Mar 9, 2015
Executives
Katie Turner - Managing Director, ICR LLC Steven L. Spinner - President, Chief Executive Officer & Director Mark E.
Shamber - Chief Financial Officer, Treasurer & Senior VP Sean F. Griffin - Chief Operating Officer
Analysts
Vincent J. Sinisi - Morgan Stanley & Co.
LLC Meredith Adler - Barclays Capital, Inc. Rupesh D.
Parikh - Oppenheimer & Co., Inc. (Broker) Karen F.
Short - Deutsche Bank Securities, Inc. Andrew P.
Wolf - BB&T Capital Markets Mark G. Wiltamuth - Jefferies LLC Scott A.
Mushkin - Wolfe Research LLC Joe Edelstein - Stephens, Inc. Sean P.
Naughton - Piper Jaffray & Co (Broker) Kelly A. Bania - BMO Capital Markets (United States)
Operator
Greetings, and welcome to the United Natural Foods Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode.
A question-and-answer session will follow the formal presentation. I would like to turn the conference over to your host, Katie Turner.
Please go ahead.
Katie Turner - Managing Director, ICR LLC
Thank you. Good afternoon, everyone.
By now you should have all received a copy of the second quarter fiscal 2015 earnings press release issued this today at approximately 4:05 p.m. Eastern Time.
The earnings press release and webcast are available under the Investors section of the company's website at www.unfi.com. On the call today are Steve Spinner, President and Chief Executive Officer; Sean Griffin, Chief Operating Officer; and Mark Shamber, Chief Financial Officer.
Before we begin, we'd like to remind everyone that 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 risk and uncertainties.
Actual results may differ materially from the results discussed in these forward-looking statements. In addition, in today's earnings press release and during the call, management will provide both GAAP and non-GAAP financial measures.
These non-GAAP financial measures include adjusted net sales, operating income, net income, and earnings per diluted share. With that, I'd like to turn the call over to Steve Spinner.
Steven L. Spinner - President, Chief Executive Officer & Director
Thanks, Katie. Good morning, and thank you – good afternoon, I should say; and thank you for joining us.
Net sales during our second quarter of 2015 remained strong with growth of approximately 23% compared to the second quarter of fiscal 2014. Net sales in the quarter were over $2 billion, highlighting the continued demand for UNFI's products and services; and $2 billion in the quarter was a record for UNFI.
Adjusting for a customer contract true-up, which I will discuss momentarily, UNFI's operating income increased over 17% during the quarter to $57.2 million; and earnings per share increased $0.09 to $0.65 per diluted share. And we did have several challenges during this quarter.
First, our Canadian business continues to be significantly impacted by the fall of the Canadian dollar against the U.S. dollar.
The impact of the dramatic drop in value of the Canadian dollar impacted the company negatively by approximately $2.1 million during the quarter. This issue was caused primarily by the procurement of U.S.-made products that are imported into Canada and paid for in Canadian dollars.
Given the dramatic and rapid change in valuation, we've not been able to pass through price increases at a rate that keeps pace with the change in the currency valuation. I expect that this condition will continue for the remainder of our fiscal year and is reflected in our revised guidance.
Our team in Canada is strong and our market share is increasing, as we continue to move UNFI best practices across the border. Second, as I highlighted in our press release earlier today, the company recognized a non-recurring reduction to net sales of $7.7 million in the second quarter to reflect amounts owed to a customer resulting from an incorrect calculation of contractual obligations to that customer from fiscal 2009 through fiscal 2014.
The company identified the incorrect calculation and brought it to the attention of its customer. The company is recognizing the reduction in the current fiscal year because it has concluded that the impact on prior period was not material.
The aggregate amount of the reduction to net sales related to this incorrect calculation during the first half of fiscal 2015 was $9.3 million, which includes a $1.6 million reduction to net sales previously recorded in the first quarter of fiscal 2015. Our company has a long-established culture of integrity in doing what's right.
The issue that caused the reduction in net sales resulted from an internal control breakdown associated with a very complex customer contract. Since the contract was signed, the business has grown significantly and we identified a breakdown in the communication between those individuals within our organization responsible for tracking payments under the contract and our business and finance teams.
While I'm extremely disappointed, we have learned from this experience and implemented new procedures and programs to improve the control process. The issue does not extend to other customers.
Third, gross margin during the quarter declined 145 basis points. 60% of the decline resulted from the Tony's Fine Foods acquisition as they work on a lower gross margin than UNFI; and the non-recurring customer payment.
Other factors included Canadian FX, lower fuel surcharges, and increased freight costs due to increasing demand for service-based carriers. Managing cost and productivity continues to be a strategic mission for us; and during the last several years, we've delivered very strong results in this area against a challenging gross margin trend.
We also continue to remain vigilant in building out our network for the long-term and ensuring that it is efficient and productive. As discussed in the first quarter of fiscal 2015 commentary, we did cease primary operations at a facility in Scotstown, Québec, and moved the business into our Montréal facility.
By merging these facilities and leveraging resources in Montréal and Toronto, we have increased service levels and lowered costs. Our facility expansions are continuing and as expected.
Our Hudson Valley facility will be transferring its final group of customers this month from our Dayville, Connecticut, and Chesterfield, New Hampshire, facilities, giving relief to capacity in those locations. Our Twin Cities facility is nearing completion and is scheduled to begin shipping to customers at the end of April.
And our Gilroy, California, facility construction is also underway; and we are excited about the opportunity to expand our presence in the very important California market. Also, our warehouse management systems rollouts have been moving forward with new DCs in Hudson Valley, Racine, Twin Cities, all running UNFI's core system platform.
As I've also conveyed, UNFI is now on a standardized demand planning and inventory optimization platform for all core UNFI distribution centers. We are fully prepared in terms of capacity and systems to manage continued growth from new customer contracts, industry growth, and additional volume from current customers.
