Dec 3, 2013
Executives
Katie Turner Steven L. Spinner - Chief Executive Officer, President and Director Mark E.
Shamber - Chief Financial Officer, Principal Accounting Officer, Senior Vice President and Treasurer
Analysts
Meredith Adler - Barclays Capital, Research Division Karen F. Short - Deutsche Bank AG, Research Division Stephen W.
Grambling - Goldman Sachs Group Inc., Research Division Brian Cullinane - Wolfe Research, LLC Scott Van Winkle - Canaccord Genuity, Research Division Kelly A. Bania - BMO Capital Markets U.S.
Jason DeRise - UBS Investment Bank, Research Division Andrew P. Wolf - BB&T Capital Markets, Research Division Ajay Jain - Cantor Fitzgerald & Co., Research Division
Operator
Greetings, and welcome to United Natural Foods' First Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, 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 first 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 Investors section of the company's website at www.unfi.com.
As a reminder, the webcast of the earnings call is also available on the company's website. On the call today are Steve Spinner, President and Chief Executive Officer; and Mark Shamber, Chief Financial Officer.
Before we begin, we'd 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 earnings release and during the call, 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 today and available on our website.
And with that I'd like turn the call over to Steve Spinner.
Steven L. Spinner
Thanks, Katie. Welcome, everybody.
Good afternoon, and thanks for joining us today to discuss UNFI's first quarter fiscal 2014 financial results. I'm going to begin with a brief overview of our strategic initiatives and quarterly results.
Mark will then provide greater detail on our financial performance, as well as our outlook for 2014. And lastly, we'll open up the call for your questions.
Really pleased with our start to fiscal 2014 at UNFI. We continued to execute on our strategies to further increase market share while improving our operational efficiency and, in turn, our operating margin.
We have a strong culture at UNFI, in which we strive to make a difference in everything we do. We're a mission-based company, very focused on being sustainable and good to the Earth and equally important, good to the communities in which we trade.
While it's not always the easiest path to take, we are intently focused on reducing our carbon footprint by 5% in 5 years while growing more than 12% a year, a very tough thing to do; consistently rerouting our fleet to reduce miles driven to help deliver the single greatest influence in reducing our carbon footprint; we're building LEED-certified buildings using solar and hydrogen in our facilities; we're motivating a workforce of over 7,000 to give back to their communities through volunteering and striving to be sustainable at work, while delivering exemplary results; and launching a foundation which has a mission to foster a sustainable and healthy food system. At UNFI, we don't view these things as differentiating.
It's just part of who we are. Is it worth it?
We think it is, and we're proud of what we have continued to accomplish. UNFI has doubled in size during the last 5 years because of our commitment to a rigid set of operating principles, a relentless focus on market share, operational excellence, One Company and our culture.
As we've grown, we've developed the resources to continue our culture of philanthropy and sustainability, while continuing to improve returns to our shareholders. We compete with many companies who don't share our mission, our beliefs or our performance.
Should our culture make a difference in our customers' decisions? Does what UNFI accomplishes in our mission matter?
Perhaps, however, we do it because it is part of our culture, who we are, and we believe the communities and customers we serve are better off because of it. So is it all worth it?
Absolutely. We're making a difference in the world, and we're quite proud of it.
Having a strong culture drives strong results. During the quarter, we grew almost 14%, or 13% net of acquisitions.
During the quarter, UNFI acquired Trudeau Foods in Minneapolis. Trudeau has historically focused on Midwest retailers with specialty perishable and dry products.
Trudeau will now become UNFI's base of operations for market share expansion in this very important market for natural, organic and specialty products. Additionally, we plan to build a new facility for Trudeau and our customers in the market shortly.
The team at Trudeau has a strong history of performance, and we're excited now to have them part of the UNFI team. Encouragingly, sales continue to be strong through the first several weeks of the second quarter of fiscal '14.
UNFI's strategic initiatives to improve operating results have been delivering consistent returns. During the quarter, gross margin increased 20 basis points versus the first quarter of 2013.
A primary driver of stabilizing gross margin other than customer mix has been the management of our inbound freight. Our national supply team has performed extremely well in a drive towards increasing service level, reducing our carbon footprint and lowering cost, all while trying to manage our impact from supplier out-of-stocks.
Specifically, during the quarter, we migrated more heavily to intermodal cross-country freight, as well as implemented a more disciplined approach to analyzing the most efficient freight lanes and service requirements, which all contributed to our gross margin improvement. Operating margin increased to 3%, up 29 basis points from the prior year, again reflecting gains in our gross margin, continued expense control and strong growth across our businesses.
Our net earnings increased 22%, and diluted earnings per share increased from $0.46 to $0.56, reflecting continued cost control and strong execution by UNFI's operating divisions. Core distribution, Woodstock Farms Manufacturing, Select Nutrition, Blue Marble Brands and our Honest Green business-to-business Internet fulfillment provider all performed quite well during the quarter.
We talked quite a bit about service level, access to inventory and performance during a very important holiday season. UNFI's service level did continue to be impacted by further elevated levels of supplier out-of-stocks.
However, we did appropriately plan for the holiday lift through increases in our inventory. Compared to our fiscal year end in July, our total inventory on hand increased 3 days to 52 days.
We felt this was necessary to deliver a high level of service to our customers for the very important holiday season. Again, we do believe, based on current supply forecasts, that inventory shortages should ease through the balance of our fiscal year, and Mark will discuss this in more detail in a few moments.
Building capacity continues to be a focus for us. As we previously discussed, UNFI currently has 4 construction projects underway for completion through our fiscal '15.
