotional side. But in aggregate, the fill rate is going to continue to be a headwind on promotional activity.

Thank you. Thank you both.

Thank you. Our next question is from the line of Scott Mushkin. Please go ahead.

Thanks and welcome, Sandy. Looking forward to working together. The Supernatural channel obviously is growing pretty rapidly even though it's cycling. I wonder if you could give us any thoughts on what's going on there, how sustainable that is?

Hey, Scott, it's Chris. Well, yes, there's a couple of reasons for that growth. One, it was the slower growth in the fourth quarter last year, so it's cycling that number from last year. So that's why we're seeing the bigger year-over-year growth in the fourth quarter. And then two, as we announced earlier in Fiscal '21, we got the extension with our largest customer there, that's opened the door for additional categories and growth. So we see that continuing, at least for the fiscal '22 year and hopefully beyond that.

Perfect. That's obviously good news. And the second question is a little bit more short-term. Obviously, you got a facility closed down because of COVID; how should we— the thing is you kind of sit back half later, but how should we specifically think about the first quarter revenues and cost just so we can kind of get the models right here?

Yeah. No, I appreciate that. This is John. As you know, we generally don't provide quarterly guidance. I think the comments that I made in the script relate to some of the headwinds we're seeing in Q1, Centralia, et cetera. I think that can help guide how you guys think about the quarter. We look at it as a full year. We know the year has various degrees of uncertainty, but we feel good about the numbers that we put out there for the full year.

And then my final one is just you guys talked about labor. Obviously, labor is a challenge. You talked about some of the things you're doing to mitigate it. Are you worried about some other distribution centers being either short-labor or COVID, or is that really not a concern that you put into the model at this stage?

Good morning, Scott. It's Eric. I would just start out by saying that Centralia was the first significant disruption we've had in our network since the pandemic began. That's large because of the proactive and robust protocols we've implemented across the network by our teams. We also are very focused on our workforce, and as Chris referenced we've taken a lot of proactive and innovative steps to not only address wage challenges, but also workforce availability and workforce lifestyle, so we remain very focused. We've seen some pockets of improvement

While we're also experiencing challenges in other DCs across the network, we're continuing to stay on it. It's our number one focus and we have the entire organization supporting our supply chain teams as we work through this.

All right, guys. Thanks for your thoughts, I appreciate it.

Thank you. Our next question is from Jim Solera from Northcoast Research. Your line is open.

Thanks, guys. Great quarter, good guidance for the out-year. I guess, first of all, I wanted to drill down a little bit on the net sales guidance for the next year. So if I'm looking kind of back-of-the-envelope math, there's $800 million in there-ish from Key Food, which leaves about $500 million upside. Could you maybe break down where you see the opportunity? Is that going to come from cross-selling wins, from new account wins, new products or any granularity on that would be awesome?

Hey Jim, it's Chris. On the Key Food win, we won't realize the full billion dollars a year that we talked about in a single fiscal year until Fiscal '23, so that will be phased in across Fiscal '22. But like the rest of it, it's going to be coming from wins of all sizes — daily wins, weekly wins. If you think about what UNFI has to offer, there is no single competitor that we compete against, so every day we're seeing wins with produce, we're seeing wins that are helping our customers with their captive distribution, we're seeing natural to conventional and conventional to natural. So in that total fiscal '22 guidance, it's all of those on top of Key Food's onboarding that we're going to have throughout the year.

Okay. Great. And actually to build off something you mentioned with the captive distribution. We've all heard about some of the supply chain and logistics challenges. Does that end up benefiting you guys? If some of these captives, retailers don't have the capacity to scale up or if they get some, whether it's COVID outbreak or any issues they might have, do they kind of lean on you guys more to support their existing network or do you guys view that as a tailwind if some of these supply chain headwinds for the broader industry continue?

The short answer to your question is yes. The supply chain is stressed right now and it's been stressed for 17 months. That environment has been an opportunity for UNFI. We're uniquely positioned because we have the full portfolio of conventional and natural. So you think about some of those large conventional retailers that we were previously just selling natural to, they can now come to UNFI and leverage our network to sell them conventional and take some relief on their captive distribution. So absolutely, what we learned through the pandemic is when the supply chain is stressed, that typically is a tailwind for us that creates opportunities for us.