On a more positive note, the acquisition of Tony's Fine Foods has continued to exceed our expectations. We continue to move forward with our plans to roll out our expanding offering of perimeter products including meats and specialty cheeses across the country.
Today, we have nine distribution centers serving the western part of the U.S. From UNFI, Tony's, Albert's, and Select Nutrition, we now offer customers a completely built-out product offering including gourmet/ethnic.
Our distribution network in this market is without equal. In many cases, our companies are using each other's assets to maximize efficiencies for supply chain, transportation, and operation support.
And we've had terrific customer acceptance with the benefits associated with adding both Tony's or UNFI programs to existing customers and new customers. Delivering our breadth of SKUs across all categories in a singular supply chain is very compelling to customers.
Scale drives down cost and increases productivity. Additionally, our corporate integration with Tony's is nearly complete and we are extremely pleased with our progress and opportunities that lie ahead.
UNFI's product and service offering with the addition of Tony's is more compelling than ever. Our strategy, which we'll roll out over the next several years, is to provide customers protein, specialty cheese, grocery, frozen, dairy, bakery, food service, supplements, personal care, ethnic/gourmet, produce, and e-commerce throughout North America.
This strategy, combined with our significant scale and supply chain, makes UNFI a terrific option for a wide range of customer channels. We are now in the process of determining SKUs and SKU mix for our first Tony's product set into a UNFI distribution center with a rollout taking place shortly.
Looking specifically at our sales growth, excluding recently completed acquisitions, we grew approximately 9% over the prior year's quarter. And while we've been talking about higher manufacture product shortages for some time, we remain optimistic that fill rates will improve based on discussions with suppliers.
In the U.S., USDA Organic still represents less than 4% of our production; and we're confident that as demand continues to grow, capacity will be built. Overall fill rates may be lumpy, especially in certain categories, however the interest of UNFI suppliers and growers are all aligned.
We want to sell more products to provide a healthier option for conventional foods. In the current quarter, however, overall demand continued to outpace manufacturers' ability to produce.
Out-of-stocks were 28 basis points higher than the first quarter of 2015, with most of the increase occurring in the organic dairy categories. Or put another way, additional out-of-stocks translated into approximately $6 million of lost sales during the period; and year-over-year out-of-stocks increased over 100 basis points or approximately $16 million during the quarter.
UNFI's fill rate in these categories were between 75% and 80% versus a historical average of over 90%. Additionally, looking at our top 30 suppliers, purchase orders were cut 17.7% in the quarter versus 10.14% in the prior year comparable quarter.
Net sales were also negatively impacted by severe weather throughout the Northeast and Southeastern U.S. UNFI operations team has done a spectacular job managing through snow, ice, and extremely cold conditions for the last several months.
Our on-time delivery rate continues to be well over 90% despite Mother Nature's attempt to slow us down. The challenges of dealing with severe weather are significant.
Tough weather brings considerable logistics challenges and additional costs. And also, as I said earlier, during the quarter, net sales were negatively impacted by the valuation of the Canadian dollar as well as the customer contract issue I discussed earlier.
On the M&A front, there are lots of opportunities which meet our disciplined strategic development program. Under our Tony's umbrella, we will continue to build out our national perishables model over the next several years.
Additionally, we'll be opportunistic in looking at companies that further our building-out-the-store strategy, including gourmet/ethnic, produce, and geographic expansion. Despite a tough quarter and the challenges we faced, our team remains deeply committed to our continued growth.
Our long-term strategy of building out the store is sound; and we continue to have confidence in the continued growth of our company. Now I'll turn the call over to Mark Shamber, our CFO.
Mark?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Thanks, Steve, and good afternoon. Net sales for the second quarter of fiscal 2015 were $2.02 billion, which represents growth of 22.5% or approximately $371 million over the prior year second quarter's net sales of $1.65 billion.
Excluding the impact of the acquisition of Tony's Fine Foods, sales increased by 8.4%. Inflation increased modestly both sequentially and on a year-over-year basis for the second quarter, coming in at 2.15%, a 21 basis point rise from Q1 and a 30 basis point increase from last year's second quarter, which had inflation at 1.85%.
On a year-to-date basis, net sales were $4.01 billion, yielding sales growth of approximately $761 million or 23.4% over the first half of fiscal 2014. Excluding the approximately $460 million of net sales coming from the Tony's and Trudeau acquisitions, our year-to-date comparable sales growth is 9.3%.
For the second quarter of fiscal 2015, the company reported net income of $27.8 million or $0.55 per diluted share, a decrease of approximately $0.1 million or 0.4% from the prior year, while diluted earnings per share decreased by 1.2%. Net income for the second quarter of fiscal 2014 was $28 million or $0.56 per diluted share.
Adjusting net income for the $4.7 million after-tax impact from the reduction in net sales described in the press release, diluted earnings per share would have been $0.65, an increase of $4.6 million or 16.4% over the second quarter of fiscal 2014. On a channel basis, supermarket sales increased by 26.6% in the second quarter, with supermarkets representing 27% of net sales.
Sales growth in the independents channel was 22.2%; and for the quarter independents represented approximately 32% of sales. The supernatural channel sales increased by 16.7%; and the supernatural channel represented 35% of net sales in the second quarter of fiscal 2015.
Food service comprised approximately 4% of sales after growing by 64.2% in the second quarter. Excluding the impact of the Tony's Fine Foods acquisition, supermarket sales increased by 7.6%, independents' sales growth was 6.9%, supernaturals sales grew by 9.5%, and food service had growth of 13.2%.
At 14.8%, gross margin for the quarter showed a 145 basis point decline over the prior year second quarter gross margin of 16.3%, and was down sequentially 117 basis points. The largest drivers to our lower gross margin in the second quarter of fiscal 2015 were the dilutive impact of Tony's, which represented approximately 58 basis points of the gross margin decline compared against the prior year second quarter, and the reduction in net sales which represented approximately 32 basis points.