We're on budget and on time for our first 2 facilities to come online, first in Racine, Wisconsin during late 2014, followed by Montgomery, New York in early fiscal 2015. This new capacity is critical to our long-term growth initiatives.
During the next 2 years, UNFI's capital expenditures will reflect the cost of this necessary new construction. In summary, I'm extremely pleased with our results during the first quarter of fiscal 2014.
Our team executed well during the quarter, and we continue to ensure that our culture and our legacy of giving back remain true. Looking ahead, we believe UNFI has all the right tools in place to continue to drive significant growth, both in terms of our top line and our bottom line over the next several years.
And now I'll turn the call over to Mark to provide some additional details regarding the quarter. Mark?
Mark E. Shamber
Thanks, Steve, and good afternoon, everybody. Net sales increased by 13.6%, or $192 million to $1.6 billion, for the first quarter of fiscal 2014 versus net sales of $1.41 billion in the prior year.
The Trudeau acquisition, which we announced in late September, and the 3 acquisitions we announced in the first quarter of fiscal 2013, positively impacted net sales by $10.7 million in the quarter. Excluding these 4 acquisitions, net sales increased by $181 million or 12.9%.
Inflation decreased modestly on a year-over-year basis to 2.04%, a decline of 11 basis points from the first quarter of fiscal 2013. However, this represented a sequential increase of 12 basis points over the fourth quarter of fiscal 2013.
For the first quarter of fiscal 2014, the company reported net income of $27.8 million, or $0.56 per diluted share, an increase of $5 million, or 21.7%, over the prior year adjusted net income of $22.8 million, or $0.46 per diluted share. On a GAAP basis, net income increased by $6.2 million, or 28.9% over fiscal 2013 first quarter GAAP net income of $21.5 million.
In the first quarter, sales to the supernatural channel increased by 12.6% over the prior year first quarter, and supernaturals represented 36% of sales for the quarter. Independent sales rose by 8.9% year-over-year, and independents represented approximately 33% of sales.
Our supermarket channel experienced growth of 19% over the prior year and now represents approximately 26% of sales. And finally, foodservice grew by 26.2% over the prior year and still represents approximately 3% of sales.
Excluding the impact of the acquisitions, supermarket sales increased by 16.4%, while independent sales growth was 8.6%. Supernatural and foodservice sales growth was unimpacted by the acquisitions.
Gross margin for the quarter was 16.9%, which represents a 20-basis-point improvement from the first quarter of fiscal 2013, which had gross margin of 16.7%. Our gross margin for the first quarter of fiscal 2014 continued to benefit from improved performance by our supply chain group, specifically with respect to our inbound logistics and procurement teams.
On the inbound logistics front, our transportation management system has been fully deployed for over a year, and we continue to make progress in this area. As Steve mentioned, we have significantly increased our use of intermodal transport in moving products across the country.
Additionally, lower year-over-year inflation resulted in less drag on gross margin while the modest sequential uptick in inflation, when combined with the full quarter of the inventory optimization module in our western region, positively impacted our results. Operating expenses for the quarter represented 13.9% of sales, a 21-basis-point improvement compared to 14.1% for the same period last year.
Adjusted operating expenses for the first quarter of fiscal 2013 were 14% of net sales, resulting in a 9-basis-point improvement over the prior year. Details of the adjustments to operating expenses in fiscal 2013 were provided in today's press release.
Fuel had a positive impact of 8 basis points in operating expenses in comparison to the first quarter of fiscal 2013, as fuel represented 73 basis points of distribution net sales in the first quarter of fiscal 2014. Fuel expenses were 2 basis points better than the fourth quarter of fiscal 2013 when fuel came in at 75 basis points of net sales.
Nationally, our diesel fuel cost in the first quarter of fiscal 2014 decreased by approximately 3.3% from the prior year's first quarter, while the national average price decreased to $3.92 a gallon, a decline of 3.7% compared to $4.07 in the first quarter of fiscal 2013 per the Department of Energy. Share-based compensation expense during the first quarter of fiscal 2014 totaled $5.5 million, or 34 basis points as a percentage of net sales, compared to $4.7 million, or 33 basis points in the prior year.
Operating income was 3% in the first quarter, an increase of 41 basis points over the prior year's first quarter operating income of 2.6%. Operating income improved by 29 basis points over the prior year quarter's adjusted operating income of 2.7%.
The prior year's first quarter operating income was adjusted by $1.6 million due to the termination of a licensing agreement and the write-off of the associated intangible asset. Our inventory days on hand averaged 52 days for the first quarter of fiscal 2014, an increase of 3 days from the first quarter of fiscal 2013 as Steve mentioned when we were at 49 days.
As we discussed in our earnings call back in September, we have been carrying higher inventory levels in an effort to compensate for issues with supplier out-of-stocks in certain categories and improve our service levels during the holiday season. It's our expectation that supplier out-of-stocks will begin to mitigate during the quarter and should return to historic levels by the end of our second fiscal quarter.
DSO for the first quarter was about 1/4 of a day worse than the fourth quarter at 21 days due to increased sales to supermarket customers who typically pay more slowly. But DSO was consistent with the prior-year quarter.
Capital expenditures were $33.2 million, or 2.1% of net sales for the 3 months just ended. The majority of the cost incurred during the quarter were associated with the construction of our new Hudson Valley distribution center located in Montgomery, New York and our new Racine, Wisconsin facility located in the Village of Sturtevant.
As a further clarification of our capital expenditure guidance provided on the earnings call back in September, we expect our total capital expenditures in fiscal 2014 to be in the range of $150 million to $160 million, or 2.2% to 2.4% of expected fiscal '14 net sales. This includes all construction costs associated with these 2 new buildings.