Awesome, and if I could sneak in one more quick question. You did a really impressive job on the operating margin side. Can you maybe just touch on a couple of levers you guys are pulling to keep that number where it is? I would imagine you guys moved some of the shrink benefits compared to the big COVID quarter last year. Any detail on that you could provide would be great.

Yeah, if you look at the EBITDA margin, what's driving that is our Value Path initiative, which has various underlying programs related to margin, SG&A, operations, etc., all of which are bringing the value you're seeing as we leverage the P&L. For FY '22 and beyond, we know we've got some headwinds, and we looked at '22 as a transition year. We knew about some health-related costs, rent and the Riverside sale-leaseback impacts. We anticipated those when we established the long-term targets. So when we think about EBITDA margin from '21 to '22, we know we've got those headwinds in '22, but once we get into '23 and '24, we're expecting to be right on track for those targets.

Great. Thanks, guys. I'll pass it on.

Thank you. The next caller is Eric Larson from Seaport Research Partners. Please go ahead.

Thank you. Congratulations on a good quarter, guys, and, Sandy, welcome aboard. We're looking forward to working with you over the next, hopefully, a number of years. So welcome aboard. The first question I have is, I believe you said that fourth-quarter inflation was 2.4%. This is the first inflationary period you've had in many years. In your guidance, are you building in maybe a 2% plus inflation rate for this year? And of course, then that should really help your gross margins; maybe John can comment on that.

Yeah, Eric. I'll start and Chris can add some color as well. The way we think about '22, we're including about 1% inflation for the year. We know the situation we're in right now, but as it relates to a full year, we think roughly 1% for the year is a reasonable assumption. Broadly, inflation is a little tailwind for us. Anything above that could provide a little upside, but internally our focus is on coordinating with suppliers so we can provide competitive pricing for our customers. That's the way we view it. But for the numbers you're seeing in the guidance, we've got 1% for the full year in our numbers.

Okay. And then just a quick follow-up to that. Your largest customer has been trying to increase the value of their grocery portfolio relative to other conventional for some time. Are you seeing the same rate of inflation across all the channels, or are there large disparities?

Eric, I think you're asking about retailer pricing strategies to pass inflation through. I won't comment on a customer's specific pricing strategy. There are many different approaches whether to pass it on or not; we can't really comment on the strategy of our customers.

Okay. I just thought I'd try. Thank you, Chris. And then just final follow-up: do you endorse the new 2024 guidance that was put out at Investor Day in June, or are you reserving the right as you get to learn the business more over the next three to five months to adjust those guidance numbers?

The answer is both. I'm excited about the strategic plan and believe we have a tremendous opportunity. I haven't seen anything that signals those numbers are not achievable. But as a team, we'll always be agile and work together to make sure our plans make the most sense for all stakeholders—shareholders, customers, employees. So I'm supportive and certainly reserving the right to tighten or adjust the plan as conditions evolve.

Thank you. The next question is from John Heinbockel from Guggenheim Partners. Please go ahead.

Thanks. So, guys, I want to start top-line in the environment. So if I think about the cross-sell embedded in the guidance for '22, it seems to me it's got to be maybe half or less than half of what it was in '21. Is that fair in order of magnitude? And then I'm curious in this environment of uncertainty, is it easier or harder to win new accounts? Are people more likely to stay with where they're at for now, or are they looking to move more than they did before? I'm curious what you're seeing on that front.

Hey John, it's Chris. I think you're looking at it the right way. As we think about our sales growth over the next three years, I think roughly half of it coming from existing customers is a reasonable way to look at it. Our growth platforms like services, brands, and Fresh will primarily come from deeper customer penetration in existing accounts. In addition to the daily blocking and tackling of getting more categories and fixing mix, the remainder will come from new customers as well. Key Food will be a big part of that in fiscal '22, so it will be more weighted that way in the short term, but long term, about half from existing customers is a reasonable expectation. As far as the environment, it's competitive, but when the supply chain is stressed, customers look for security. With our distribution network, buying scale, and broad product portfolio including Fresh, we have proven to win more often than we lose during stressed environments.