Our gross margin was also negatively impacted on a year-over-year basis due to higher supplier out-of-stocks, lower fuel surcharge revenue, the decline in the value of the Canadian dollar and our Canadian business, increased inbound freight costs, and shifting customer mix. Gross margin for the first half of fiscal 2015 was 15.4%, compared to 16.6% in the prior year; a decline of 119 basis points, again driven by the same factors in Q2 that I just covered, with dilution from Tony's representing more than 55 basis points of the dilution on a year-to-date basis as well.
Our operating expenses for the quarter were 12.4% of net sales, compared to 13.3% for the same period last year. This represents a 94 basis point improvement over the prior year as operating expenses as a percentage of net sales continued to benefit from the acquisition of Tony's and their related cost structure, the mix shift in our business, positive trends in our self-insurance areas, lower fuel cost, and lower performance-based incentive expense.
Included within operating expenses are $0.2 million in restructuring cost associated with the closure of our Scotstown, Québec, location in Canada. Our costs to-date relating to this restructuring have been lower than initially projected due to the decline in the Canadian dollar and the continued use of our Scotstown facility, which would delay any potential impairment of the associated assets until we cease using the building.
Fuel had a positive impact of 7 basis points on operating expenses in comparison to the second quarter of fiscal 2014 as fuel represented 64 basis points of distribution net sales in the second quarter of fiscal 2015. Fuel expenses were 6 basis points better than the first quarter of fiscal 2015, when fuel came in at 70 basis points.
Nationally our diesel fuel cost in the second quarter of fiscal 2015 decreased by approximately 3% from the prior year's second quarter, while the national average price declined to $3.30 a gallon, a decline of 15.1% compared to the $3.88 a gallon in the second quarter fiscal 2014, per the Department of Energy. Our year-over-year decline in diesel fuel cost is below the Department of Energy's percentage decline due to our use of locking in a portion of our pricing using fixed price contracts.
Share-based compensation expense during the second quarter of fiscal 2015 totaled $3.6 million or 18 basis points as a percentage of net sales, compared to $4 million or 24 basis points in the prior year. Operating income for the quarter second quarter was 2.5%, a 52 basis point decline over the prior year second quarter operating income of 3%.
Adjusting for the $7.7 million pre-tax amount associated with the reduction in net sales, operating income was 2.8%; a decline of 14 basis points. Other net expense during the quarter consisted of a gain of $0.8 million from the sale of our Canadian retail location located in British Columbia, which was completely offset by non-cash charges of $0.8 million associated with the impact of the continued decline of the Canadian dollar on our Canadian business.
Inventory was $922 million at quarter-end, as days inventory on hand averaged 51 days for the second quarter, an improvement of 2.5 days over the prior year's second quarter which was 53 days. Consistent with my statements last quarter, the primary driver of the year-over-year improvement was the inclusion of Tony's, as Tony's inventory turns are much faster than Unified's broadline business due to the heavier perishable concentration.
Within our broadline business, we continue to compensate for the continued issues with supplier out-of-stocks in certain categories by carrying higher inventory levels. DSO for the second quarter improved modestly on a year-over-year basis, but remained at 22 days.
Capital expenditures were $28.8 million and are $56.2 million for the year-to-date, representing 1.4% of net sales on both the quarter and a year-to-date basis as we're trending below our target range for fiscal 2015. Outstanding commitments under our credit facility were $401 million at quarter-end with available liquidity of approximately $210 million including cash and cash equivalents.
Our leverage was consistent with the prior quarter at 2 times on a trailing 12-month basis. As discussed in today's press release, we're updating our guidance for fiscal year 2015.
We expect net sales to be in the range of $8.19 billion to $8.29 billion, which represents a 20.5% to 22% increase in total net sales over fiscal 2014. Our previous sales guidance was $8.13 billion to $8.38 billion.
In addition, we are narrowing our diluted earnings per share guidance for fiscal 2015 to a range of approximately $2.81 to $2.90 per diluted share. This reflects the impact of the reduction in net sales in the second quarter, as well as the anticipated ongoing negative impact of the decline in the Canadian dollar.
Our previous GAAP earnings guidance was $2.88 to $3.01 per diluted share. Adjusted for the impact of the $7.7 million reduction in net sales, our adjusted earnings per diluted share for fiscal 2015 is expected to be in the range of $2.90 to $2.99 per diluted share; an increase of approximately 15.1% to 18.7% over fiscal 2014 GAAP earnings per diluted share of $2.52.
At this point, we'll turn the call back over to the operator to moderate the question-and-answer session. Operator?
Operator
Thank you. In the interest of time, please limit your questions to one question and one follow-up question.
One moment please, while we poll for questions. Our first question comes from Vincent Sinisi with Morgan Stanley.
Vincent J. Sinisi - Morgan Stanley & Co. LLC
Hi. Good afternoon.
Thanks very much for taking my question.
Steven L. Spinner - President, Chief Executive Officer & Director
Sure.
Vincent J. Sinisi - Morgan Stanley & Co. LLC
Just wanted to ask you guys a little bit further about the customer sales recognition in this quarter. If you could, without of course getting into too specifics, was it a term with that specific customer that is not included in any of your other contracts, or is it more of a case where it just is a term that is in others just wasn't accounted for properly with this particular one?
I know you said it's not applicable to other customers.
Steven L. Spinner - President, Chief Executive Officer & Director
I mean we're not going to get into the specifics of any specific contract because every contract is different. And like I said in the press release, we discovered the issue, we reported it to the customer, and we resolved it with the customer, which speaks to the level of transparency and integrity that we deal with.
And the issue did occur over for several years and the fact that we didn't catch it is not acceptable. We've learned a lot from the experience and we've worked real hard to implement appropriate controls to prevent it from happening again.
And all the disclosure around the issue is in the press release, as well as the comments that I've made this morning.