Upon completion of construction, we expect to finance the cost of these buildings. Debt financing may take the form of a mortgage of these and other UNFI-owned properties, or we may elect to engage in a sale-leaseback of these 2 facilities.
As a result of our financing decision, our CapEx guidance may change. We will update our guidance accordingly once we've made the decision.
Our previous CapEx guidance of $80 million to $95 million, or approximately 1.2% to 1.4% of expected fiscal 2014 net sales, excluding our plans for financing the construction of our new facilities in Wisconsin and New York, remains the same. Outstanding commitments under our credit facility were approximately $265 million at quarter end with available liquidity of approximately $231 million, including cash and cash equivalents.
Our leverage increased to approximately 1.1x on a trailing 12-month basis as a result of a higher debt level due to the combination of our acquisition of Trudeau Foods; higher capital expenditures, as I just discussed; and our normal seasonal investment in inventory going into the holidays. In today's press release, we reaffirmed our guidance for the fiscal year ending on August 2, 2014.
As a reminder, fiscal 2014 is a 52-week fiscal year, while fiscal 2013 was a 53-week fiscal year. For fiscal 2014, we expect net sales to be in the range of approximately $6.65 billion to $6.78 billion, an increase of approximately 9.7% to 11.8% over fiscal 2013.
Adjusting for the 53rd week in fiscal 2013, sales growth for fiscal 2014 is expected to be in the range of approximately 11.8% to 14%. GAAP earnings per diluted share for fiscal 2014 are expected to be in the range of approximately $2.40 to $2.50 per share, an increase of approximately 10.1% to 14.7% over fiscal 2013 GAAP earnings per diluted share of $2.18.
Excluding the impact of the 53rd week in fiscal 2013, which is approximately $0.04, we expect growth of 12.1% to 16.8% for fiscal 2014. Finally, included in our fiscal 2014 earnings guidance is approximately $2.5 million to $3 million of nonrecurring expenses associated with the planned opening of our new Wisconsin facility, which is expected to begin receiving products late in the third quarter of fiscal 2014, and duplicate rent and building costs associated with one of the Denver facilities that we exited in fiscal 2013 but has a lease that will not terminate until the end of fiscal 2015.
At this point, I'll turn the call back over to the operator for the question-and-answer session. Operator?
Operator
[Operator Instructions] Our first question is from Meredith Adler of Barclays.
Meredith Adler - Barclays Capital, Research Division
Two questions for you. First, you've obviously gotten a lot of benefit from inbound freight and how you handle that.
What do you perceive as being the opportunity going forward? Is there still much more to be done?
Steven L. Spinner
We just nationalized our inbound freight, as well as what we call our IPAR, which is our inventory planning or day-to-day procurement function. And so they now actually run under one umbrella across the country.
And so as we standardize both of those processes, there's going to be some more savings for us. The single biggest driver in inbound freight is to appropriately negotiate the term of the way we move the freight and then to use the most cost-efficient method to move it without affecting service levels.
So as an example, during the quarter, we significantly increased the use of our intermodal rail in moving freight across the country, which obviously has significant savings to us. And there are still plenty of runway left for us to continue to take advantage of that -- those standards that we've recently put in place nationally.
Meredith Adler - Barclays Capital, Research Division
Okay, great. And then I don't know how much you want to comment about the current sales environment.
It sounded like your sales were continuing to be strong. Is there any -- obviously, people are very concerned about what Whole Foods had to say last quarter, but is there anything that you're seeing that leads you to believe that there's any really meaningful change in the industry?
Steven L. Spinner
No. I don't think so.
I think that like -- we were at a conference recently, and we said maybe there's a little bit more volatility up one week, down the next. But when you look at it over the course of a month or a quarter, we're not seeing any slowdown or change.
Operator
The next question is from Karen Short of Deutsche Bank.
Karen F. Short - Deutsche Bank AG, Research Division
Just following on Meredith's question -- I mean, obviously, your top line is incredibly strong. But I guess, Steve, I just wanted to follow up a little bit on sales trends this quarter and the first quarter and then again to clarify something on the second quarter.
So when I look at your top line in the first quarter, excluding acquisitions by channel, and I look at this on both a 1- and 2-year basis, it does looks like sales decelerated a little bit on both metrics. So I guess -- I mean, do you agree with that statement, I guess would be my first question?
Steven L. Spinner
Well, I think -- Karen, I'll interject there -- and I think that the one thing that -- I'm not going to remember as well on the 2-year, but I mean, certainly, last year's first quarter, we had not yet lapped the Safeway business. We had 2 months benefit against no comp in the first quarter of 2012.
So -- I mean, we would have expected on a year-over-year, looking at the channel, to see it be somewhat slower as a result of that. But on a 2-year stack, I'll admit that I can't go back to fiscal '12 off the top and remember what the comp was there.
Mark E. Shamber
Yes, I don't remember what it was either.
Karen F. Short - Deutsche Bank AG, Research Division
Okay. So looking at this quarter then, you would say they're strong as it relates to no change from the run rate in the first quarter, but wouldn't necessarily say they've increased.
Is that fair?
Steven L. Spinner
I'd say that's fair.
Karen F. Short - Deutsche Bank AG, Research Division
And then I just was wondering, when you look at the competitive environment -- I mean, competitive as it relates to your competitors, this isn't really something that we discuss a lot. But I mean, you're obviously taking significant share, and I would say I don't know if you have a lot of competition given your scope of SKUs in your geographical scope.
But are you seeing any reaction from any of your competitors in terms of...