All right. Maybe as a follow-up then, where do you guys sit today on capacity utilization or availability in the network? I know it'll vary by DC, but are there any places that are getting stressed? And then your thoughts on automation if labor stays elevated. What more can you do on automation? You've done the big SuperCenters with automation; can you bring automation on a more limited basis to more DCs or is that not financially feasible?

It's a good question. During the pandemic we learned our network can pump out more volume — we haven't yet hit the level we saw in the third quarter of fiscal '20, but we know the existing network can handle more volume. We're also building: we started our new DC in Allentown to service the New York metro market and continue to invest in CapEx for building expansions or new buildings where needed. It does vary by market, but we have a long-term capacity plan embedded in the fiscal '24 guidance that we believe supports those targets with our planned investments.

John, I'd add that going through Centralia we saw the network pivot very quickly during that disruption to service our customers on the West Coast, further demonstrating our capacity as well as the value of our strategic investments. Texas is getting an expansion and other projects are underway.

We're also investing heavily in our Carlisle, PA automated building, which should come online next summer. And just a reminder, we have full-scale automation for our RePax offering in Riverside, California and Richfield, Washington that are in operation now and yielding benefits in productivity, quality, and labor efficiency.

Thank you.

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

Hi. Good morning. Also just wanted to add my welcome to you, Sandy; look forward to working with you. Also, on your outlook for Fiscal '22, I think in your slides you have an estimated market contraction of about 1% to 2%. Can you help us understand your thought process there? I'm assuming that's volume-related, but just the thought process and how you see that impacting retail versus wholesale.

The numbers we're providing are obviously wholesale, but it is consumer-driven, Kelly. That reflects the moderation from pantry-loading and shifts between away-from-home spending and in-home spending. We expect moderation throughout the year relative to pandemic-driven elevated levels.

Okay. That's helpful. And then, I guess this is another question on wages and benefits. Can you help quantify to what extent you are investing on a year-over-year basis? What headwind is that to the guidance in terms of wages and benefits and overtime and so forth?

Hey Kelly, this is John. We won't get into specifics on that, but given the known market challenges, we've made reasonable assumptions in our guidance for what those costs will be for us in '22 compared to '21, and that's embedded in those numbers. Beyond that, we generally won't provide more specifics.

Okay. I'll try one more just on retail here if you don't mind. I believe you mentioned the gross margin was flat to last year in retail. I was just wondering if you could talk about puts and takes there as I would assume shrink would be a bit more of a headwind this year, but maybe there are other factors. And more broadly as you think about retail EBITDA margins — they have increased materially; do you expect them to stay at these higher levels in Fiscal '22?

Sure Kelly. A lot of what you're seeing is a combination of factors: excellent retail leadership throughout the pandemic; the timing of potential sales synergies coming out of the acquisition; and the fact that we're now in a position to continue to run those businesses. Regarding margin rates, there are puts and takes related to promo spend and some noise, but there are corresponding offsets. We expect those margin rates to be relatively stable; there is no dramatic movement one way or the other embedded in our guidance.

Go on to the next question.

Certainly. Our next question is from William Reuter from Bank of America. Your line is open.

Good morning. You mentioned some disruption in terms of service levels from some of your vendors. What levels of fulfillment of orders are you seeing, and how has this impacted your ability with your customers in terms of service levels?

It's been a roller-coaster. We ended significantly above our service level compared to the fourth quarter prior, and we were improving, and everyone expected that trajectory to continue. But over the last three months, we've seen deterioration due to macro factors—labor, freight, raw materials, and so forth. As far as our ability to service customers, when we face supply constraints we work to manage expectations: replacing planogram items with items we do have in stock, taking high-demand, low-inventory items off promotion, and working with suppliers daily to secure our fair share. Scale helps our customers because for most of our suppliers we're a top one, two or three customer, which gives us larger buying power and allocations for high-demand SKUs.

I would imagine these are industry trends that your customers generally understand and don't create a great risk of customer losses when contracts end. Am I understanding that right or has there been frustration from some customers?

You're right that this is industry-wide and customers have been patient and understanding. But there is fatigue across the retailer community with limited assortments and out-of-stocks. We work every day to manage those issues and secure supply for our customers.