Vincent J. Sinisi - Morgan Stanley & Co. LLC
Okay, Steve. Thanks.
And just a quick follow-up, if I may. Regarding the Tony's infrastructure, I know that you've said in terms of the rollout of that preparing the platform which could be through M&A, could be organic, any just updates in terms of when we could hear anything further about starting to put those products further eastward?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean that's a great question.
And so I made some comments that we were getting ready to roll the Tony's set into a DC And as much as we'd like to share that information with you, we do feel like it's a competitive advantage. And so it's at the top of our list in terms of both M&A underneath the Tony's umbrella, as well as moving the Tony's products across the country.
For those of you who follow the industry, you can see how powerful natural protein and perimeter is to the retailers. And so we certainly recognize that and we've built a lot of capacity that has the ability to handle these perishable products.
It's really unique because you can't just take these products and throw it into a refrigerator. They all require multiple temperature zones, and that is exactly what we've built into our new DC.
So we're excited about it. It's at the top of our list; and stay tuned.
Vincent J. Sinisi - Morgan Stanley & Co. LLC
Okay. Thanks very much.
Good luck.
Operator
Thank you. Our next question comes from Meredith Adler from Barclays.
Meredith Adler - Barclays Capital, Inc.
I'm just going to follow up with what Vinny was asking about, because you were talking about what was happening on the West Coast, and I think I ended up getting a little bit confused. You actually have West Coast distribution centers carrying the Tony's product or just that there's a relationship of cross-docking or whatever?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. So today there's a relationship of cross-docking primarily between our Albert's business, Meredith, which is very much into the perishable side of the business as well as produce; and obviously Tony's has a huge presence both in terms of NorCal, SoCal, and the Pacific Northwest.
And so the first step was to make sure all those companies were working well together to make all those products accessible to all of the customers within the western half of the U.S.; and that we are deep into that process. The next step, which we're also deep into, is putting together a Tony's SKU set into a non-western based UNFI distribution center; and we're excited about that as well.
Meredith Adler - Barclays Capital, Inc.
So I guess I'm still – I must be very dense this evening. But by making all of these products accessible to the customers on the western part of the U.S.
that does not necessarily mean that you have a Tony's set in a DC? It's more like you are able to sell the products and send an order to a Tony's distribution center?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean, so the way it works, I mean, for these products you have to buy it in significant quantities.
It requires a tremendous amount of scale. You have to buy it in large quantities and you have to move it in large quantities.
And so we're essentially using our Tony's NorCal facility as our redistribution point for those products; and those products will come into NorCal and get redistributed out to UNFI DCs as they need them.
Sean F. Griffin - Chief Operating Officer
Yeah. If I may, Meredith.
This is Sean. The Pacific Northwest, Northern California and Southern California, today, we have significant cross-dock opportunities and beyond even Albert's organics; and these opportunities are being thoroughly flushed out today.
So we can do what we can do today through cross-docking utilizing Tony's acquisition of inventory and cross-dock. Moving forward, looking beyond Northern California, Pacific Northwest and SoCal, establishing key customer relationships is paramount before we can move for the obvious reasons of highly perishable foods and products.
So that is to be determined, and we'll have more information as those opportunities and that specific market develops.
Steven L. Spinner - President, Chief Executive Officer & Director
As an example, where we have an existing customer relationship, where we do sell them some of these categories, some of the Tony's type categories, well, we're not an efficient buyer because we just don't have enough volume in the UNFI DC. So the first step is to migrate away from UNFI trying to buy these products direct and using the Tony's infrastructure to do it for us, where the cost of goods is better, the turn of the inventory is better, and there's a much broader SKU base.
So those are the things that we checked off the list first. But rest assured, it is a very big competitive advantage for us to move those products into the UNFI DCs that we've just built.
But I think it would be a competitive disadvantage if we got into more specifics than that.
Meredith Adler - Barclays Capital, Inc.
Okay. So I have one other quick question.
These people that you paid the $7.7 million, did they give you an award or send a case of champagne or something that you were so honest?
Steven L. Spinner - President, Chief Executive Officer & Director
Well, listen, we've got a really strong culture and we did the right thing.
Meredith Adler - Barclays Capital, Inc.
Yes, you did. Thanks.
Operator
Our next question comes from Rupesh Parikh from Oppenheimer.
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Thanks for taking my question. So I just wanted to touch on maybe some of the customer sales growth during the quarter.
So it looks like the conventional supermarket channel slowed, at least compared to last quarter. So I just want to see if there's any more color you can provide in terms of what's happening within that channel?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. Rupesh, it's Steve.
So our conventional business has been growing 20%-plus for quite a while. And when we first started winning the conventional business, which drove that 20%-plus growth, we said at the time that our growth in the channel would be lumpy because you take on a lot of business, you lap it, you take on more business, you lap it.
So you get this very lumpy growth within that channel; and I think it's just a timing issue for us right now. We're optimistic about the pipeline for new business through both new and existing customers.
I mean I will tell you that not from our perspective, but from the retailer's perspective, it's a pretty tough competitive retail environment as well. But from UNFI's perspective, as it relates to new customers, I think it's a timing issue more than it is anything else.
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Okay. And then just going back to your commentary on FX before, two questions.
One, I wanted to just confirm that $2.1 million, is that a net income number, the impact of FX? And number two, as you look at your Canadian business, do you expect to recover margins as the Canadian dollar maybe stabilizes over the next few quarters?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
So I'll answer the first part of the question and I'll let Steve answer the recovery side. So the $2.1 million number is a pre-tax number, Rupesh.
It's not an after-tax number.
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Okay.
Steven L. Spinner - President, Chief Executive Officer & Director
And as far as the FX and pricing, it would be easy for me to say, you know what, yeah, we're going to pass it through; but easier said than done. And we're working hard to come up with a model that is essentially a frequency equalizer that gives the customer both the pain and the gain.