Steven L. Spinner
There's a couple of good competitors that we compete with every day. Again, from our perspective, the biggest competition per se in the conventional channel is direct.
And so in that particular channel, the -- we have to make sure that we are extremely proactive in making sure we have the right new items coming in the top because we know that as more and more of these items become more conventional that the supermarkets are going to buy them direct, just because it makes sense for them to do that. So there's not really -- not something new there.
It forces us to just make sure that our data is right, and we have the right people out there making sure the right new items are coming in. But on a day-to-day competition, I wouldn't say that there's anything different.
We are obviously closest to the consumer. We have the most built out distribution network between the United States and Canada.
We have the most vibrant SKU offering, but there's also tough competition. We fight it every day, mostly in the supermarket channel.
Karen F. Short - Deutsche Bank AG, Research Division
Okay. And then just the last question is I guess it seems like some of your initiatives are finally flowing to the bottom line, which is great.
And I guess I'm wondering, it seems like your guidance for the full year is conservative based on what we've just seen in the first quarter. So is that just conservatism?
Or is there anything -- I know there's different costs that flow through the P&L from these different initiatives on CapEx, but anything to think about there? Because it just seems like some of what you saw in the first quarter should be sustainable for the rest of the year.
Mark E. Shamber
We perfectly -- I mean, I would say, Karen, that we typically don't adjust the guidance after the first quarter. So -- I mean, if we're able to maintain the pace that we had this quarter through the second quarter, when we report in March, we would certainly update at that time.
But on one quarter, I don't know that we would update it because circumstances can change on a macro level that would make us perhaps regret that. We don't see anything of that nature, but it could still happen.
Operator
The next question is from Stephen Grambling of Goldman Sachs.
Stephen W. Grambling - Goldman Sachs Group Inc., Research Division
Just a quick follow-up to that, can you maybe provide a little more quantification on the different buckets of the gross margin improvement, for example, maybe what the headwind was from out-of-stocks, the impact from mix shifts, inbound improvements, et cetera?
Steven L. Spinner
Yes. I mean, we typically don't get into that granular detail, Stephen.
Clearly, the drivers in gross margin are supplier promotion. And obviously, when the supplier out-of-stocks are higher than they are -- have historically been, we not only lose the gross margin associated with the sale, but we also lose the gross margin associated with any income related to the way that product moves through the system, whether it be promotional activity, forward buy and a whole slew of other things.
The other primary drivers are just initiative-based, and that's just managing inbound freight, buying it appropriately, having the right service level, having the right inventory on hand. But we really tend to be very careful about getting into more granularity than that.
Mark E. Shamber
Yes. I mean, I think the one thing I would say though, Stephen, I mean, is if you look at last year, we highlighted that we incurred almost -- I think it was $1 million, give or take $50,000 last year in the first quarter, in moving product around because of the out-of-stock issues that we were facing.
And that number was minimal in this year's first quarter. So I mean, I think, breaking anything out specifically, I think on a year-over-year basis, that alone probably contributed about 6 or 7 basis points.
But the other items, we typically don't try to break those out in detail.
Stephen W. Grambling - Goldman Sachs Group Inc., Research Division
Okay, that's actually very helpful. And another quick follow-up to your comment on competition from direct and then SKU introductions, can you maybe talk about the amount of SKU turnover today and maybe how that's changed over the past -- I mean the past couple of years?
Steven L. Spinner
It's been pretty consistent. 8% to 10% of our new revenue every year comes from new product introductions.
Obviously, just as many are falling off. So the challenge is to make sure that, that 8% to 10% coming in is greater than whatever is falling out the bottom through direct.
Now, again, the only channel that direct affects is the supermarket channel, which is 25%, 27% of our total business. So we call it out, but there hasn't been any wholesale change to that over the course of the last year or so.
Operator
The next question is from Scott Mushkin of Wolfe Research.
Brian Cullinane - Wolfe Research, LLC
This is actually Brian calling in on for Scott. Just wanted to maybe look out across '14, and maybe just touch on if you guys saw any upside for the year.
Would you see it more on a revenue side or on a -- from the gross margin or operating expenses? Where do you kind of see any upside to your guidance as you maintained it through this quarter?
Mark E. Shamber
Well, I mean, Brian, I think a similar answer that we gave to Karen's kind of question is, I mean, we -- the guidance is the guidance. So I wouldn't be willing to sort of highlight where the upside could come from.
The way we set the guidance is looking at all the various factors and seeing how many of them come out favorable to how we budgeted versus how many of them come out unfavorably. So additional gross margin upside, additional sales upside, better leverage on the operating expenses or continued performance on the initiatives we have in place all work in our favor.
But you have items such as a bad debt on a customer or out-of-stocks where you're moving product around, and those go in the negative bucket. So -- I mean, I think they're no different than they are in any other year, and it's just a matter of how things play out over time.
But at the end of one quarter, it's just too early to see where things could play out over the next 3 quarters that could result in us succeeding the high end.
Brian Cullinane - Wolfe Research, LLC
Sure, okay. And then maybe just -- we were talking about some of the traditional supermarket space.
We've kind of heard that there's a good amount of business that's available in the traditional supermarket space. How do you guys see yourself positioned to maybe capture some of that opportunity?
And any color there?
Steven L. Spinner
Well, I mean, we're building a lot of new capacity. We've got 4 buildings going up over the next 2 years.
And so obviously, one could back into the fact that our buildings are at capacity today, and two, we would hope that we have some new business wins that we can put into these facilities. But we certainly don't have anything on the horizon of any scale for the next 6 to 12 months.