And then lastly for me, you provided a lot of the components of free cash flow in terms of EBITDA and CapEx. The pieces we don't know are working capital assumptions for the year, as well as proceeds from the sale-leaseback facility out west. Can you provide anything that will get us to that leverage below three times — meaning how much below three times are you thinking or what the range from asset sales might be?

We've managed the specifics internally, but the two remaining components are working capital and proceeds from the Riverside sale-leaseback. When you think about the large facility square footage and bringing inventory in for a large new customer, you can imagine the working capital impact of those things coupled with the broader growth embedded in our plan. The Riverside sale-leaseback will be discussed when the deal closes in FY '22, but we view it as a good transaction for debt reduction. Guiding toward below three times is comfortable for us given the uncertainty as we move through Fiscal '22, and if we have an opportunity to tighten that up we will.

Great. Thanks. That's all from me.

Thank you. The next caller is Spencer Hanus on for Greg Badishkanian from Wolfe Research. Please go ahead.

Good morning. This is Spencer Hanus on for Greg. I just wanted to drill down into inflation run rate to the full year of next year. Any additional color?

The way we think about the next 12 months is that we're in an inflationary environment now, but on balance for the year we think roughly 1% is reasonable. We're seeing similar inflation pressures as others, but for the full year we modeled about 1% in our guidance.

That's helpful. Do you think your fill rates are lagging the industry today or are you in line? Has the worsening of service levels impacted your ability to get cross-sell wins over time? And then just a quick follow-up on the Centralia DC: has that reopened yet?

I'll take the fill rate question. No, we do not believe we are below the industry; we think we are above the industry because of our purchasing scale. We also do quite a bit of volume through Fresh, and Fresh categories have been less impacted compared to center-store CPG categories. So we think our fill rates are actually above the industry average, albeit the industry is lower than we'd like. Regarding cross-sell wins, the stressed supply chain typically creates opportunities for us, and we continue to win. I'll hand the Centralia question to Eric.

I'm happy to report that our Centralia distribution center has returned to normal operating business again. We had a two-day full shutdown and then a partial disruptive week, and I want to thank our customers for their cooperation as we worked through that situation.

Perfect. Thank you.

Thank you. We have time for one last question from Peter Saleh from BTIG. Please go ahead.

Great. Thanks for taking the question and congrats, Sandy. I just want to come back to inflation. I know you guys have guided to about 1% inflation for FY '22. It sounds like inflation is running similarly to your Q4 number in the first quarter, so are you assuming inflation trails off in the back end of the year? What would be driving that? Any more color would be helpful.

We view a 1% full-year inflation assumption as reasonable. We're seeing similar inflation as everyone else now, but we don't believe the current elevated rate is sustainable for a full 12 months. At what point it trails off and how is uncertain — your guess is as good as mine — but the current environment does not seem sustainable for a full year.

Understood. And then on the labor environment, can you give us a sense of where your staffing levels are today versus pre-pandemic and what you're seeing on turnover? Has turnover slowed or moderated recently?

Our turnover has not slowed materially. The workforce has a variety of options, and we've taken a number of steps to improve our associates' experience and retention, including wages, benefits, daily pay and other lifestyle programs. This is an ongoing challenge and we are focused on it, putting all of our resources against supporting our supply chain and distribution centers.

Thank you very much.

Thanks to all of you for joining us on today's call. As I hope all of you can sense, we have a solid plan on how to create value for our customers and grow UNFI. We have the leadership team in place to continue to execute that plan. Our customers are some of this country's finest food retailers — from publicly traded chains to single-store independents, from value and ethnic operators to general market-focused retailers to high-end operators, and everything in between. We hope to serve their customers and add value to their businesses in the process. We're confident in our ability to deliver on our Fiscal 2022 outlook. The entire leadership team and I are committed to driving those results. I look forward to meeting many of you in the investment community throughout the coming months and continuing to update you on our key initiatives and performance over the course of the fiscal year. For our customers, we thank you for the continued trust and business we do together. And to our suppliers and especially UNFI associates listening today, my thanks to you. Thanks, everyone.

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