But that's a tough slog. I think we'll make progress, but it's a tough slog.
It's going to take a while.
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Okay. Thank you.
Steven L. Spinner - President, Chief Executive Officer & Director
And we're not the only one competing out there either. So everybody's got the same problem.
Rupesh D. Parikh - Oppenheimer & Co., Inc. (Broker)
Okay. Thank you.
Operator
Our next question comes from Karen Short from Deutsche Bank.
Karen F. Short - Deutsche Bank Securities, Inc.
Hi, thanks for taking my question. So just looking at your organic growth, we all do the calculation on what organic growth was in the first quarter versus what it was in the second quarter.
And back in the first quarter you had said your organic growth had accelerated throughout the quarter, from 10.2%, now you're kind of at that 8.9%. I guess no matter how I look at it, even if I try to adjust for the FX impact, I mean there's obviously a lot of moving parts in trying to get to a true organic number.
But can you give us some more color there, because there definitely seems to have been a slowdown.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean there's a couple of things that I think attributed (sic) [contributed] to that, Karen.
Obviously, the FX is a big part of it. The other major components of kind of the sales question is certainly higher supplier out-of-stocks hurt us; and that was primarily in the dairy category, which is a high dollar volume number, because our dairy fill rates in the quarter were – I think I mentioned in my commentary, but was in the 75% range, which is difficult to recover from.
We also had – the weather was really tough, not only in New England, but we had really tough weather in the Southwest with ice storms that they're just not used to dealing with; where we didn't have six hours' worth of disruption, we had days' worth of disruption. And once you lose those days, you never get them back.
I wouldn't say that there's any new competitive threat out there on the distribution side. That's pretty much unchanged.
I'm not sure about any changes in customer behavior. We're just not close enough to it at this point.
One would think that perhaps with fuel on the downslide that that would help, but I think those are the primary drivers in the numbers that you're looking at.
Karen F. Short - Deutsche Bank Securities, Inc.
So is it fair to say into the third quarter, into your third quarter to date, I mean obviously most of the things that you just listed as causing the slowdown, none of them have really I don't think changed dramatically. You haven't really seen an uptick?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I would say that that's accurate.
Karen F. Short - Deutsche Bank Securities, Inc.
Okay. And then I guess back to the supermarket channel, when I look at the two-year trends especially, and I know you've commented on the fact that you've had very strong growth in the 20%-plus range for quarter after quarter, and I mean obviously that's apparent from the numbers.
But the slowdown was definitely there, and I guess what I'm curious about is maybe not a change in the competitive landscape from going direct, but what about any changes on the competitive landscape from, say, other conventional distributors? Are you seeing anything like that, or not really?
Steven L. Spinner - President, Chief Executive Officer & Director
No, not at all. I mean the same competitive threat in conventional and regional I think that was there a year ago or two years ago is still there today; and we need to do a good job in establishing the value in UNFI.
And that is, we basically trade in a slow-moving world, and the only way you are efficient in a slow-moving world is to have the right supply chain infrastructure. And I can tell you that there is nobody even remotely close to the supply chain infrastructure that we have.
And we're all about having a very broad SKU offering with a lot of new items; and that's just not one thing I worry about.
Karen F. Short - Deutsche Bank Securities, Inc.
Okay. And, sorry, just last housekeeping.
Can you just give the dollar impact of FX in the first quarter? I didn't catch that last quarter, if you gave it.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Karen, I don't have the first quarter impact handy. I can follow-up offline afterwards with that.
I just don't have it off the top.
Karen F. Short - Deutsche Bank Securities, Inc.
Okay. Thanks.
I'll get back in the queue.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Okay, Karen.
Operator
Thank you. Once again, if you do have a question, you may ask one question and one follow-up.
Our next question comes from Andrew Wolf from BB&T Capital Markets.
Andrew P. Wolf - BB&T Capital Markets
Okay. Thanks for repeating that warning.
I actually want to ask a follow-up on the slowing in the supermarkets. I guess, I just want to be direct about it.
It looks like you did it on a GAAP basis, not adjusted. And the $7.7 million adjustment, would that be in the supermarkets?
We could go back and calculate it ourselves, if that's the case?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. Andy, I mean, we intentionally did not put it to a specific channel from that standpoint.
So we only reported it on a GAAP basis.
Andrew P. Wolf - BB&T Capital Markets
Okay. I guess the other thing is, Karen sort of let you off the hook on whether people are going direct, or maybe, Steve, you answered that and I missed it, but are you seeing an increase in the rate of SKUs that are turning fast enough that supermarkets are just taking them in-house and there's not enough new slower moving SKUs hitting?
Is there some kind of mismatch?
Steven L. Spinner - President, Chief Executive Officer & Director
No. It's actually on the contrary, Andy.
I mean what we've determined is that – and we're only talking about the conventional channel, right, which is not a significant portion of our business in its entirety. So it's only one singular channel that goes direct.
And nothing is different today than two years or three years ago. And the interesting thing that we've learned is that direct buyers are truckload buyers.
And so if you're buying 30 SKUs or 40 SKUs direct, you may get – let's use an example of you may get a 500 basis point or 600 basis point advantage over UNFI by buying it direct. Well, that's compelling if you just look at it in a very black-and-white way, but what ends up happening when a conventional retailer takes it direct is they get a much higher degree of out-of-stocks because they really have to wait until they can put together a 40,000-pound load to place another order, which means they'll have too much of one item and not enough on others.
And so if you actually do the calculation of that 500 basis point or 600 basis point advantage in buying direct versus the lost margin at retail because of having a diminished fill rate on the items that they bought direct, it's a really compelling reason to give it back to UNFI; and there are many cases where that happens.
Andrew P. Wolf - BB&T Capital Markets
That's interesting. So that – I mean it sounds like a good pitch, but you're saying that it's actually moving some product back to you guys?