Brian Cullinane - Wolfe Research, LLC
Okay. And then maybe just one more on some of the margin trends, because in the press release, you guys called out it was up year-over-year and -- but down a little sequentially.
For '14, what -- is it best to look at some of these margin trends on a year-over-year basis? Or are you guys focused a little more on the sequential side?
Which one do you guys think is best as we model out the rest of the year?
Mark E. Shamber
We tend to look at it on a year-over-year basis versus sequential. I mean, presumably, that if we're seeing expansion on a year-over-year -- on a sequential basis, it should carry through to the next quarter in the sense of however the mix shifts.
But what we see as an example, our third and fourth quarter are much stronger quarters for our Albert's Organics business, which has a higher gross margin, but it also has a higher operating expense. And so we get some lift in the third quarter and the fourth quarter from the Albert's division.
Similarly, the third and fourth quarter are stronger for the independents, at least on a relative basis. And so year-over-year, a look at the independents in our Albert's business is how we evaluate it and then where the initiatives that we're undertaking on the gross margin side are paying off.
Brian Cullinane - Wolfe Research, LLC
Okay. Just wanted to make sure there wasn't a change there on -- because of the difference.
Operator
The next question is from Scott Van Winkle of Canaccord Genuity.
Scott Van Winkle - Canaccord Genuity, Research Division
Steve, I appreciate not breaking out detail on the gross margin. Can I ask it a different way over a longer time period?
If you look in '12 and '13 and now -- we're talking about '14. But in '12 and '13, the gross margin fell [ph] was kind of 60 to 70 basis points per year.
And in each of those years, you more than offset that with lower operating expenses. And we always pointed to the mix shift in your customers.
Now that your gross margin is up 20 basis points, you're getting just a very small amount of leverage on your operating expenses. Is there -- is it all mix?
Or is there -- was there something that allowed you to kind of squeeze on the expense side to offset lower gross margin in the past that maybe you're not doing today?
Steven L. Spinner
Well, I mean -- I think that we had a lot of low-hanging fruit in our expense control, primarily within our operations. And we had a terrific amount of success in bringing our costs down.
Now we knew going into bringing on a higher volume of lower margin supermarket customers, that we were going to have to lower the expenses at a rate that exceeded the decline in the customer mix shift. I mean, it was just an easy algorithm to figure out.
And fortunately, we had the upside in order to do that. We have less upside in the future as it relates to continuing to bring down our operating expenses at a rate that's similar to the decline that we've had in the last couple of years.
But on the other side, we're in the early innings of our supply chain initiatives, the nationalization of our enterprise item number and data warehouse and all the things that could potentially give us a lot of lift in our gross margin. So all of the opportunity that we had in reducing the expenses in the operations -- we're pretty far down the path.
So I would expect that the decline in the operating expense rate will not be anywhere near as significant as it has been in the past. But my hope is, as Karen so eloquently put, we're finally getting some of the payback of the initiatives that we put in a couple of years ago.
Mark E. Shamber
And, Scott, one other thing I'd just add to that, is that from our standpoint, what also comes into play in any given quarter from an expense perspective is where we're performing versus our own incentive plans. So last year, when we're experiencing some of the challenges with out-of-stock and had higher costs and moving product around, we were underperforming versus our incentive plans.
And this year, with the performance that we had in the first quarter, we're outperforming. So we have higher incentive comp accruals from that standpoint as well.
Scott Van Winkle - Canaccord Genuity, Research Division
Got you. And then last year, we've talked a lot about the transportation management system -- painfully, 12 months ago, very positively today.
Can you guess on what we're going to be talking about for the next 12 months as far as all the initiatives you have in place, which one is going to be maybe the biggest source of gain over the next 12 months?
Steven L. Spinner
Yes. I mean, we -- I'm pretty sure we talked about our inventory optimization initiative.
We now have it fully deployed in the West, which covers about 40% of our revenue. It is in the process of being integrated into the East.
So we'll start to see the inventory optimization benefit towards the latter part of our fiscal year of '14 and fully deployed in our fiscal '15. So if I had to point to the single greatest opportunity for gross margin expansion, it will be the deployment of inventory optimization in the East.
Scott Van Winkle - Canaccord Genuity, Research Division
Great. And then another if I could.
Mark, you said that you expect the out-of-stocks to come under even better control as the quarter progressed. How do you know that?
I mean, obviously, you got data, but I'm wondering, are you better at forecasting? Have you reached out to these vendors?
Do you know what's coming in? I'm wondering how there's -- confidence level on the out-of-stocks.
Mark E. Shamber
Yes. I mean, there's a high level of communication with the primary suppliers.
For the most part, the things that are driving our out-of-stock rate are a limited number of products as opposed to manufacturers, either driven by demand or access to commodity products. And so we know that once the new crops come in, we'll satisfy the out-of-stocks in those particular cases.
In the other scenarios, it's more manufacturing capacity, whether it's adding another co-pack [ph] or putting up a new line. And so we have enough kind of data from the manufacturers that points to specific dates that we know we're going to start receiving some of the products that have been out of stock for quite a while.
Scott Van Winkle - Canaccord Genuity, Research Division
And then, Steve, I'm sorry, one more. In the first couple of questions, you were talking about sales trends both this quarter and relative to last quarter.
Did you comment -- when you said sales trends were strong thus far into the Q2, did you comment that, that was consistent with kind of where you exited Q1? Is that what I caught there?
Steven L. Spinner
Yes.
Operator
The next question is from Kelly Bania of BMO Capital.
Kelly A. Bania - BMO Capital Markets U.S.
I was hoping you could help us connect the dots a little bit on the success you're having with lowering inbound freight costs and how that's connected to inventory optimization and the supply chain management success that you're having. Can you help us understand how those are all connected a little bit more?