Steven L. Spinner - President, Chief Executive Officer & Director
Yes.
Andrew P. Wolf - BB&T Capital Markets
Okay. If I could just squeeze one more in, the gross margin still was down if you adjust everything.
I don't know if you've accounted for weather and I know a lot of people don't want to use weather as an excuse. But the gross margin still contract around 50 bps if you take out, as far as I can tell everything, you talked about Tony's, Canada, and so forth.
Is that mix driven more than anything, or what explains that within the core business?
Steven L. Spinner - President, Chief Executive Officer & Director
Again, I think the primary drivers in this particular quarter – I mean it just kind of all hit us is obviously the Tony's Canadian FX, the higher degree of out-of-stocks, and the lost sales associated with it and lost margin associated with it. Freight was a significant factor in that.
Obviously, diesel does not fall as fast as gasoline, number one. And number two, because of significant shortage in drivers, service-oriented drivers, the freight rates haven't come down anywhere close to the decline in the cost of the diesel; and that's a big hit for us.
Customer mix and all the other sales issues I mentioned earlier, those are the primary drivers to the gross margin challenges we had in the quarter. And, again, the key thing that we have to do which we have a lot of success doing is, as we grow, we have to continue to lower the cost and be more efficient at a rate that is at least equal to the decline in the gross margin.
This quarter, we didn't do it, but we do have a long history of delivering that.
Andrew P. Wolf - BB&T Capital Markets
Okay. Can I just ask a follow-up on that?
How do you eventually pass through the increased freight rates? Is that part of your inflation rate, or how do you [indiscernible (41:19)?
Steven L. Spinner - President, Chief Executive Officer & Director
Well, no. We move about 40%-some-odd of our own freight.
And so we have to wait, because you can't go ahead and change prices every week or every two weeks. And so we tend to do it...
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
We cycle through and actually try to avoid any freight rates uniquely, but tied to any product cost increases on our review cycle that is annual.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. So, unfortunately, we've got to wait.
Andrew P. Wolf - BB&T Capital Markets
Okay. Thank you.
Operator
Thank you. Our next question comes from Mark Wiltamuth from Jefferies & Company.
Mark G. Wiltamuth - Jefferies LLC
Hi. Just one clarification on the organic sales growth rate.
The 9% number you called out, does that include the FX drag in it or it was – I also heard a 9.3% number, so I'm not sure which is the correct number to focus on for organic.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
So the 9.3%, Mark, is the number for the first half of the year. The organic number for the second quarter on just a strictly GAAP basis would be 8.4%.
The number that Steve referenced would exclude the reduction in net sales and the impact of the Canadian FX. So that's a rounded 9% for the second quarter, a little bit north of 9% with those two headwinds factored in.
Mark G. Wiltamuth - Jefferies LLC
Okay, got it. And just a bigger picture question on the selling to the perimeter of the store, we heard a lot about the meat, cheese and specialty opportunity at Tony's, but we really haven't heard anything about produce in the perimeter.
Are you not pursuing that category, or is that something that could come down the road, or are there dynamics on that category that make it less attractive?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. No.
We've kind of intentionally not talked about that, so thank you for bringing it up. Produce will move into the only markets where we don't have produce today, soon, which coincidentally is in some of the northern parts of California and the Pacific Northwest.
The other component of produce – and here historically we've been organic only. And our produce business, if you look back over the last couple of years, our Albert's business has grown 20%-plus a year in the last, I don't know, three years, four years.
And we've got competition, conventional competition that now carries organic produce. So the obvious thing that we need to do is to completely round out our product offering with quality conventional produce; and that's something is a strategic decision for us that we are moving towards.
Mark G. Wiltamuth - Jefferies LLC
And on that front, I mean is it easier to use brokers, or do you have to do acquisitions to get in that direction?
Steven L. Spinner - President, Chief Executive Officer & Director
No. We actually own a sourcing business called Pacific Organic based in California, which does a lot of the sourcing for us; and a lot of our long-term growers have conventional products as well.
So it's a pretty easy transition.
Mark G. Wiltamuth - Jefferies LLC
Okay. Thank you very much.
Steven L. Spinner - President, Chief Executive Officer & Director
Thank you.
Operator
Our next question comes from Scott Mushkin from Wolfe Research.
Scott A. Mushkin - Wolfe Research LLC
Hey, guys. Thanks for taking my question.
So I just want to get back to the growth rate and take a kind of I guess a longer view of it, Steve and Mark. Just if I'd look at kind of the organic growth rate, on almost every channel it's been slowing.
I mean it's lumpy here and there, but the trajectory has kind of been down over the last 24 months. So the question I have, is there oversupply issues coming in?
There's too many people have entered the market? Particularly when you think of a lot of the guys that have made a huge push are some of the guys distribute to themselves directly, like a Costco and a Kroger, now Target's going to make a big push.
So what are your thoughts there? I mean just if you kind of like of said, step back and say, okay, what's the trajectory, it seems down.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. I mean again I think that there's been a fair amount of headwind associated with fill rates.
I mean fill rates have hurt us pretty badly over the past two years. I think it's going to get better.
The Natural Products Expo was this past weekend. We had a lot a high level meetings with suppliers and suppliers seem to believe that some of the worst fill rate problems are behind us.
I don't worry overly about a slowdown only because I'm still optimistic about our ability to take on new product categories, expand Tony's across the country. We have some other things that we're working on in building out the store from e-commerce to gourmet/ethnic.
These are all things that are going to allow us to continue to take market share regardless of what happens in the industry. So I think it's – like I said earlier, I think it's a little bit of a timing issue.
We had a little bit more headwind than we had anticipated, but long-term I feel really good about where we are.
Scott A. Mushkin - Wolfe Research LLC
And do you do a lot of dairy to Whole Foods or no?
Steven L. Spinner - President, Chief Executive Officer & Director
I mean I'm not going to comment about what we do with any specific customer. We sell a lot of dairy; a lot of dairy.
Dairy vendors are in our top – two biggest dairy vendors are in our top 10 suppliers. So when they have 75% fill rates, we're struggling.
Scott A. Mushkin - Wolfe Research LLC
And then the other question is just on the independent channel. It's really a structure of the industry.
I mean I was looking back to the model and it's gone from about 36% of sales now down to 32%. I mean is this going to be a constant battle that you fight, where that's your most profitable kind of channel, but it's likely to shrink over time as some of the bigger retailers become more involved in the channel, or is that not the right way to think about it?
Steven L. Spinner - President, Chief Executive Officer & Director
I think the biggest factor in changing the mix is the addition of Tony's, as well as some channel shift.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
And the other thing, Scott, is we've got such a heavy penetration on the independents, there's not a lot of additional market share to gain; whereas on the supermarkets, we don't have as large of a market share. And so when we win those new supermarket customers, it leads to additional dilution of the independents as a percentage of the overall business, even though they put up good comp growth.
Steven L. Spinner - President, Chief Executive Officer & Director
And the biggest winner in the build-out of our store, our perimeter is the independent. That's where they need the most help.
We think at least that they need to differentiate by adding items that are distinctive, whether it's perimeter food service, prepared foods, vegan options, and so on and so forth. That's what's going to enable the independents to continue to grow at the rate that they've been accustomed to.
If they try to compete on center store price, that's going to be a tough one. And so that's why our perimeter program, whether it be through Albert's or Tony's or UNFI, is incredibly important to getting it right for the independent.
Scott A. Mushkin - Wolfe Research LLC
That makes a ton of sense. Thank you.
Great answers. Appreciate it.
Operator
Our next question comes from Joe Edelstein from Stephens.
Joe Edelstein - Stephens, Inc.
Hi. Good afternoon.
Thanks for taking the questions. Last quarter you had been talking about an expense drag, I believe a $12 million number was referenced, just thinking about the full year really associated with the openings and the volume shifts as you open up the new distribution centers.
But I'm curious how did that really play out in the quarter? I mean obviously you had some good SG&A leverage here to offset some of those gross margin declines that everybody has talked about today.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
I think, Joe, just one clarification is, we had talked about that on the fourth quarter call and the 12 million number was the number that we incurred in fiscal 2014. So as we've gotten into fiscal 2015 and we opened the Racine facility towards the end of the third quarter into the fourth quarter of fiscal 2014 and we opened the Hudson Valley facility in the first quarter and Sean can comment on, we've pretty much got the facility almost fully phased at this point.
We've managed to get out of a lot of the off-site that's helped alleviate some of that on a year-over-year basis.
Steven L. Spinner - President, Chief Executive Officer & Director
And it is important to note, Joe, that we've worked very hard not to call out specific expenses related to why it costs so much to open a DC and the drag, because it's so incredibly important to our future. Having the capacity is what's going to enable us to grow at a rate that's faster than the industry and at a rate that allows us to continue to take market share in all these products that we spent the last 15 minutes or 20 minutes talking about.
And so we need to make the investment, we need to incur the cost. It is complicated, difficult, heavy lifting to open a 550,000 square foot building.
Sean F. Griffin - Chief Operating Officer
I'd also say that there is certainly an operational drag associated with getting a new distribution center up to the productivity means that the other more mature distribution centers are hitting. With respect to Racine, we're seeing terrific results and will lap the last phase of business in the Racine DC in September here upcoming.
So we're still way in advance of lapping a year and we're seeing really strong results from a productivity perspective. Hudson Valley of course is just now concluding or completing the end of this period their last phase and the short returns as it relates to both productivity and service look solid.
So the challenge as well is the distribution centers that are moving volume to the new DCs and that generally takes three months or four months of getting the workforce planning model in place. And we certainly are seeing that in the Midwest.
I would say that the distribution centers in the Midwest are really outperforming our expectations in that regard; and we're really just getting started in the East.
Joe Edelstein - Stephens, Inc.
Thanks for the details there. And this would also kind of tie into the next question.
Earlier you spoke about the rollout of the WMS system. You just mentioned some of the workforce planning systems, but where do you stand with some of the other investments as it would relate to this year in particular?
Sean F. Griffin - Chief Operating Officer
With respect to WM, as we just described it, with respect to inventory optimization and demand planning, we are fully enabled, fully implemented, and throughout the broadline centers of UNFI. We are moving directionally towards a single point of contact as it relates to one buyer buying for 16 distribution centers and having a more intimate relationship with the supplier in that regard.
And, frankly, greater productivity from the folks that are pressing the trigger in that respect. We have just rolled out a new real-time alert system that provides our customers with text messaging as it relates to how our drivers are performing against their expected delivery time.
We have some pretty significant transportation economies from our system, both on the inbound transportation side and the outbound transportation side. And, Steve, I think that pretty well covers the current state.
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah.
Joe Edelstein - Stephens, Inc.
That's great. If I can maybe just ask one more question.
Steve, earlier in your comments you mentioned just M&A generally, but in terms of M&A can you give us a sense for how the pipeline looks? I don't know if you've ever given a specific number of NDAs or anything that you might have worked on in the past, but any color there would be appreciated?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. No, I've never given that.
I can tell you that we're working on a handful now. I think that for distribution businesses, fortunately the valuations are still what they've been historically or what we've typically paid historically, which is encouraging.
And so there's quite a few companies that we're looking at. They're great companies and they'd be a terrific part of UNFI.
And as they happen, we'll let you know.
Joe Edelstein - Stephens, Inc.
Sounds great. Thanks for taking the questions.
Operator
Our next question comes from Sean Naughton from Piper Jaffray.
Sean P. Naughton - Piper Jaffray & Co (Broker)
Hi. Good afternoon.