Steven L. Spinner
Yes. I mean, the 2 things are not connected other than they both impact our gross margin.
Inventory optimization is essentially a demand planning tool. It enables a buyer to use a lot of historical data that essentially puts together an appropriate amount of inventory purchase based upon historical demand.
But it also makes sure that when we do place an order, that wherever possible, we place that order on some kind of promotional schedule. And so when we do that, those promotional dollars flow directly into our gross margin.
We bring down our inventory days, and we increase our service level because the demand plan algorithms essentially take the manual work out of planning for highs and lows in product demand, a very sophisticated tool that's working very, very well in the West. As far as inbound logistics, inbound logistics are a component of our product cost.
So the more efficiently we can move the freight around the country, that freight becomes a profit center for us. So, for example, if a supplier gives us $1 a case to move the freight from point A to point B, and we actually move it for $0.80, that becomes a $0.20 profit center for UNFI.
One of the big drivers in the quarter has been a migration away from full-truckload cross-country to intermodal cross-country, where the truck actually goes on a train. It's a little bit slower.
It takes a couple of days more to make the trip, but it's far more efficient in terms of costs and also has a much better carbon footprint. And so those are the things that we look at.
Kelly A. Bania - BMO Capital Markets U.S.
That's very helpful. And then just wanted to get an update on WMS and the plans for that being implemented this year.
Steven L. Spinner
We -- yes, sure. We are going to implement about 2 DCs a year, 2 to 3 DCs a year.
We're on schedule to do that. We are going to bring our new facility in Racine, Wisconsin up on our new WM platform, and that's going to be, I guess, towards third quarter.
Mark E. Shamber
Yes. I mean, it may come up in the middle of the third quarter, but not be shipping till the fourth.
Steven L. Spinner
I think we have one in between there?
Mark E. Shamber
I believe so at the current timeline.
Steven L. Spinner
One in between there, another facility in between. But we've got a whole team focused now on the WM implementations.
I think we have it down to a science -- the last 2 that we did, we had very, very few issues associated with them. The beauty of bringing up Racine as a new facility is we won't move any customer into that facility until we're sure that it works exactly the way we need it to.
Kelly A. Bania - BMO Capital Markets U.S.
Great. And then if I can just squeeze in one last one since you mentioned Racine.
Can you maybe talk about the opportunity in that market and with the acquisition that you recently made?
Steven L. Spinner
Yes. I mean, the Racine and Trudeau are not really connected in any way because Racine is actually pretty far from Minneapolis.
We are going to go ahead and build another facility for our Trudeau folks within the Twin Cities. But our Racine facility will serve as the entry point for the Chicago market.
Historically, we've have a great presence in natural and organic, but not in specialty, only because we haven't had the capacity. And the Racine facility will give us full access to all the natural, all the organic and all the specialty product for that market, which is a great market.
And so we have very high hopes there. Today, we pull into Chicago from Iowa and from Greenwood, Indiana.
But again, only in the natural and organic side just because our buildings don't have the capacity for specialty today.
Operator
The next question is from Jason DeRise of UBS.
Jason DeRise - UBS Investment Bank, Research Division
I wanted to ask about the trend at the independents and if you thought that -- maybe if you can hopefully quantify, but if not, give some color around if that's being driven by customer wins for you versus what your current customers are doing in their trend. And then, I guess, underneath that, if that's being driven by unit openings or if that's rate of sale.
Steven L. Spinner
Yes. I mean, that's a good question.
We've actually done a lot of work on that because obviously, we want to make sure that, that channel continues to grow. And what we determined is that the independents are growing.
They're growing 8-plus, 8% to 9%, and that 8% to 9% is a true 8% to 9%. Because if you cull out a lot of the fast-growth independents, multi-independents, if you look at same-store comps, it all points to the same data that says that category is growing in the high-single digits.
Jason DeRise - UBS Investment Bank, Research Division
Okay. And what do you think is driving that versus maybe where they've been previously relative to the market?
Steven L. Spinner
Well, I mean, they've been running in the high-single digits now for a couple of years. And I think it's continued demand for the products that we sell.
It's -- we talk a lot about the crossover consumer, the consumer who starts with a couple of natural and organic items and over time gradually gets to the point where the typical supermarket doesn't have the SKU mix to satisfy them. And so they either find their way into Whole Foods or into an independent.
And I think that's certainly happening. You look at the millennials.
Millennials tend to buy local smaller stores, more comfortable in a natural and organic store than they are perhaps in some of the mass merchandisers. So I would say that both those things contribute to the rate of growth from the independents.
Jason DeRise - UBS Investment Bank, Research Division
Great. Can I ask -- I'm sorry if I missed this, but the inflation outlook for the year?
Mark E. Shamber
I don't think we gave it in the prepared remarks, but I think that with what we've seen to date, Jason, we probably are hovering around 2%. Again, 25 basis points either way for the next quarter or 2.
We've had a couple of periods that are above 2 and a couple that are below. It's just a frequency with which various suppliers put through price increases.
But they all seem to be in the 2% to 3% range. And so we're averaging about 2% because there are some categories that aren't seeing price increases.
Jason DeRise - UBS Investment Bank, Research Division
Okay. And sorry, another modeling question here.
On -- you mentioned the inventory days on average was 52. But I guess if I look at the ending inventory, it seems a lot higher than that.
I'm wondering if...
Mark E. Shamber
That's just -- I mean, again, we talked about -- in the comments, we built the inventory earlier. So we've had all of the inventory that we felt we needed for the Thanksgiving holidays already on board in mid-October, maybe even a little bit earlier than that.