I am just going back to the produce front on Albert's, we talked in the last couple years that – you had called it out as a 20%-plus grower, but has that actually been growing here in fiscal 2015, or is that part of the slowdown in the independent and potentially any part of the conventional channel?
Steven L. Spinner - President, Chief Executive Officer & Director
I wouldn't get into the specifics of Albert's individually, other than I would tell you that our perishable business in Albert's is now growing faster than our organic produce business. And we need to make sure that our produce business, not just organic produce, but our produce business grows at least 20%-plus a year.
Sean P. Naughton - Piper Jaffray & Co (Broker)
Okay. And then on the inflation front, I think you hit 2.15% in the quarter, obviously doing a little bit better on that line item.
Can you just talk about the outlook for the balance of the year and then maybe how much that benefited you in the quarter?
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. I mean to the second part of the question, Sean, that's not something we usually break out.
I mean it doesn't help us in the gross margin percent, although the lift translates down into the operating margin dollars and should help the percent a little bit. A sequential increase of 20 basis points doesn't make a huge change during the quarter.
As it relates to the back half of fiscal 2015 and where we would see that going, I think that there's probably a little bit more of a slight updrift from there, whether it gets to 2.25% or so, or maybe a little bit higher. And looking out to the fourth quarter, I think from there I'd say they could go as low as 2% and as high as 2.5%.
There's not usually a heavy amount of changes that take place in the May, June timeframe at least from a weighted average standpoint, but we often see some good inflation depending on what the particular suppliers do in July.
Sean P. Naughton - Piper Jaffray & Co (Broker)
That's helpful, just a last question. Any change in the mix of the business?
Anything that's material, whether it's more private label going on right now flowing through the DCs? Any comment there on sales mix changes?
Thanks.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
I mean the only thing I would note, and it certainly played into the Tony's numbers in the quarter and some of the pressure on the gross margin, is that certainly in the second quarter there was a lot of turkeys that were sold, which have a much lower gross margin percent even though you do a lot of sales volume off of it. But I think other than typical seasonality where you're doing more volumes in soups in certain categories at this time of year.
And as we move into the spring and the summer, you'll shift to some of the categories that are stronger there and something like the soups and the broths will get a little bit weaker. Nothing that's really a major shift in the trends.
Sean P. Naughton - Piper Jaffray & Co (Broker)
Okay. Thank you.
Operator
Thank you. We have time for one more question.
Our last question comes from Kelly Bania from BMO Capital.
Kelly A. Bania - BMO Capital Markets (United States)
Hi. Good evening.
Thanks for fitting me into the questions. Just wanted to go back to guidance.
It sounds like for the year you've lowered the revenue guidance by about $60 million to $90 million, just kind of using round numbers here. And it sounds like you've called out FX, weather, the out-of-stocks.
Just curious if you could comment, is there any core kind of revenue slowdown that you're incorporating into your new guidance? But your earnings guidance is also the midpoint of the range is still maintaining that kind of same level as before.
So I guess it's a two-part question. One, is there any core impact outside of those factors on the revenue guidance?
And then, two, how do you maintain the earnings per share guidance at a similar rate?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. So, Kelly, I think the issue is – what we did was we took a look again at the Canadian FX for the balance of the year.
We obviously had to take into consideration the customer contract net reduction to sales, the higher supplier out-of-stocks. And I think those were the primary drivers on how we got to the revised guidance and ultimately the revised EPS guidance.
Mark E. Shamber - Chief Financial Officer, Treasurer & Senior VP
Yeah. I think that we saw some strong performance in the first half of the year that helped us get past some of the – as we talk about it and the way we set the guidance, I always use the example of the 10 factors, and we've gotten past a couple of them.
And so that sort of is where we've had some positives on the expense side. But certainly we've seen some headwinds on the sales side, which is leading to some of the adjustment on the high end of the guidance.
Kelly A. Bania - BMO Capital Markets (United States)
Okay. That's helpful.
And then if I could just follow-up on Tony's, obviously inflation has been pretty high in a lot of, I would think a lot of their categories in terms of the meat. And so just curious how you're managing that, how Tony's is managing that, if it's playing out as you expected.
And then I guess just longer term, as you think about Tony's, how much is supply a constraint for growing that business faster as you think about rolling it out to more DCs?
Steven L. Spinner - President, Chief Executive Officer & Director
Yeah. So let me answer the last question first on supply.
The Tony's business covers a pretty broad spectrum of products, whether it be bakery, deli, food service, prepared foods, and then the natural protein and specialty cheese. So if you think about supply in specialty cheese, food service, bakery, et cetera, I don't think we've ever had any significant supply chain issues within those categories.
If you look specifically at natural protein, antibiotic free, hormone free, natural proteins, whether it be beef, pork, poultry, et cetera, the great thing about Tony's is that they've been around for a long time and they've got terrific relationships with the growers. We have some very unique programs specifically with growers of natural protein that gives us the ability to ensure that we'll have supply.
It's a real competitive advantage for us. So supply at Tony's is not something I'm overly concerned about; and we're going to roll it out in a way that ensures that we have the supply to meet the demand.
Looking at inflation or deflation, Tony's does a great job looking at inventory by lot, by product category. So we have a great deal of insight and transparency into whether or not beef is inflating and pork is deflating.
And since we turn the inventories relatively quickly, barring some catastrophe which I don't see happening, we've got a pretty good control over the cost of goods into Tony's.
Kelly A. Bania - BMO Capital Markets (United States)
Great. That's very helpful.
Thank you.
Steven L. Spinner - President, Chief Executive Officer & Director
Okay.
Operator
Thank you. I'll now turn the call back over to our speakers for closing comments.
Steven L. Spinner - President, Chief Executive Officer & Director
Thanks for joining us this afternoon to discuss our second quarter 2015. Have a terrific day.
Operator
Thank you. This does conclude today's teleconference.
You may disconnect your line at this time. Thank you for your participation.