And so we are higher at quarter end just by virtue of when the timing falls in a holiday. Normally, we would probably have built it a little bit into the first or second week of November, but we just didn't want to get caught short to the extent that we could control it.
Jason DeRise - UBS Investment Bank, Research Division
I mean, would expect that number to come back closer to where you ended the year in the next few quarters? Or is there anything better than that with the inventory optimization?
Mark E. Shamber
I'm sorry, are you talking dollar-wise or days-wise?
Jason DeRise - UBS Investment Bank, Research Division
Sorry, I'm back to days-wise. And I guess the added piece is should we think about getting back to last year?
Can it be better because of the inventory optimization work?
Mark E. Shamber
Well, I think that it will come out of the second quarter above 50 days because that's typically what ends up happening just by virtue of how December is not as strong of a month. And so it sort of artificially inflates it.
I would expect that as we get into the third and fourth quarter, we're probably back in the 48- to 49-day range, again, barring any supply issues or anything else that transpires from that perspective. So on the IO side, it'll be rolled out in the East over the course of the third and fourth quarter, so it won't probably be fully deployed until into the fourth quarter, possibly even at the end of the fourth quarter.
So we'll maybe get a modest benefit there, but it does take some time to work through the buying patterns and the inventory that you had on hand, even once you implement that.
Jason DeRise - UBS Investment Bank, Research Division
I apologize for squeezing a fourth question in here to everybody in the queue. Is the -- back to the gross margins on the increase year-over-year, would you say that the inbound freight savings was larger than the customer mix effect or less?
Mark E. Shamber
I won't answer it. I mean, I think we gave the 7 basis points.
And the other 13, we'll leave for folks to try to split how they think. But we don't want to get into that level of detail because it leads satellite too much into a couple of the channels, particularly the [indiscernible].
Operator
The next question is from Andrew Wolf of BB&T Capital Markets.
Andrew P. Wolf - BB&T Capital Markets, Research Division
I joined the call a little late, but I think, Steve, I think I heard you say that -- on the question about a lot of maybe new business in conventional being for bid or available or -- that you said nothing going for UNFI for the next 12 months. Just want to confirm that.
And would the reason be just capacity or just that, that idea that there's not a lot up for bid right now is not really what you see in the market?
Steven L. Spinner
Yes. I mean, Andrew, I hate to spend any time talking about what we may or may not have in the pipeline.
We're very busy building these buildings, with 4 of them -- 2 of them under construction, 2 soon to be under construction. That's our primary focus.
There's always contracts that come up at one point or another, and you never really know what could happen with any particular conventional retailer. The construction gives us the ability to be ready.
Because in certain markets, if we were asked to do it within the next 2 months, there's no way we could do it because we don't have the capacity. So I think the reference point that I made was that there's certainly nothing imminent that I would see happening within the next 6 months.
After that, you'd probably have to ask me then.
Andrew P. Wolf - BB&T Capital Markets, Research Division
Okay. You think it's fair to say -- I mean, if I were maybe one of these retailers, I might want to wait to see if your distribution centers got done on time.
If for nothing else, than to create an active option with an incumbent. So do you think maybe that's what's going on?
People are just waiting? The retailer is just waiting to -- for you to get your capacity up?
Steven L. Spinner
I don't know. I don't know.
It could be anything. I can tell you this, we've got a very, very good business development team, and they know where the opportunities are.
And we're going to take them where we can, when we can. The worst thing we could do is to take on a project that we can't do properly.
We'd rather pass on that opportunity and wait till next time. So we're just going to have to wait and see.
Andrew P. Wolf - BB&T Capital Markets, Research Division
And I also wanted to follow up on the inventory optimization that you -- you've explained that and hashed that out. But I wanted to -- is that at all linked to the common items and the data mining and the database management?
Is that sort of a precursor? Or is the common item in the database -- data mining kind of a separate project?
Steven L. Spinner
Yes. I mean, they are separate projects.
They're going on at the same time. And we will have inventory optimization in the East before we have a true common item across the country.
Because, without getting into the technical detail, we have to add a 6-digit to our Western business system item number and a whole lot of other complexities before we can truly be on a national item number. But we don't have to wait to do that in order to put IO into the East.
Andrew P. Wolf - BB&T Capital Markets, Research Division
Okay. And why -- what will the common item number -- what opportunities will be -- will it avail after you're done with inventory optimization?
Is it on procurements? Or is it just another iteration of inventory optimization that is more robust?
Steven L. Spinner
I mean, if you think about having a common item across the country and the data that it provides you with in terms of how you buy the product, where you buy the product, how many people are involved in buying the product, migrating to a true single item gives us so many flexibilities that we just don't have today. And there are a lot of national customers that need it because they want one item number across the country, they want one price across the country, and having that backbone is really an enabler to so many things.
But it's just tedious work getting there. It's going to take a while, but we'll get it done.
In the meantime, we've got IO and a couple other initiatives that are going to get in considerably sooner than that, and those are the things that have the big payback.
Operator
The next question is from Ajay Jain of Cantor Fitzgerald.
Ajay Jain - Cantor Fitzgerald & Co., Research Division
So first, I just wanted to clarify about your CapEx guidance that it was previously based on just maintenance CapEx. Now you're giving a revised figure for new capital projects, as well as maintenance CapEx, is that correct?
Mark E. Shamber
No, that's not correct. I mean, what we are saying, Ajay, is that the previous guidance excluded the construction costs of the 2 new buildings, which we intend to finance, although we have not chosen by which method we will do so.
But it did include investment. I mean, we don't have $80 million to $95 million of maintenance CapEx.
Ajay Jain - Cantor Fitzgerald & Co., Research Division
Okay. So I just -- I wanted to ask then about your cash flow outlook and how you're planning to fund the CapEx requirements.
I think, Mark, you said you're going to make that financing decision later, but I'm just wondering if you can give any more color on how you're going to cover the financing deficit because the way I've modeled it is it could be more than $100 million of additional funding requirements for this year. You talked about sale leasebacks as an option, but do you expect that you're also going to need to draw down on your revolver to cover that capital expense?
Mark E. Shamber
Well, Ajay, I'm not -- I mean, again, I don't have your model, so I'm not sure what you're referring from the $100 million. But there will probably be -- I mean, I think we said it at the beginning of the year that there will probably be some utilization of the credit facility.
But certainly, x the construction aspect, which we finance, it will not be close to $100 million.
Ajay Jain - Cantor Fitzgerald & Co., Research Division
Okay, that's helpful. And I had one follow-up question.
I know you talked about the gross margin improvement. You sort of beat that to death and I've just -- I wanted to ask, like apart...
Mark E. Shamber
You've got a lot of questions.
Ajay Jain - Cantor Fitzgerald & Co., Research Division
Well, I just wanted to ask apart from the customer mix and the better management of inbound freight. Can you talk about whether you're also seeing any evidence of increased vendor support or anything else you're doing in terms of how you're going to market, that might be driving some of the gross margin improvement?
Mark E. Shamber
No. I mean, I don't think we've -- I mean, I don't think we're seeing anything from increased vendor support.
I mean, the vendors, suppliers continue to promote where they feel the need is. And certainly, in some categories where the demand has been strong, they reduced promotional dollars from that standpoint.
But it's certainly not from additional vendor support.
Ajay Jain - Cantor Fitzgerald & Co., Research Division
And so is that slight uptick in gross margin what you're expecting to see over the balance of the year? Or do comparisons get more unfavorable at some point?
Mark E. Shamber
Again, we look at it from a year-over-year standpoint and as the mix perspective. So I'd like to think that we have the opportunity to get -- could be 10, could be 20 basis points of gross margin expansion in any given quarter, but it gets impacted by the components of the mix in that quarter as to which channels -- if we're at 14% or 13% next quarter and it's -- the independents were at 12% and the supermarkets were suddenly at 9%, we would likely have a stronger gross margin, but we would have much higher operating expenses.
And so we're working under the assumptions that the mix component stay relatively the same, but that the benefits of IO and TMS that we've put in place, that those continue to help on a year-over-year basis.
Operator
We have time for one final question, it comes from the line of Meredith Adler of Barclays.
Meredith Adler - Barclays Capital, Research Division
I'd like to flip around the promotional question that you just got and say, is there any indication that your customers want you to share those promotional monies with them? I mean, I followed food distribution -- conventional food distribution for a long time, and there was a point where there was a lot of pushback from the customers, that they wanted more promotional moneys.
Is there a risk of that for you guys?
Steven L. Spinner
No. We actually pass-through the most of the promotional money to the customer.
What this is, is basically an administrative fee that we collect for processing the promotional information. So in other words, if a customer wants -- has negotiated with a supplier for a $1 off on a certain product, we pass-through that promotional money and collect a fee for handling the transaction.
Meredith Adler - Barclays Capital, Research Division
I see. And that boosts the gross margin?
Steven L. Spinner
Correct.
Mark E. Shamber
[indiscernible] expense down and operating expenses, but you get the benefit in gross margin because it comes as part of the product price.
Meredith Adler - Barclays Capital, Research Division
Okay. I see.
So there is sort of a -- it's shows up in different line items?
Mark E. Shamber
Yes.
Meredith Adler - Barclays Capital, Research Division
And the net is really just a fee?
Mark E. Shamber
Correct.
Meredith Adler - Barclays Capital, Research Division
Just another question then about the new facilities that you're building. You did talk about there being some onetime costs.
Can you be specific about what quarters you're going to see those onetime costs? And is -- sure, go ahead.
Mark E. Shamber
Yes. I'm sorry, I didn't realize you had a -- there was a second part to it.
Yes, I mean, with -- as it relates -- so I mean -- and I know you had missed the fourth quarter call, so the way it's broken out, Meredith, is there's 2 pieces. There's about $1.2 million to $1.6 million that's associated with the deferred rent, and that will occur relatively ratably over the course of the year.
So it's roughly $300,000 to $400,000 every quarter related to the Denver facility that we've exited but we're still paying rent on. The additional $1.3 million to $1.8 million is associated with the Racine facility coming online, and we'll start to incur those costs in the third quarter, and there will be some carryover into the fourth quarter.
And it really -- the breakdown depends on how quickly we hire the people and when we start shipping. So if we hit the ship date that we have targeted, it's probably a relatively even breakdown between the 2 quarters.
But if, for some reason, we start shipping a little bit later, we might hire a little bit later and then more of the cost would shift to the fourth quarter.
Meredith Adler - Barclays Capital, Research Division
Okay. And is it right to think about this as onetime if you have 4 facilities that you're building over the next 2 years?
Mark E. Shamber
No. I mean -- and that's part of the reason we highlighted so the folks know what those components are so that when we don't have new facilities, they'll see that kind of consistency.
But -- I mean, we included it in the guidance and don't attempt to back it out because we are going to have, to your point, new facilities over the next 3 to 4 -- 2 to 3 years, anyway.
Steven L. Spinner
Thank you, everybody, for joining us on UNFI's first quarter 2014 results. Have a great day, and we'll talk to you during our next quarter's results.
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.